“If a company like that doesn’t have market access and can’t roll over its debt and can’t have enough cash on hand to deal with its obligations, what they’re going to do is they’re going to lay people off. … So, by announcing our facility and including those companies, the ones who actually need the credit… now [have] lots of cash on their balance sheets.”

So, what if free markets do not want to finance companies with shaky operations? The Fed has decided it will effectively nationalize debt markets by removing the risk for investors so that these companies can get the funds to continue operating. In the Fed’s way of thinking, higher and vibrant markets create and save jobs.

To be sure, that is what largely happened after 2008 financial crisis as the central bank began buying bonds under a policy known as quantitative easing. A steep price was paid.

While the economy grew for almost 11 years in the longest expansion on record, annualized growth was below average. This was attributable to an economy that had become less flexible and more reliant on stimulus.

Another consequence was laid out by former Federal Reserve Bank of New York President and fellow Bloomberg Opinion contributor Bill Dudley last week: The Fed’s choices: not have a recovery, have less inequality; or have a recovery with buoyant financial asset prices and more inequality.

The natural disaster response is to do everything possible to ensure the economy is in the best place possible to bounce back. That means saving the banks, ensuring ample liquidity and supporting consumers. Without those measures we would have to resort to barter to get financial transactions done.

“We’re not even thinking about thinking about raising rates,” he told a video press conference Wednesday. “We are strongly committed to using our tools to do whatever we can for as long as it takes.”

The Federal Open Market Committee earlier said it would increase its holdings of Treasury securities and agency residential and commercial mortgage-backed securities “at least at the current pace” to sustain smooth market functioning.

A related statement from the New York Fed specified that the pace of the increase would be about $80 billion a month for purchases of Treasuries and about $40 billion of mortgage-backed securities.

“Acting on mortgage-backed securities and Treasuries underscores their belief that more support is needed,” said Diane Swonk, chief economist with Grant Thornton in Chicago. “The Fed does not see a victory in the employment bounce-back. The risk of deflation is still high and the economy needs more support to heal more fully.”
 

$120 billion a month for the next two years will add nearly $3 trillion to the size of the Fed’s balance sheet. It sounds like a lot but the Fed added nearly $500 billion to its balance sheet in May, so $120 billion is a significant deceleration of support.

Greetings Eoin. Firstly, thank you for the daily commentary and Big Picture Long Term view. They remain the highlight of my weekend and are greatly appreciated. I’m interested in your comments regarding future expectations of inflation.

I hope I’m summarising you accurately, but in essence the thinking runs that the provision of vast amounts of monetary liquidity from Central Banks, combined with Government fiscal spending will at some point come home to roost, and drive up inflation.

If so, why then did we not see an inflation spike following the 2007/08 GFC, where massive (at the time) injections of liquidity and fiscal spending should have delivered the same result?

One view is that we did get inflation following the GFC, just that it showed up in asset prices, not in consumer prices. Equities, bonds, property, luxury goods, art and even later on precious metal prices all benefited from the increased liquidity following 2008. As you have previously highlighted, massive advances in technology, changes to the way we work and live, outsourcing of jobs to lower wage economies, and historically low interest rates have all combined to keep consumer inflation in check over the same period.

Are we to assume that this time is different, and we should expect consumer price inflation at some point, or is it safer to expect history to rhyme and that inflation will again show up in asset prices? If so, should we presume the liquidity will chase better returns and lower P/E multiples of Europe and Emerging Economies this time around? And finally, when investing I’m always conscious of the wise words from the famous British Economist, John Maynard Keynes “The market can stay irrational longer than you can stay solvent”. Spoken nearly a century ago, and never more relevant than today! Many thanks for your time

Thank you for this important email and your kind words. The global response to the 2008 global financial crisis was to bailout the sinners, and pass the bill on to savers. The massive liquidity provided and increases in government debt loads the bailout entailed, saved the global economy. However, it also exacerbated inequality, because, as you highlight the inflation benefitted the holders of financial and physical assets. The coronavirus has laid bare that divergence and it is fanning the flames of left-wing populism.

“You have been calling for some ‘consolidation’ for equity markets for a number of weeks now (which I expected too), but this just hasn’t come to pass. Instead we have seen a relentless charge higher in virtually every market. You’ve stated that it’s liquidity driven which until recently at least, little participation from the professional money managers. Short term yields no longer can be relied upon as a risk indicator with the Fed deliberately compressing yields at the front end. To what extent, if any, has this recent episode viewed the way you look at markets through a charting lense. A despondent sceptic of this rally here, it seems the only winning strategy is just to ride the liquidity train, and rotate one’s positions towards riskier assets (travel, emerging etc) as the new safe havens (tech) reach maturity.

Thank you for this question which may be of interest to other subscribers. In a response to a similar email on May 12th. I led with this observation. “The best time to buy is following a significant pullback. The next best opportunity is following the first reaction from an important low. The next will be when a breakout to new highs occurs.

The worry about China is the sustainability of its debt-fuelled economic growth. The basic weaknesses of the Eurozone are that it still doesn’t have a backstop for its rickety banking system and that it lacks a shared fiscal capacity; what’s more, Italy’s finances are so weak that they continually threaten to upset European solidarity. In the US, the national institutions of economic policy actually work: they demonstrated this in 2008 and are doing so again now. The Fed and the Treasury exert a huge influence not only over the US economy but the entire global system. The question is how they stand in relation to a profoundly divided American society and how their technocratic style of policymaking is received by the know-nothing nationalist right wing of the Republican Party and its champion in the White House.

Over recent years, each of these weaknesses has at various times seized the attention of the fund managers and business leaders who direct global business, and the experts and technicians who advise them. It isn’t a secret that China’s debt bubble, Europe’s divisions and America’s irrational political culture pose a challenge to the functioning of what we know as the world economy. What caused the panic last month was the realisation that Covid-19 has exposed all three weaknesses simultaneously. Indeed, in Europe and the US the failure of government has been so severe that we now face a public health catastrophe and an economic disaster at the same time. And to make matters worse, Donald Trump appears tempted to juggle the two.

This article decries the reliance of economies on central banks largesse. I think most of us have some sympathy with the fact that the swamping of asset markets in liquidity is not the most ideal scenario because of the risk of mispricing and misallocation of resources. However, it is the reality we are dealing with.

Hello Eoin, if "liquidity trumps everything else" and assuming that governments worldwide will continue New Monetary Theory with massive deficit spending financed by monetization by central banks at essential cero or negative real interest rates, then this wall of liquidity should further propel the ongoing general "melt up" of stock and debt markets allowing a prolonged, demand driven risk-on rally.

In this case precious metals would lose their supposed unique "safe haven" status/advantage until such time that serious inflation or stagflation or a likely collapse or reset of the monetary system becomes visible to a large part of investors - if at all.

Until such (far-off?) day of reckoning, precious metals would neither be needed as protection against systemic crisis as "NMT would be working beautifully" nor for return purposes as stocks and other assets will be pushed up by abundant liquidity. For investors in precious metals/mining stocks the critical questions therefore is:

How long will stocks and other financial assets outperform and "unneeded" precious metals correct or even collapse? Looking back at 2011 and onwards, precious metals collapsed and stayed low until mid-2019 whilst continuing QE1- QEn (the predecessor for NMT) around the world made stock and debt markets boom for the next 9(!) years.

As this time round central banks and governments "shot before asking" by IMMEDIATELY providing unlimited liquidity and fiscal deficits instead of slowly finding and providing relief to financial markets as they did in 2008-2012 and onwards, the best part of the run-up in precious metals may be behind us and the place to invest is in stock markets without much regard to old fashioned valuation discipline.

Most of the performance of the past 10 years has been by way of a multiple expansion - why not have the S&P 500 trade at 25+ trailing earnings if real interest rates are negative and there is a worldwide "Powell/central bank put" as a guarantee against any serious losses?

My questions to you: 1. Why stay invested in PMs NOW and risk a serious corrections/collapse in PMs? 2. When will investors at large recognize - if at all (?!) - that NMT is and will be seriously debasing the currency and nominal values of all assets and that PMs are relatively better or at least, competitive investments/stores of value than say quality stocks (which pay at least a small dividend)?

Thank you for reflecting on the above and sharing your views with the collective. All the best, B

Thank you for this summary of the questions many investors are asking. The rationale behind any bubble is valuations don’t matter. The evolution of ETFs as trackers of indices is the clearest evidence anyone might wish for that this trend is already well underway. Market cap weighted indices are closet momentum strategies so tracking them turns everyone into a momentum investor.

While the U.S. President Donald Trump’s speech Friday was heated in rhetoric, it lacked specifics around measures that would directly impact the city. He announced the U.S. would begin the process of stripping some of Hong Kong’s privileged trade status without detailing how quickly any changes would take effect and how many exemptions would apply.

“Trump’s comments gave no immediate measures on Hong Kong and leave room for negotiations with Beijing,” said Castor Pang, head of research at Core Pacific-Yamaichi International. “Trump’s comments have eased investors’ concern about the impact of potential sanctions on the Hong Kong economy.”

With significant domestic challenges the Trump administration has probably concluded that now is not the best time to further escalate tensions with China to the point where they are irredeemable. That has helped to support the Chinese markets.

There’s no sign yet that the stimulus package is anything more than a one-off response to an unprecedented crisis. Even so, investors are viewing it with a bullish lens. “It’s completely new territory for the European Union,” Michael Strobaek, global chief investment officer at Credit Suisse Group AG, said in a Bloomberg TV interview. “And that would make the European Union as an investment much more attractive for global investors.”

That would represent a shift for European markets, which have been unpopular compared with the U.S. For example, European equity funds suffered from outflows more than any other major region this year, losing about $31 billion, according to data from EPFR Global and Bank of America Corp.

Bond Buyers Toast EU Ambition in Moment They Were Waiting for Gary Kirk, a money manager at TwentyFour Asset Management in London, which oversees 17.8 billion pounds ($22 billion), is sticking with his U.S. bias. “It’s a bit early to get overly excited,” said Kirk, who’s waiting to see how the details are hammered out and whether it will pass muster with more austere governments in north Europe.

The Eurozone’s so-called sovereign wealth crisis arose because investments creditor nations’ pension funds made in private enterprises in the Eurozone’s periphery went bad. That was blamed on lax regulation and egregious behaviour with the result respective governments were forced to absorb private sector debts. That blew out sovereign debt ratios and caused a crisis. The response to the coronavirus could not be more different. Coupled with a willingness to loosen fiscal constraints, there is now also willingness to break the taboo of direct transfers to weaker nations. That is significant development even if it proves transitory in the near term.

The coronavirus outbreak in Italy has struck overwhelmingly among the nation’s older population and those with preexisting medical conditions, according to the national health authority.

Almost 96% of the country’s virus fatalities had previous medical conditions, data from Italy’s ISS health institute show. The ISS, which publishes a range of studies on the outbreak including a detailed weekly report, confirms a trend seen since the beginning of the emergency, with the average age of Italians who’ve died from the virus at around 80.

“The latest numbers show that new cases and fatalities have a common profile: mostly elderly people with previous illnesses,” ISS chief Silvio Brusaferro said at a news conference Friday.

The coronavirus pandemic forces us to engage in some grizzly calculus to try and figure out how markets are likely to respond to unfolding events. The reality of aging is we develop chronic conditions, one of which is likely to eventually kill us. Whether that is high blood pressure, heart disease, cancer or diabetes, aging contributes to the ill effects of all these ailments.

The Swiss National bank recently published their schedule of public investments for the most recent quarter ending in March: https://www.sec.gov/Archives/edgar/data/1582202/000158220220000002/xslForm13F_X01/InfoTable_Q12020.xml.

After examining their portfolio mix, just about 4% of the portfolio is invested in the Materials segment, which encompasses 175 positions totaling USD $4.5B. Of this, 24 positions are in gold mining stocks totaling USD $1.216B and 9 are in silver stocks totaling USD $26M.

The Swiss National Bank has followed an iconoclastic policy of investing directly in companies for much of the last decade. That makes a lot of sense since it helps to accrue positions in income producing real world assets which either pay dividends or retain income for further growth. They made significant purchases of US tech stocks about a decade ago and positions in gold mining shares today signal an appreciation for both value and thematic investing.

Bank Indonesia is using bond purchases to support the rupiah and help fund the government’s Covid-19 response. Too much quantitative easing, though, could backfire and fuel worries about the accommodation of unfettered government spending.

Critical for reassuring investors, in our view, is that the central bank stick to its pledge to cap bond purchases in the primary market at 25% and intervene only as a last resort. If these promises are broken, QE could weigh on the rupiah like a pair of cement shoes.

Emerging market central banks embarking on QE might already be skating on thinner ice than peers in developed markets. Bank Indonesia, for one, has a shorter track record for demonstrating independence from political interference.

The relative strength of the Rupiah is a standout relative in Asia and is mirrored by the stability of the Philippine Peso. Both countries have deployed quantitative easing to support their respective bond markets and short up their currencies.

Less than 24 hours after Angela Merkel and Emmanuel Macronlaid out a radical plan that would see the European Union collectively finance its response to a virus-induced recession, countries were already expressing disapproval, threatening to doom the nascent proposal.

The German and French leaders on Monday threw their weight behind a plan to allow the EU’s executive arm issue 500 billion euros ($548 billion) of bonds, with the proceeds going to help member states affected most by the pandemic. Controversially, recipients of the funds won’t need to pay the EU back and the securities would be financed collectively. That means richer countries, like Germany, would be bankrolling poorer ones.

Angela Merkel arrives to address a joint press conference with Emmanuel Macron, attending via video link, in Berlin, on May 18.The plan represents a remarkable about-face for Germany, and the proposal, which needs unanimous approval by all 27 members of the EU, faces stiff headwinds from the bloc’s more frugal members.

“We still have to convince other member states, four in particular: Austria, Denmark, Sweden and the Netherlands,” French Finance Minister Bruno Le Mairesaid on Tuesday. “And we mustn’t hide the fact that it will be difficult.”

Austrian Chancellor Sebastian Kurz immediately threw cold water on the Franco-German plan, saying that he had consulted with his Danish, Dutch and Swedish counterparts, and that they remained opposed to any money being given to fellow countries in the form of grants. Any funds would have to be repaid by the beneficiaries, he said.

Europe needs to come up with a clear vision for its existence or it will not survive. The founding rationale for the EEC was to put age-old animosities aside and to concentrate on trade. Everyone making money and delivering improving standards of living would help to foster peace. That was successful enough to encourage further cohesion.

The office of Australian Trade Minister Simon Birmingham declined to comment. When asked about the list, China’s foreign ministry didn’t address the specifics but said the government “has always sought to find common ground while putting differences aside, cooperate to achieve win-win results and will not harm others to benefit oneself.”

“We hope the Australian and Chinese side can meet in the middle, take more measures to improve bilateral relations and deepen mutual trust, and provide favorable conditions and atmosphere for practical cooperation in various areas,” the ministry said.

Australia’s China Addiction Leaves It Vulnerable to Trade Spat

Speaking earlier at a briefing in Beijing on Tuesday, Chinese foreign ministry spokesman Zhao Lijian said China would back a resolution at the World Health Assembly later Tuesday that calls for a “comprehensive assessment” of the pandemic that differs from “Australia’s earlier proposal of a so-called independent global review.”

“We suggest the Australia side to go through the text carefully,” Zhao said. “If Australia is willing to change its course and give up the political manipulation of the pandemic, we will welcome that.”

Asking for an independent review of the origins of a virus which has ravaged the global economy is reasonable. That’s particularly true when it comes to trying to figure out where the next pathogen is likely to arise from and acting to prevent it. China has already razed and sanitised the wet market in Wuhan. That was completed in February so they have no intention of allowing an investigation.

Now, imagine that, rather than shoring up markets solely via guarantees, the Fed could push most short-term interest rates across the economy to near or below zero. Europe and Japan already have tiptoed into negative rate territory. Suppose central banks pushed back against today’s flight into government debt by going further, cutting short-term policy rates to, say -3% or lower…

,,,A number of important steps are required to make deep negative rates feasible and effective. The most important, which no central bank (including the ECB) has yet taken, is to preclude large-scale hoarding of cash by financial firms, pension funds, and insurance companies. Various combinations of regulation, a time-varying fee for large-scale re-deposits of cash at the central bank, and phasing out large-denomination banknotes should do the trick.

This is the economic equivalent of “use it, or lose it” when applied to money. The idea of forcing banks, pensions and insurance companies to invest is fine on paper but takes no account of the credit worthiness of the assets being purchased. The time to institute this kind of policy is after a major decline when bankruptcies have washed away high leverage and investors need an incentive to speculate. At today’s valuations, where asset prices have already been rising for 12 years, forcing speculation is a recipe for an asset bubble of epic proportions.

I can only agree with you having worked from home since the early 2000s (maybe you remember my office at home when you were with Bloomberg in Luxembourg). It fits well with businesses like ours where financial data et al. are immaterial or small ones focused on selling on internet. It is more difficult for activities where in situ interpersonal relationship is more important (journalism for example).

However, the time spent in endless and useless meetings where their organization or required presence has more to do with politics than business. Undoubtedly, working from home will increase productivity and reduce cost due to less space required at offices. As for retail, this should affect office prices.

Thank you for sharing your experience. I’ve always thought of commuting as the greatest waste of human productive capacity imaginable. Spending half an hour in the morning with my head in someone’s else armpit was never my idea of fun. If remote working becomes more acceptable, it will result in a significant loss of income for cities from corporate taxes and ancillary business income declining. That is an obvious risk in cities where property prices are at historic peaks.

“The consensus out there seems to be: ‘Don’t worry, the Fed has your back,’” said Druckenmiller on Tuesday during a webcast held by The Economic Club of New York. “There’s only one problem with that: our analysis says it’s not true.”

While traders think there is “massive” liquidity and that the stimulus programs are big enough to solve the problems facing the U.S., the economic effects of the coronavirus are likely to be long lasting and will lead to a slew of bankruptcies, he said.

“I pray I’m wrong on this, but I just think that the V-out is a fantasy,” the legendary hedge fund manager said, referring to a V-shaped recovery.

Druckenmiller’s remarks are among the strongest comments yet by a Wall Street heavyweight on the bleak outlook facing the U.S. They also stand in contrast to the optimism that has pushed the S&P 500 Index to rally almost 30% since its March low even as the pandemic has brought the economy to a standstill, seized up credit markets and ended the longest bull market in history.

The damage spurred the Federal Reserve to unveil a raft of emergency lending programs and Congress to unleash almost $3 trillion in stimulus funds. But those programs aren’t likely to spur future economic growth, Druckenmiller said. “It was basically a combination of transfer payments to individuals, basically paying them more not to work than to work,” he said. “And in addition to that, it was a bunch of payments to zombie companies to keep them alive.”.

Have we just seen an impressive countertrend rally in an evolving medium-term bear market, or are we on the cusp of seeing an additional down-leg which could see new lows posted? It’s a multi-trillion Dollar question but another related one is how are investors responding to Jay Powell’s statement today.

Then came World War I when warring countries ran enormous deficits that were funded by central banks’ printing and lending of money.  During the war years gold was international money as international credit was lacking because trust was lacking.  Then the war ended, and a new monetary order was created with gold and the winning countries’ currencies, which were tied to it, at the center of that new monetary order. 

Still, in 1919-22 the printing of money and devaluations of several European currencies were required as an extension of the debt crises of those most indebted, especially those that lost World War I.  As shown this led to the total extinction of the German mark and German mark debt in the 1920-23 period and big devaluations in other countries’ currencies including the winners of the war that also had debts that had to be devalued to create a new start.

With the debt, domestic political, and international geopolitical restructurings done, the 1920s was a boom period, which became a bubble that burst in 1929.

In 1930-45, 1) when the debt bubble burst that required central banks to print money and devalue it, and then 2) when the war debts had to increase to fund the war that required more printing of money and more devaluations. 

At the end of the war, in 1944-45, the new monetary system that linked the dollar to gold and other currencies to the dollar was created, and the currencies and debts of Germany, Japan, Italy, and China (and a number of other countries) were quickly and totally destroyed while those of most winners of the war were slowly but still substantially depreciated.  That monetary system stayed in place until the late 1960s. 

The purchasing power of fiat currencies is rapidly being debased. That is helping to support the nominal prices of stocks, property, gold and bonds. The $4 trillion surge in the total assets of central banks over the last couple of months has supported prices for just about all asset classes. The best performing assets have been those that have historically benefitted from deploying free abundant capital to fuel growth since 2009.

Regulators on both sides of the Atlantic have spent the better part of three years trying to kill the
London interbank offered rate. Now, they’re looking to it once again to underpin hundreds of billions of dollars in loans as they seek to rescue their economies.

U.S. policy makers last week changed tack and turned to Libor as the benchmark for their $600 billion Main Street Lending Program, which will buy debt from potentially hundreds of companies. The move came a day after U.K. officials granted banks a six-month extension to keep issuing loans tied to the beleaguered reference rate, which is supposed to be phased out by the end of 2021.

The timetable to do away with the benchmark linked to trillions of dollars of financial assets appears increasingly at risk as central bankers lean on Libor to help expedite their massive stimulus efforts. As they lend legitimacy to the much-maligned rate, some market watchers say it’s highlighting the shortcomings of replacements, while others note it could ultimately lead to a more difficult transition down the road.

“The crisis does make it tougher and it will put a lot more time pressure on meeting the deadline,” said Darrell Duffie, a finance professor at Stanford University who has written extensively on Libor. He called the Fed’s decision, while necessary, “very unfortunate” and a missed opportunity to pivot
away from the benchmark, adding that it’s a sign that U.S. lenders “were not getting ready” for the transition. 

When I originally took regulatory exams back in 2003 there were quite a few areas of the financials markets in London that relied on gentleman’s agreements for regulation. Mergers & acquisitions, the law society, the gold and silver market and most of all LIBOR were all self-regulated markets. One of the biggest changes that followed the credit crisis was to try and exert greater control over the organs of the financial system.

Eurostat reports that there was roughly €2 trillion of outstanding German government debt at year end 2019. ALL German government bills (Bubills) and bonds (Bunds) have a negative yield, which simply means that bondholders are prepared to pay the German government an annual fee to lend their money to the German Government, be it at -0.65% for very short term debt to -0.52% for 10yr debt to -0.13% for 30 year debt.
Did the yesterday’s German Constitutional Court ruling just change the risk/reward for investors in European government bonds?
 
The current 10 year Bund yield of -0.52% can be broken down into two components:

+ 0.48% Inflation Breakeven Rate.
- 1.00% Real Yield. 

The German constitutional court’s ruling that central bank purchases are potentially illegal is mostly an internal affair. The extent to which the ECB is subject to German law is highly debatable but pressing that point has political consequences for any country. There remains ample room for legal two-stepping to avoid any official censure which is why the bond market has brushed away any concerns.

Almost every major crisis and recession has resulted in lasting implications. The 1973 oil crisis ended the Bretton Woods system and brought about the regime of floating currencies and exchange rate volatility. September 11 permanently changed the way we travel and raised the level of security in public settings and airports. Unprecedented monetary easing after the 2008 Great Financial Crisis further propelled the unlikely continuation of the 30-year rally in government bonds and facilitated the resurgence of tech stocks and credit markets. The Global Covid-19 Crisis will also leave its permanent imprints on consumers, markets and economies. Although we are only a few months into the crisis, it is key to look forward to the next economic cycle and ask: what are the structural changes created by the Covid-19 outbreak and who will be the winners and losers?

For companies, the focus will shift to building resilience
As the virus outbreak results in demand and supply shocks unprecedented in terms of speed, depth and breadth, many companies face tremendous pressure, and this will have a lasting impact on risk perception.  Companies will turn more cautious and focus on building resilience in terms of their business strategies and balance sheets, and shareholders will expect management teams to take steps to ensure that the business is strong enough to take the next big shock.

A link to the full report is posted in the Subscriber's Area.

Consumers are wondering about what the trajectory for their earnings are going to be. Nobody knows what the outlook for their businesses is likely to be in the aftermath of the lockdowns or how long recovery is going to take. There is a temptation to think corporations are going to be as cautious as individuals.

“We’ve come through the peak, or rather we have come under what could have been a vast peak, as though we have been going through some huge alpine tunnel,” Johnson said. “And we can now see sunlight and the pasture ahead of us, and so it is vital that we do not now lose control and run slap into a second and even bigger mountain.”

And

“As part of coming out of the lockdown, I do think face coverings will be useful both for epidemiological reasons and giving people confidence it’s safe to go back to work,” Johnson said. “We will be saying a lot more next week and in the coming weeks about how and when we propose to unlock the various parts of the U.K. economy.”

The government has announced more than 60 billion pounds ($75 billion) of direct aid to companies and individuals to help them weather the pandemic, and offered 330 billion pounds of loan guarantees. The Office for Budget Responsibility on Thursday said the government’s virus response has cost almost 105 billion pounds in the current fiscal year.

Asked whether the government would need a new period of austerity, including cuts to public services in order to restore the country’s finances, Johnson rejected the approach.

“I think the economy will bounce back strongly, I think that this government will want to encourage that bounce back in all kinds of ways,” he said. He added that he’d “never particularly liked” the term “austerity,” saying “it will certainly not be part of our approach.”

Very few mainstream parties have been able to evolve enough to appeal to the growing populist fringes of political discourse. The Conservatives in the UK and Republican’s in the USA have been able to co-opt the revolutionary agenda by embracing fiscal easing.

I am really enjoying Mr Treacy’s comments of the day and look forward to it every morning.

Mr Treacy in today’s update mentioned key sectors that have the most chance of trending up over the next decade – and alluded to a couple shares (e.g. Google and Apple) that may make it to dividend aristocrat list in 10-15 years.

It would be great if Mr Treacy could provide a list of top 20-50 shares that have steadily increased dividends over the last 10 years and based on trends have the highest probably on making it to dividend aristocrat list in 10-15 years.

Thank you for your kind words and this email which may be of interest. I mentioned in last night’s audio that technology companies are often among the most reliable in increasing their dividends once they eventually decide to initiate payments. That’s been true of companies like Apple and Microsoft but Google and Amazon do not pay dividends so even if they started today it would be 2045 before they become dividend aristocrats. For a list of companies with solid records of dividend increases, but which do not yet fulfil the criteria to be dividend aristocrats, take at a look at the dividend champions and contenders sections of the International Equity Library. 

In Xiangcheng, a district in the eastern city of Suzhou, the government will start paying civil servants half of their transport subsidy in the digital currency next month as part of the city’s test run, according to a government worker with direct knowledge of the matter.

Government workers were told to begin installing an app on their smartphones this month into which the digital currency would be transferred, the worker said.

Civil servants were told that the new currency could be transferred into their existing bank accounts, or used directly for transactions at some designated merchants, the person said.

China is ahead of many other countries in preparing the launch of an official digital currency. In recent years, the use of traditional paper bills and cash has declined sharply, and smartphone payments have become so ubiquitous that many Chinese people, particularly younger urban dwellers, no longer carry their wallets or cash for shopping. Instead, they use Tencent Holdings Ltd. ’s WeChat Pay and Alipay, operated by Ant Financial Services Group, an affiliate of Alibaba Group Holding Ltd.

Parallel currencies are an oddity which highlight a government’s desire to fully control the ability of consumers to spend their own cash. The ultimate aim of these kinds of moves is to separate the use case for money so different units can be used for different purposes. The façade of wishing to curtail money laundering or terror financing is ubiquitous to all governments and this is a trend which has global appeal for heavily indebted countries.

A link to the full report is posted in the Subscriber's Area.

The US consumer is holding up for good reason. With an additional $600 a week in unemployment benefits, on top of the $1200 sent to 90% of the population, many people are making more money than if they were working.

Thanks for the regular coverage. I have been a subscriber for a long time, and find this really the only voice of sanity and unbiased views. So, thanks. Could you elaborate on the statement you mentioned where the bond investors should be cautious because / if majority of the bonds are held by the government. Also, could you kindly help think through and elaborate how the fed would deal with the following - exits from the agency papers the Fed is buying. Is there any limit on how much the Fed can buy in this program? - how will the fed deal with losses in the Junk bond ETFs if there were to be defaults? Are the losses guaranteed b6 the Treasury?

Thank you for your kind words and long-term support. Governments very seldom pay back their debt. Instead they are more interested in the cost of servicing the total relative to other spending priorities. As interest rates have trended lower, the cost of servicing has followed, even as the overall quantity of debt has increased. That has created a situation where if interest rates rise, for any reason, the ability of the US government to fund itself will be impaired.

The quicker the printing of money to fill the debt holes, the quicker the closing of the deflationary depression and the sooner the worrying about the value of money begins.  In the 1930s US case, the stock market and the economy bottomed the day that newly elected President Roosevelt announced that he would default on the government’s promise to let people turn in their money for gold, and that the government would create enough money and credit so that people could get their money out of banks and others could get money and credit to buy things and invest. 

This latest book by Ray Dalio is well worth taking the time to read. Chapters are being released weekly via LinkedIn. His focus on governance, hard money and the credit cycle will be familiar to veteran subscribers but it is always refreshing to hear an additional perspective and not least because of the study of long-term cycles which he throws fresh light on.

Australia has announced they are increasing petroleum reserve stocks. Small steps in the global oil market. We have lots of gas not much Oil. Government argument oil prices are low. Think I can see political / defense US / Australian ambitions in this move.

The Governor of the RBA made a speech a few months back the RBA will support all local banks. That investors should feel confident about the security of their bank deposits and securities. Can I trust these comments? I almost fell out of my chair when Glenn Stevens made this statement

Thank you for this email which may be of interest to other subscribers. It makes sense that Australia should build up an oil reserve when prices are cheap. It certainly beats doing it when prices are high and a significant reserve is a geopolitical imperative during a time when stress between the great powers of our day is only likely to increase.

Good afternoon Eoin, I am enjoying the daily video and the written commentaries. Regarding your medium and long-term view that the price of gold is and will be reflecting the increasing and competitive debasement of currencies, but that presently gold is in an overbought phase, please explain what you would consider the maximum drawdown in gold to undo the overbought situation.

Would that imply that gold should e.g., give up about $170 (10%) and reach approximately $1530 which I believe is the 200 SMA? Same question for silver. In what time frame do you expect the undoing of the overbought situation for gold (and silver) to happen? Days, weeks, months? How quickly would the bull market resume?

It seems that the script of the last financial crisis is happening at 4-5 times the speed of 2008/2009...) What likelihood do you see that governments and central banks in the end will intervene (on an international scale) to either confiscate or prohibit the private holding of gold and silver and/or otherwise make sure that the nuisance of gold and silver as uncontrolled non-fiat money disappears? Roosevelt and others like Hitler, Soviet Union already proved that this can be successfully implemented ...Second addition to my first message/questions: To what extent did the rally in stocks trigger yesterday's and today's downdraft in the PM sector? Thank you!

Thank you for this series of questions which may be of interest to subscribers. The mantra that delivers the best returns is “don’t pay up for commodities” and that applies even in a bull market. Gold and the precious metals generally are prone to volatility and often posted failed upside breaks. Chasing the market higher will only work on the relatively rare occasions when the trend accelerates; whereas more often than not precious metals trends adopt a sawtooth profile.

A link to the full report is posted in the Subscriber's Area. 

Let’s set aside for the moment questions of timing and think about what changes we can expect to be durable from the virus-induced recession.

The first thing that springs to mind is a loss of income which will take a while to recover. For some that will be quite soon, for others who need to find a new job it will take longer. As we go from full employment in many countries to something less that necessarily represents lower growth overall and by extension lower corporate earnings.

A link to the full report is posted in the Subscriber's Area. 

The idea of Modern Monetary Theory scandalised investors a year ago but very much the reality today as central banks fall over themselves to accommodate the efforts of governments to spend their way out of the trouble. My contention since early this year was the coronavirus will be temporary but the monetary and fiscal effects will be very long lasting.

“This is a crisis so easily correctable,” he said. “The GSEs [Fannie Mae and Freddie Mac] for years have always assured the servicing community that in the event of a major credit event, they’ll be there to make sure they provide the liquidity. From what we are hearing, and we can’t verify it, the FHFA director instructed the GSEs not to set up a liquidity or advance facility.”

When asked for a response to the industry plea, Calabria on Monday declined to comment.

Both Stevens and Bray said that because of this new and momentous risk in the mortgage market, it is suddenly much harder for borrowers to get new loans or refinance current mortgages. Wells Fargo is already placing restrictions on jumbo lending to its customers.

“It’s just going to create more fear within the nonbank servicing sector. The banks that service them are going to start to not lend,” said Bray. “Ultimately that impacts homeowners. They won’t be able to be served because these companies will be in the middle of a crisis. We’ve seen a lot of businesses close their doors, and if you start closing the doors of servicers, you’re impacting people’s lives much more than other sectors. You’re talking about their homes. It’s the largest asset they have.”

The buck has to stop somewhere. If homeowners are given a free pass on skipping mortgage payments that simply pushes the onus for making payments up the line to servicers who need to pay mortgage bond coupons. When major tenants like H&M or Primark refuse to pay rents, it puts a great deal of pressure on landlords who still have mortgage payments to meet. I have not seen any commentary yet on how much forbearance will be made available to commercial property REITs.

Even as the number of jobless claims soar, companies around the globe are capitalizing on investors’ thirst for debt by moving ahead with larger and riskier bond offerings.

T-Mobile US Inc. is selling $19 billion of bonds in the year’s second-largest sale, while the high-yield market is coming back to life with three new deals, including one from Tenet Healthcare Corp. T-Mobile and Tenet announced their debt offerings just ahead of what turned out to be 6.6 million more Americans applying for unemployment benefits, double last week’s record. More borrowers like VMware Inc. and Ross Stores Inc. came forward after that, on top of 17 in Europe.

Issuers are seeing a resurgence in risk appetite, as massive demand for new issues has allowed companies to go bigger and bolder with their debt offerings. Cruise line operator Carnival Corp., though technically investment-grade rated, was able to draw massive demand from high-yield investors for a bond sale that ended up being larger and cheaper than expected. Junk bond funds are expected to see a record inflow this week when Refinitiv Lipper reports data later Thursday, reversing six straight weeks of outflows.

There are two important factors at work in the investment grade market. The first is interest rates might be zero, economies under duress and anxiety high but investors still need to capture yield and cashflows. The second is the Federal Reserve is backstopping purchases of investment grade debt so investors now have a measure of security in purchases that did not exist two weeks ago.

Many thanks for your continuing high-quality service, exemplified by the comprehensive Income ITs spreadsheet you produced yesterday. It will be invaluable for Private Investors such as myself. On a separate topic, do you have any views on the banks in the light of the suspension of dividends? In particular, I see that HSBC shares are approaching chart support from 1997-98 and 2016.

Thank you for this question. There is no denying that bank shares have declined significantly so it is logical to question whether they are close to a low. With dividends being eliminated, a rise in defaults inevitable, a moratorium on buybacks, and tight margins from low interest rates the big question is whether the bad news has been priced in.

A link to the full report is posted in the Subscriber's Area.

Corporate defaults are inevitable considering the leverage in the system and the sudden disappearance of revenue for many companies. Where companies had borrowed heavily to fund acquisitions or buybacks, they now have to make debt payments with no, or much reduced, incoming revenue. That is an obvious problem particularly affecting some of the most indebted tourist, auto and aeronautics companies. The biggest challenge for banks will be in how exposed they are to small companies on a local level because many are now in dire financial straits.

The coronavirus crisis has transformed the fiscal landscape at a stroke. Britain was on course for a budget deficit of 55 billion pounds in the fiscal year starting April. Now, according to the Institute for Fiscal Studies, borrowing could be as much as 200 billion pounds as an economy on course to shrink at least 5% this year hammers tax revenue and drives up spending on welfare.

That could leave the deficit just below the 10% reached in the aftermath of the financial crisis and push up already elevated debt levels.

The chancellor announced his first economic package to deal with the outbreak when delivering the budget on March 11, unveiling 12 billion pounds of measures to mitigate the effects of the outbreak on the economy.

As evidence mounted that the crisis was snowballing, he followed up with a 350-billion pound stimulus package comprising government-backed loans as well as 20 billion pounds of grants and tax cuts for struggling companies.

Then, last Friday, he announced 7 billion pounds of extra welfare spending and said the government would pay 80% of salaried employees’ wages up to a maximum of 2,500 pounds a month -- a plan Bloomberg Economics estimates will cost 17.5 billion pounds.

Announcing further details of the job-retention program today, the Treasury said the government will also cover employers for the National Insurance and minimum auto-enrolment pension contributions of furloughed workers, saving firms 300 pounds a month per employee on average.

The trouble with the coronavirus is not so much in the mortality rate but in the speed with which it is spreading. Overloading hospitals with scarce resources and scary reports of tens of thousands dying has put a great deal of pressure on the economy. However, it is also worth considering that despite the scale of the challenge faced in Italy, they have seen the peak in the infection growth rate. That suggests the problem is unlikely to get worse.

But it’s the alphabet soup of new programs that deserve special consideration, as they could have profound long-term consequences for the functioning of the Fed and the allocation of capital in financial markets. Specifically, these are:

CPFF (Commercial Paper Funding Facility) – buying commercial paper from the issuer.
PMCCF (Primary Market Corporate Credit Facility) – buying corporate bonds from the issuer.
TALF (Term Asset-Backed Securities Loan Facility) – funding backstop for asset-backed securities.
SMCCF (Secondary Market Corporate Credit Facility) – buying corporate bonds and bond ETFs in the secondary market.
MSBLP (Main Street Business Lending Program) – Details are to come, but it will lend to eligible small and medium-size businesses, complementing efforts by the Small Business Association.

To put it bluntly, the Fed isn’t allowed to do any of this. The central bank is only allowed to purchase or lend against securities that have government guarantee. This includes Treasury securities, agency mortgage-backed securities and the debt issued by Fannie Mae and Freddie Mac. An argument can be made that can also include municipal securities, but nothing in the laundry list above.

So how can they do this? The Fed will finance a special purpose vehicle (SPV) for each acronym to conduct these operations. The Treasury, using the Exchange Stabilization Fund, will make an equity investment in each SPV and be in a “first loss” position. What does this mean? In essence, the Treasury, not the Fed, is buying all these securities and backstopping of loans; the Fed is acting as banker and providing financing. The Fed hired BlackRock Inc. to purchase these securities and handle the administration of the SPVs on behalf of the owner, the Treasury.

In other words, the federal government is nationalizing large swaths of the financial markets. The Fed is providing the money to do it. BlackRock will be doing the trades.

This scheme essentially merges the Fed and Treasury into one organization. So, meet your new Fed chairman, Donald J. Trump.

My rule of thumb for plotting a route through the market mayhem of the last six weeks has been to take what people expressed disquiet about last year and amplify it. Modern Monetary Theory has gone global even quicker than the coronavirus. It is now the de facto economic policy for much of the world and has seen just about every government concede to the requirement for fiscal laxatives.

“The Fed has effectively shifted from lender of last resort for banks to a commercial banker of last resort for the broader economy,” said JPMorgan Chase & Co. chief U.S. economist Michael Feroli.

The coming rain of credit -- historic in both size and scope -- will be made possible by $454 billion set aside in the aid package for Treasury to backstop lending by the Fed. That’s money the central bank can leverage to provide massive amounts of financing to a broad swathe of U.S. borrowers.

“Effectively one dollar of loss absorption of backstop from Treasury is enough to support $10 worth of loans.” Fed Chairman Jerome Powell said in in a rare nationally-televised interview early Thursday morning. “When it comes to this lending we’re not going to run out of ammunition.”

He told NBC’s “Today” show that the Fed was trying to create a bridge over what may well be a substantial decline in the economy in the second quarter, to a resumption of growth sometime in the latter half of the year.

“It’s very hard to say precisely when that will be,” he said. “It will really depend on the spread of the virus. The virus is going to dictate the timetable here.”

While the Fed can help by keeping interest rates low and ensuring the flow of credit, “the immediate relief” for Americans will come from the Congressional aid package, Powell said. The bill includes direct payments to lower- and middle-income Americans of $1,200 for each adult and $500 for each child.

Combined with an unlimited quantitative easing program, the Fed’s souped-up lending facilities are set to push the central bank’s balance sheet up sharply from an already record high $4.7 trillion, with some analyst saying it could peak at $9-to-$10 trillion.

The new stimulus plan is providing money to 90% of consumers, but also to corporations, municipals and both the government and corporate bond markets. In terms of both size and scope the package is designed to provide a life line to all markets and, so far, it is having the desired effect.

In addition to Troubled Asset Relief Program (TARP)-like programs to assist companies and industries, there is no other choice but for the Fed to step up to keep markets functioning. That’s why I’ve been saying that we would need to see about $4.5 trillion of quantitative easing (QE) before everything was resolved. This is in addition to emergency lending through the discount window, dealer repo operations, central bank liquidity swaps, and the Commercial Paper Funding Facility, Primary Dealer Credit Facility, and Money Market Mutual Fund Liquidity Facility. That would take the Fed’s balance sheet to at least $9 trillion, or about 40 percent of last year’s gross domestic product (GDP). That might sound like an alarmingly big number, but to put it in perspective the Bank of Japan’s balance sheet is the equivalent of 105 percent of GDP. So, the United States is a piker on QE.

The Fed has now entered its ‘at all costs’ phase of assistance. I will freely admit my initial estimate from six months ago the Fed’s balance sheet would reach $6 trillion is now wildly overoptimistic. Considering the extent of the challenge and the desperate need for liquidity $10 trillion is probably a more likely number for the size of the Fed’s balance sheet.

The comment suggested his distaste for the practice predates the coronavirus outbreak and echoed criticism from Democratic presidential candidates who have long viewed buybacks as a waste and social ill.

“When we did a big tax cut and when they took the money and did buybacks, that’s not building a hangar, that’s not buying aircraft, that’s not doing the kind of things that I want them to do,” Trump said on Friday. “We didn’t think we would have had to restrict it because we thought they would have known better. But they didn’t know better, in some cases.”

Trump said he would support a prohibition on buybacks for companies that receive government aid. The five biggest U.S. airlines -- prime targets for bailout funds -- spent 96% of their free cash flow on repurchases over the last decade, money that could have been used to build rainy-day funds. Overall
buybacks started to slow in the first couple of months of the year in the U.S., when they were $122 billion in January and February, down 46% from a year earlier in the slowest start to the year since 2009.

While some viewed share repurchases as one of the driving forces behind the bull market, the practice was constantly criticized, particularly in populist circles. Companies were simply inflating their stock prices inorganically, using cheap money in the process, so the argument went, exacerbating wealth inequality as the ultra-rich cashed out.

Buybacks have been the primary source of demand supporting the market, particularly during pullbacks, over the last decade. The problem with relying on buybacks as a rationale for being bullish is they are inherently procyclical. The majority of companies are not in a position to buy back shares following big declines. Additionally, since debt loads have increased, at least in part to fund buybacks, they are overleveraged at peaks and debt obligations come before equity during a downturn.  

The SARS epidemic did not become a pandemic. Its effects were limited to a relatively small number of countries and, even then, the majority of infections occurred within the hospital setting. The trough in markets evolved when the growth rate in new infections moderated which eventually contributed to the peak in new infections. COVID-19 is global and has infected many more people that SARS ever did and particularly because the large numbers of serious cases have overwhelmed healthcare systems.

Liquidity is vanishing for U.S. equity futures. Traders of S&P 500 e-minis are now only offering to buy or sell a few contracts at a time -- often numbering in the single digits -- compared with an average of more than 1,000 just a month ago, data from Deutsche Bank Asset Allocation show.

Drastically thin markets are alarming because they can fuel outsize price swings. With futures markets being halted almost every day in the wake of wild swings, the lack of liquidity is so severe now that it’s fueling concern even among the pros who’ve lived through the worst market crashes in history.

“There’s no liquidity in any market,” said Rick Bensignor, the founder of Bensignor Group and a former strategist for Morgan Stanley, who has traded the futures market for 40 years. “When you’re talking about restructuring a portfolio too, you have to think about the potential slippage that’s involved to get anything done.”

Of course it’s no surprise that markets would thin out when investors, strategists, and economists alike are unsure of the ultimate impact of the coronavirus pandemic. And it’s not clear if the low liquidity may be feeding upon itself -- i.e., are traders staying away because liquidity is so horrible, or is it just a natural side effect caused by all the uncertainty?

“‘Thinly traded’ now an understatement considering how much liquidity in futures market has collapsed,” tweeted Liz Ann Sonders, the chief investment strategist at Charles Schwab. U.S. contracts hit exchange-mandated halts for the ninth time in 10 days overnight Sunday, before an announcement of unlimited quantitative easing from the Federal Reserve ignited gains that lasted just 20 minutes before turning negative again.

Strategists at JPMorgan Chase & Co. have estimated liquidity in U.S. futures markets is seven times worse than the poorest levels during the financial crisis. According to Bensignor, typically when it comes to size, anywhere from 200 to 500 blocks trade on both the bid and offer side of a wager at every tick. Watching his screen Monday morning, there were fewer than 10.

“You are going to have to deal as you restructure portfolios,” he said in an interview on Bloomberg Television. “You’re also going to have to realize that doing so is going to cost a lot of money compared to what you had to do in the past, where you could basically just do it for no cost because of the liquidity.”

One of the reasons stock markets have sold off so aggressively is because the spike in volatility initiated an epic deleveraging in the macro hedge fund sector. The knock-on effect of that deleveraging was to inhibit the ability of high frequency traders to make markets. That exposed, again, the limitations of the Volcker Rule.

Margin calls are the likely culprit behind a slump in Treasury futures that sunk a popular hedge fund trade in recent weeks. Funds who had been making highly-leveraged bets on price moves between Treasury futures and bonds saw their positions collapse when investors hit with margin calls sold the contracts.

Some of the recent dollar strength may also have been driven by margin demands. South Korean brokerages who hedge their exposure to structured products with dollar-denominated derivatives positions are facing calls, forcing them to scoop up dollars. In gold, investors liquidating bullion holdings to raise cash have been blamed for the metal’s epic slump.

Wild moves reign among risky assets like corporate bonds and oil -- opening up the possibility of more margin stress.

“Half the people we talk to think the current environment is worse than the financial crisis,” the Wells Fargo strategists wrote.

The Volcker Rule was designed to cut banks out of the shadow banking sector. Instead it created an additional step between how shadow banks can access liquidity and the central bank. Since banks were unable to go after the most lucrative leveraged trades, they instead provided macro hedge funds with the capital required to pursue these strategies.

Thank you for the excellent commentary received daily! A question for your view - PE industry claims $2trillion "dry powder" available for deployment but can this be LP drawdown commitments which still has to be called & will come from liquidating other investments at current market prices or even defaulting on obligations?

Thank you for your kind words. It is the support of subscribers like you that ensures this service persists.

In the aftermath of the credit crisis Blackstone deployed billions in the US housing market and became one of the biggest residential landlords in the country. That action helped put a floor under the market. They correctly concluded the majority of people would not have the resources to save for a down payment and would instead be renters indefinitely.

The Coronavirus crisis, the most serious event since the Global Financial Crisis (“GFC”) of 2008/2009, has set in motion a series of governmental policies whose unfortunate effect is to choke both demand and supply in the global economy.  These policies - prudential measures taken by governments united in their desire to appear to be “doing something”- are likely to be worse, economically speaking, than the disease itself.  Relief comes only with the passing of time or the finding of an anti-viral remedy, the latter a distant prospect at this stage.

Earnings news, monetary news, fiscal news and pandemic news are all following the disheartening course that we feared.  An emergency Fed meeting last Sunday, slashing rates to near zero, failed to reassure.  The next day, Wall Street produced the second of 2 record points drops in a week, falling -13%.  Equity markets have fallen by an average of about -30% from their January highs.

Equity markets are now oversold and distorted by panic.  The market finds it hard, if not impossible, to “price” risk when an end to the crisis is undefined and earnings unknown. And what discount rate should one use in a global panic when rates are near zero?  Many stocks trade under “fair value” on “normalized” earnings.  But the risks being taken by governments are such that there may be worse to come: bankruptcies in directly affected sectors like leisure, hospitality, airlines, hotels and “bricks and mortar” retail.  There may even be nationalizations in troubled sectors.  On the other hand, other sectors, also hit hard by the same waves of panic selling, may emerge as new long-term leaders in a changing world where personal safety, health fears, depersonalizing technology and e-commerce may enjoy further and more widespread adoption.

Millions of people just lost their jobs in the retail and restaurants sector. Weekly jobless figures are reported with a two-week lag, so today’s 281,000 increase is reflective of the week ending March 7th. Most cities in lock down made the decision over last weekend so next week’s figure will be higher but the release on April 2nd is likely to take jobless figures to new highs. The only limiting factor is the ability of people to sign on for benefits given the system’s capacity restraints.

The Federal Reserve established temporary dollar liquidity-swap lines with nine additional central banks,
expanding the rapid roll-out of financial-crisis-era programs to combat the economic meltdown from the coronavirus pandemic.

The new facilities total $60 billion for central banks in Australia, Brazil, South Korea, Mexico, Singapore, and Sweden, and $30 billion each for Denmark, Norway, and New Zealand. The swap lines will be in place for at least six months.

The announcement followed the late Wednesday launch of a Fed facility to support money market mutual funds and comes as part of sweeping emergency measures the U.S. central bank has unleashed to support the economy from the coronavirus.

The Fed already has standing swap lines with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank.

Boosting the availability of Dollars is a necessary development following the currency’s surge over the last two weeks which is reflective of a massive deleveraging in the nonbank lending community of hedge funds.

The Bank of England followed Thursday with its second emergency cut in borrowing costs this month, taking the benchmark rate to a record-low 0.1%. The BOE also announced a boost in its asset-purchase program target to 645 billion pounds ($752 billion), made up mainly of gilts.

The two decisions mark the latest in an escalating global response to an outbreak widely seen driving the economy into recession. ECB President Christine Lagarde reinforced the message that policy makers will do all they can, saying there are “no limits to our commitment to the euro.”

The program brings the total of the ECB’s planned bond purchases this year to 1.1 trillion euros, its biggest annual amount ever.

“The ECB was forced to react quickly,” Christoph Rieger, head of fixed-rate strategy at Commerzbank AG, wrote in a note to clients. “The new envelope of 750 billion euros should help bring in spreads more lastingly, but it is questionable whether this will be the turning point of the broader financial market rout.

The bonds of peripheral Eurozone members did indeed bounce today but Germany’s bonds sold off. Spreads might be tightening as a result of the ECB’s actions but this is significantly altered environment from what we have seen previously.

A link to the full report is posted in the Subscriber's Area.

A point I have made repeatedly over the years is understanding how volatility shapes the size of positions in quantitative funds is essential to understanding market structure. The funds which deploy high leverage by betting on low interest rates and record low volatility look like geniuses when times are good but the deleveraging that arises from a spike in volatility can have a swift effect on both performance and the wider market.

Volatility on both equities and bonds is surging. At the same time the inverse relationship between bonds and equities is breaking down. That is particularly deadly for the much-vaunted risk parity strategy which is experiencing its biggest drawdown in years.

the 10yr-3mth graph for US Treasury bills....is it available in the Chart Library? What is its Bloomberg symbol? Thanks in advance for any info.

Thank you for this question. If you go to the Chart Library you will now find this spread using “yield curve spread” as your search parameter.

The Treasury market buckled Tuesday at the prospect of a flood of U.S. spending to fend off an economic nightmare.

Yields at the long end of the curve shot higher on Treasury Secretary Steve Mnuchin’s proposal for a $1.2 trillion stimulus package. Rates on 10- and 30-year bonds shot up more than 36 basis points, their biggest one-day increases since 1982, while an iShares ETF tracking Treasuries maturing in 20 or more years sank a record 6.7%. The U.S. 10-year yield, the world’s borrowing benchmark, is now more than 70 basis points above the record low set last week.

The surge in yields is in response to the massive supply pressure on the way, rather than any expectations for a recovery in growth or inflation, said Jon Hill, rates strategist at BMO Capital Markets.

“It’s clear there’s a recession coming, and policy makers need to do everything they can to avoid a depression,” Hill said.

Tuesday’s market reaction also follows emergency steps by the Federal Reserve to support commercial-paper markets and pump more liquidity into the system, and Sunday’s surprise interest-rate cut, which took the target policy rate to near-zero. These efforts have amplified the steepening in the yield curve, as the gap between two- and 10-year yields touched its widest point in two years, at 59 basis points.

I recorded an interview with Jim Puplava today on FinancialSense Online and he quoted back to me my statement “that the coronavirus will be temporary but the policy response is infinite” I stand by that view because the worst case scenario is we get a vaccine in a year and that allows activity to pick again. Between now and then the range of policy responses is increasing by the day.

Over the past week, the Federal Reserve has hit the U.S. dollar funding markets with a barrage of liquidity and tools to ensure they remain lubricated. Yet indicators of funding stress are still showing pressure.

In an emergency action Sunday, the central bank slashed interest rates to zero, adjusted the parameters of global dollar swap lines, in additional to offering trillions of dollars of liquidity via operations for repurchase agreements. Here’s what some of the key metrics have to say about the level of distress in the financial system:

Despite the Fed action, the repo market remains volatile. At one point during Monday’s trading session, the rate for overnight general collateral was around 2.50%, according to ICAP, which is well above the central bank’s new target range for the fed funds rate of 0% to 0.25%. While the bid-ask spread is now around 2%/1.25%, the central bank said it plans to conduct another overnight repo offering of up to $500 billion.

Cross-Currency Basis Swaps
The Fed on Sunday also lowered the rate on its U.S. dollar liquidity swap lines in coordination with other central banks. As a result, the three-month cross-currency basis for dollar yen -- a proxy for how expensive it is to get the greenback -- briefly spiked to its widest on record Monday in Asian trading before pulling back, according to Bloomberg data since 2011. Strategists at Bank of America believe volatility may persist until the Fed fixes the commercial-paper market and there are “more avenues available to secure USD funding.”

Libor-OIS
The gap between the London interbank offered rate and overnight index swaps expanded Monday to the widest level since 2009, led by an increase in Libor’s three-month tenor.

Widening: QuickTake
Rates on three-month commercial paper for non-financial companies reached the highest level since the financial crisis relative to OIS. This suggests companies may be having difficulty selling commercial paper, as they tend to do during times of stress. As a result, Wall Street strategists expect the Fed to announce a resurrection of a crisis-era facility for commercial paper.

The Fed reactivating swap lines between other central banks, cutting rates to zero, reducing reserve requirements for banks to zero and announcing a $700 billion quantitative easing program all point to a clear effort to ensure the financial system remains liquid as the economy shuts down. Ensuring liquidity is a priority for central banks but it is a factor that sends a signal to stock market investors that there may be something else they need to pay attention.

U.S. stocks trimmed staggering losses of more than 8% earlier in the day as investors absorbed the Fed’s muscular decision.

The buying will include coupon-bearing notes and match the maturity composition of the Treasury market, it said. Ten-year U.S. Treasury yields fell sharply to trade around 0.68%.

“The Treasury securities operation schedule includes a change in the maturity composition of purchases to support functioning in the market for U.S. Treasury securities,” the New York Fed said.

Term repo operations in large size have also been added to help markets function, it also said. The New York Fed said it would offer $500 billion in a three-month repo operation at 1:30 p.m. and repeat the exercise tomorrow, along with another $500 billion in a one-month operation, and continue on a weekly basis for the rest of the monthly calendar.

The call on the repo market is likely to continue to rise because banks, the world over, are increasingly starved of liquidity. The liquidity shortage that appeared in Q3 was but a foretaste of the difficult environment we are currently presented with and suggests the remedial action to ensure property functioning of the money markets is going to be significantly larger than currently envisioned.

Vontobel Asset Management’s risk-parity product has cut its stock position from 140% about a month ago to around 28%, while its bond exposure remains around 260%, says head of multi-asset Daniel Seiler.

“You reduce your volatility with a negative correlation and if that is not the case anymore, you will obviously need to reduce the volatility with a different measure and this could deleverage your whole portfolio,” he said from Zurich, referring to the link between bonds and shares.

On a positive note, for both asset classes to fall in tandem for an extended period, “what you would need is an inflationary shock and at the moment I don’t see that at all,” Seiler added.

With bond yields now so low, there are others on Wall Street who may disagree.

An inflation scare is one possible scenario where both bonds and equities fall at the same time. It is not the only one. Against a background where the pace of economic activity is taking a war-like dislocation the bigger risk is a solvency crisis or a liquidity crisis.

Lagarde told European Union leaders on a conference call late on Tuesday that without coordinated action Europe “will see a scenario that will remind many of us of the 2008 Great Financial Crisis,” according to a person familiar with her comments. With the right response, the shock will likely prove
temporary, she added.

Lagarde said her officials are looking at all their tools for Thursday’s policy decision, particularly measures to provide “super-cheap” funding and ensure liquidity and credit don’t dry up, said the person, who declined to be identified because the call was private.

Still, she stressed that central-bank measures can only work if governments throw their weight behind them too, with steps to ensure banks keep lending to businesses in affected areas, said the person. An ECB spokesman declined to comment.

Lagarde spoke hours before the Bank of England became the latest central bank to take emergency action. It announced a 50 basis point interest-rate cut early Wednesday, combined with measures to help keep credit flowing, and said it still has more policy space to act if needed.

The ECB has been cautioning Eurozone governments for much of the last decade that fiscal stimulus has to be part of the solution to the region’s debt/growth challenges. That exhortation has fallen on deaf ears as the region’s creditors imposed fiscal conservativism on the most profligate debtors.

Boeing obtained the loan from a group of banks last month to help it deal with its cash burn while it prepares to return its 737 Max plane to the skies. It initially tapped about $7.5 billion of the debt, and is now expected to draw the rest, said the people, asking not to be named discussing private information. Boeing plans to draw the remainder of the loan as a precaution due to market turmoil, one of the people said.

Companies affected by the virus are increasingly turning to banks for short-term financing to provide a safety net. United Airlines Holdings Inc. raised $2 billion in new liquidity with a secured term loan, while Norwegian Cruise Line Holdings Ltd. recently signed a new $675 million revolver. Should credit conditions worsen, more firms may start to draw down their credit lines, market watchers say. Boeing’s loan came about before Covid-19 spiraled into a global crisis and was expected to be fully drawn eventually.

“They want to have cash on the balance sheet,” said Bloomberg Intelligence’s Matthew Geudtner. The Max grounding, the company’s joint venture with Embraer SA and looming debt maturities will also weigh on Boeing’s cash hoard, he said.

The easiest way to determine where the biggest risks reside in this market is to use this metric: Whatever people were worried about in 2019, the coronavirus makes things worse.

“Market momentum this powerful will not be reversed by even a very large supply shock,” said John Wraith, a U.K. rates strategist at UBS Group AG in London. “Negative yields are clearly a possibility, especially in safest, shortest issues.” The scope of estimates from primary dealers of U.K. government bonds, known as gilt-edged market makers, was broad ranging.

The most conservative -- Morgan Stanley -- sees a supply of 146.3 billion pounds, while Nomura International Plc estimates an increase to 185 billion pounds. That’s a level not trumped since former leader Gordon Brown oversaw a record 228 billion in 2009-10 to help extricate the country from the financial crisis.

Now that Johnson has delivered on his election promise to “get Brexit done” after years of political turmoil, to retain support he must address the concerns of those in some of the poorest regions of the U.K. That requires funding for infrastructure, health care and job creation. Finance minister Rishi Sunak on Sunday hinted the nation’s fiscal rules could be ditched as he prepares a massive package of measures to tackle the coronavirus crisis.

The entire UK yield curve is a couple of interest rate cuts from negative yields so it is an ideal time for the government to borrow more than it needs to ensure ample liquidity to combat the negative effect of the coronavirus, to placate a restive population eager for better standards of living and to ensure a smooth exit from the EU.

Last week in Vienna, ministers from Russia, Saudi Arabia and other members of the group left a fractious meeting with no deal to continue the cuts beyond April 1. Saudi Arabia heavily discounted its oil over the weekend, triggering a plunge of more than 20% in international crude futures.

Rosneft’s London-listed shares dropped 19.5% on Monday, while markets in Moscow were closed for a public holiday. In a separate statement, Russia’s finance ministry said that the country’s oil-wealth reserves would be sufficient to cover lost revenue “for six to 10 years” at oil prices of $25 to $30 a barrel.

 

Unconventional oil and gas has been one of the biggest gamechangers for the global economy in history. When the world’s biggest consumer, where production peaked decades ago morphs into the world’s biggest producer and a net exporter it changes the fundamentals and interrelationships of the market.

A link to the full report is posted in the Subscriber's Area. 

The Credit Suisse team do an excellent job of highlighting where the risks are and provide a handy list of instruments to monitor to get an idea of how liquidity flows are functioning.

The repo market illiquidity in September was a signal to everyone that the tightening program had gone too far. There was nowhere near enough available capital in the system to allow the global money market to function. The Fed stepped in with a large swift injection of liquidity; inflating its balance sheet by $400 billion in four months.

Though the Fed met Wall Street’s hopes for aggressive action with its half-point reduction, Chairman Jerome Powell seemed to unnerve markets by saying it’s unclear how long the virus’s impact will last. Traders were already pricing in another rate cut later this month, with more to come in June.

“The market is trading right now on a lot of fear and uncertainty,” said Gary Pollack, head of fixed income at DWS Investment Management. “The Fed certainly didn’t bring calm, and the virus continues. The Fed’s relatively large move also made people wonder what they know that we don’t.”

The central bank’s decision came a few hours after Group-of-Seven finance chiefs issued a coordinated statement saying they were ready to act to shield their economies from the virus. Policy makers faced pressure to act after the OECD warned the world economy faces its “greatest danger” since the 2008 financial crisis.

The market is pricing in the assumption the US economy is going to lock up in exactly the same fashion as the Italian or Chinese economies did as coronavirus concern/paranoia spreads. There is no doubt the virus is dangerous for at-risk groups, but the bigger question is whether its effects will persist beyond the first quarter or perhaps second quarter, not least because warmer weather will likely curtail its spread as temperatures rise.

A more urgent consideration is today is Super Tuesday. The biggest issue investors are worried about is the potential Bernie Sanders is going to be the next President of the USA. The range of proposals he has tabled include breaking up the banks, financial services taxes, capping interest rates, breaking up internet and cable companies, Medicare negotiations for drug pricing, importing foreign drugs, capping prices, end health insurance, banning fracking, insist on 100% renewable utilities and railroads, cars and manufacturing. It’s very unlikely any of these will become law without the Democrats retaining the control of the House and also winning the Senate. However, President Trump has demonstrated just how much power the executive branch has and therefore there are grounds for worry.

The coronavirus scare is obviously a factor for markets at the moment, but the repo crisis remains in the background too. First question - what are your thoughts on relative (best and worst) asset class performance if the repo crisis flares up on top of the coronavirus pandemic. Second related question - does the coronavirus effect (eg reduced rates, lower company profits, high yield bond risks etc) make it more likely that repo will get worse?

Thank you for this question which is particularly relevant against a background of tighter liquidity as banks underperform. Here is Bloomberg’s repo market summary from yesterday:

Already on Friday, Federal Reserve Chairman Jerome Powell opened the door to cutting interest rates to contain what he called the “evolving risks” to economic growth from the virus. The Paris-based OECD now expects the weakest global growth this year since the 2009 recession, and said a “long lasting” epidemic would risk a worldwide recession.

The prospect of central banks’ action temporarily halted the worst rout in stocks since that crisis. But the selloff resumed on Monday, with U.S. futures falling and Treasuries rallying.

Money markets now see the Fed lowering its main rate by 50 basis points this month, and give a 70% chance the European Central Bank will pare its by 10 basis points.

Economists at Goldman Sachs Group Inc. predicted the Fed will ultimately slash by 100 basis points in the first half of the year. The BOE will cut by 50 basis points and the ECB by 10 basis points, it said.

There is even speculation that the Fed will move before its policy makers gather on March 17-18, and some economists see the potential for international policy makers to coordinate cuts for the first time since 2008. Investors increasingly bet the central banks of Australia, Canada and Malaysia will ease at meetings already scheduled for this week.

“Global central bankers are intensely focused on the downside risks,” Goldman Sachs economists led by Jan Hatzius said in a report on Sunday. “We suspect that they view the impact of a coordinated move on confidence as greater than the sum of the impacts of each individual move.”
 

Government bonds are very overbought in the short-term, with US-10-year Treasuries testing the 1% level. That’s been possible because investors have rapidly priced in four quarter point cuts this year with the potential for the first two to be announced within the next two weeks. The potential for synchronised action from a number of central banks is rising, with the aim of lending assistance but also boosting confidence.

After a week characterised by selling across the board, a great deal of profit taking has taken place and many overextensions relative to the trend mean have been unwound. The question I believe many people will be concerned with is whether the coronavirus is going to be the catalyst for an economic contraction? I thought it would therefore be worth monitoring the kinds of instruments that offer a lead indicator for that kind of concern.

A link to the full report is posted in the Subscriber's Area. 

The graphic of mortality versus contagion included in the appendix of the report is the best one yet comparing COVID-19 with other killers.

The proximity of the Spanish flu to the range of potential outcomes from the new virus is obviously a topic of conversation. The Spanish flu came in three waves, in Spring 1918, Autumn 1918 and Winter 1919 and disproportionately killed young people. COVID-19 on the other hand tends to most kill people with compromised lung function and older people.

Energy led the decliners as oil prices fell below $47 a barrel, while bonds of rental car Hertz Global Holdings Inc. slumped as much as six cents on the dollar. Leveraged loans tied to American Airlines Group Inc. and Travelport Worldwide Ltd. also slipped. The high-yield CDX index, which trades on price, was down a full point at one stage.

High-yield bond investors are trying to assess the big unknown: whether the coronavirus will be just a short-term problem if it can be contained, or, far worse, turn into a pandemic that could pose a long-term drag on the economy and spark a recession.

“The sell-off is accelerating,” said William Smith, a portfolio manager at AllianceBernstein. “Initially we were seeing more weakness in liquid securities, but today there are multiple situations where bonds are down more than five points.”

Riskier credits are less well able to ride out earnings volatility than better capitalised companies. That’s generally why they need to discount their bond offerings. Spreads in the sector were priced for near perfection heading into the end of 2019 as the stock market continued to rebound following the provision of $400 billion in stimulus to the repo market. The potential knock-on effect to demand for consumer products resulting from the virus scare is an obvious risk.

Berkshire Hathaway Energy is now celebrating its 20th year under our ownership. That anniversary suggests that we should be catching up with the company’s accomplishments.

We’ll start with the topic of electricity rates. When Berkshire entered the utility business in 2000, purchasing 76% of BHE, the company’s residential customers in Iowa paid an average of 8.8 cents per kilowatt-hour (kWh). Prices for residential customers have since risen less than 1% a year, and we have promised that there will be no base rate price increases through 2028. In contrast, here’s what is happening at the other large investor-owned Iowa utility: Last year, the rates it charged its residential customers were 61% higher than BHE’s. Recently, that utility received a rate increase that will widen the gap to 70%.

The extraordinary differential between our rates and theirs is largely the result of our huge accomplishments in converting wind into electricity. In 2021, we expect BHE’s operation to generate about 25.2 million megawatt-hours of electricity (MWh) in Iowa from wind turbines that it both owns and operates. That output will totally cover the annual needs of its Iowa customers, which run to about 24.6 million MWh. In other words, our utility will have attained wind self-sufficiency in the state of Iowa.

In still another contrast, that other Iowa utility generates less than 10% of its power from wind. Furthermore, we know of no other investor-owned utility, wherever located, that by 2021 will have achieved a position of wind self-sufficiency. In 2000, BHE was serving an agricultural-based economy; today, three of its five largest customers are high-tech giants. I believe their decisions to site plants in Iowa were in part based upon BHE’s ability to deliver renewable, low-cost energy.

Of course, wind is intermittent, and our blades in Iowa turn only part of the time. In certain periods, when the air is still, we look to our non-wind generating capacity to secure the electricity we need. At opposite times, we sell the excess power that wind provides us to other utilities, serving them through what’s called “the grid.” The power we sell them supplants their need for a carbon resource – coal, say, or natural gas.

Berkshire Hathaway now owns 91% of BHE in partnership with Walter Scott, Jr. and Greg Abel. BHE has never paid Berkshire Hathaway a dividend since our purchase and has, as the years have passed, retained $28 billion of earnings. That pattern is an outlier in the world of utilities, whose companies customarily pay big dividends – sometimes reaching, or even exceeding, 80% of earnings. Our view: The more we can invest, the more we like it.

Today, BHE has the operating talent and experience to manage truly huge utility projects – requiring investments of $100 billion or more – that could support infrastructure benefitting our country, our communities and our shareholders. We stand ready, willing and able to take on such opportunities.

I found this to be an enlightening discussion of the utilities sector. The long-held perception is that these kinds of businesses can afford to pay out the majority of free cashflow in dividends because they are charging rents on established pieces of infrastructure with easily forecastable maintenance and renewal trajectories. As Berkshire’s experience with wind demonstrates, this ignores the long-term risk of exogenous shocks, technological innovation, changing regulation and infrastructure reaching the end of its useful life.

Contagion experts Peter Sandman, Ian Mackay, and Jody Lanard sum up my view in this passage from Past Time to Tell the Public: It Will Probably Go Pandemic, and We Should All Prepare Now:

“We are near-certain that the desperate-sounding, last-ditch containment messaging of recent days is contributing to a massive global misperception about the near-term future. One horrible effect of this continued 'stop the pandemic' daydream masquerading as a policy goal: it is driving counter-productive and outrage-inducing measures by many countries against travellers from other countries, even their own citizens back from other countries.

“But possibly more horrible: the messaging is driving resources toward 'stopping' and away from the main potential benefit of containment – slowing the spread of the pandemic and thereby buying a little more time to prepare for what’s coming.”

For readers who can spare the time, I suggest tuning out media noise – much of it dwelling on the malevolent distraction of which individual may have been spreading Covid-19 – and going straight to research papers being released daily by PubMed Central, the data bank of the US National Library of Medicine.

That way you avoid the sort of misunderstanding I just heard on the BBC, which stated that the death rate is comparable to flu. No, it is not. The average morbidity of flu annually is 0.1pc; Covid-19 is an order of far greater magnitude.

The latest tracking data as of Feb 22 (unreliable, but the best we have) is that the mortality rate is 4pc in Wuhan, 2.8pc in Hubei, and 0.8pc in other regions of China, though all figures are creeping up as slow deaths hit the data.

There can be long lag times after infection so it is too early to infer ratios from South Korea, Italy and Iran, but this is surely more like the Spanish Flu of 1918 than anything we are used to. Chinese data suggests that roughly 14pc of those infected over the age of 80 are dying.

You can read most of the PubMed abstracts free and can see what is coming out of labs in China – some of them excellent – or in Hong Kong, Korea, Japan, Europe and North America. There are already 80 peer-reviewed papers. The unfiltered findings are arriving almost in real time. They give you an extra edge.

The annual seasonal flu becomes a pandemic every year. The coronavirus shares enough similarities with the flu in how it spreads to become a pandemic. Meanwhile, it is far more deadly.

This graphic, produced by the New York Times a few weeks ago gives us a good picture of what we are dealing with. The mortality rate is anything from 8 to 40 times more deadly than flu while the transmission or contagion factor is about the same or higher.   

A link to the full report is posted in the Subscriber's Area.

“The Fed has got your back and they will do whatever is necessary to support asset prices” That is the mantra of stock market investors who have been following a diversified or balanced investment strategy for the last decade. In between there have been occasions when the mantra was challenged, particularly following Jay Powell’s appointment as Fed chair. However, the pivot to easier policy and the response to the repo tightness in Q3 have reasserted belief in the mantra.

“What do you do with your cash?” said Luke Hickmore, investment director at Aberdeen Standard Investments in Edinburgh, where he helps run a number of bond funds. “Leaving it standing there makes no sense and the experience over the last 10 years is that there is no pain in buying bonds. Learnt behavior is that it is safe. Inflation is nowhere and central banks start buying every time yields go higher.”

Heavy demand for tax-exempt income drove yields on even the riskiest municipal bonds to 3.58% on Friday, the lowest since Bloomberg’s records began in 2003. The influx has compressed spreads across the country and caused some debt in high-tax states like California and New York to yield less than top-rated benchmark securities. Municipal mutual funds have reported inflows for the 58th straight week on Feb. 13.

With 30-year debt yielding 1.92% in the USA, 1.59% in Australia, 1.42% in Canada, 1.05% in the UK. 0.36% in Japan and 0.04% in Germany bond investors, and particularly pension funds, are at a loss for where to invest to generate the returns necessary to meet their future liabilities.

Kraft Heinz Co. was downgraded to junk status by Fitch Ratings, which predicted the company’s leverage will remain high for an extended period as the maker of Jell-O and Classico pasta sauce works to stabilize declining sales.

The food company was cut to BB+ from BBB- by the credit-ratings company, with a stable outlook. Fitch said the company may need to divest a sizable portion of its business in order to reduce its debt.

The downgrade follows Thursday’s earnings report, in which Kraft Heinz reported a drop in fourth-quarter sales that sent its bonds and stock tumbling. It was the latest sign that the company’s turnaround plan still has a long way to go.

Kraft Heinz said Thursday it would release a more detailed turnaround plan around the time of its next earnings report in early May, though many investors and analysts had been looking for it sooner.
 

Kraft Heinz’ dividend was 62.5¢ in 2018, 40¢ in 2019 and is expected to be 20¢ in 2020. The decline in the share price has supported the yield, which is currently 5.98% but the outlook for additional dividend cuts puts that under question. The company is likely to be a case study in how intangible values cannot be used to underpin a credit rating during a time of technological and social upheaval.

“Pretty much every client we talk to wants to buy the dip,” wrote Tobias Levkovich, Citigroup Inc.‘s chief U.S. equity strategist in a note. “And that is not comforting.”

The S&P 500 edged higher Thursday, extending the week’s gains to more than 3.5%, as the Stoxx Europe 600 Index climbed to a record and stocks soared in Asia. A gauge of European credit risk hit its lowest since 2007.

Yet the battle against the virus could suffer a setback as factories reopen in China in the coming days and more people come into contact with each other. On the other hand, if factories fail to reopen, the economic impact could prove much more severe.

At Robeco, money manager Jeroen Blokland is eyeing the rally warily. The head of multi-asset funds at the Rotterdam-based firm recently cut an overweight allocation to stocks to neutral because of the spread of coronavirus. He says it’s not yet time to dive back in.

“Every investor is looking for the bottom and wants to find it a little bit earlier than his neighbor,” he said. “We need a little bit more confirmation that the outbreak will be contained before moving again.”

The stock market responds to liquidity because that has an influence on all asset prices and regardless of other short-term factors the Treasury yield is below that of the S&P500 which is generally supportive of the buy the dip strategy. Nevertheless, the stresses coming to bear as a result of the Wuhan Acute Respiratory Syndrome (WARS) are significant and need to be taken seriously.

how is the Yield Curve inversion? The famous inverted US yield curve - only when measured by 3mth/10y (NOT 2y/10y) - has been a reliable predictor of US recession 12-24 months ahead when measured from start point and provided inversion lasted more than 3mths. So somewhere between May 2020-May 2021 we should expect recession. History suggests that this inversion always reverses well before recession arrives. Mainly because Fed eases short rates to avoid recession. So, déjà vu?? Regards

Thank you for this question which may be of interest to other subscribers. The question of the yield curve and how good a lead indicator it is tends to be discussed and dismissed before every recession. This occasion has been no different and it would be foolhardy to think boom and bust have been banished just because some Davos attendees have proclaimed it so.

Chinese officials took issue with U.S. comments about the country’s response to the coronavirus outbreak, and promised they would bring the infection under control.

“U.S. comments are inconsistent with the facts and inappropriate.” Chinese Ministry of Foreign Affairs Spokeswoman Hua Chunying said in statement posted online Friday. The World Health Organization “called on countries to avoid adopting travel bans. Yet shortly afterward, the U.S. went in the opposite direction, and started a very bad turn. It is so unkind.”

U.S. officials said this week that they had difficulty getting specialists from the Centers for Disease Control and Prevention to the front lines of the outbreak in China, and late Thursday the State Department advised Americans traveling in China to come home. Commerce Secretary Wilbur Ross on Thursday also said the outbreak may help bring jobs back to the U.S.

China’s ambassador to the United Nations, Chen Xu, said during a press conference in Geneva that the country had been transparent about the disease.

“We have conducted our business in an open and transparent manner with the outside world,” he said.

Xu said that China would work with the World Health Organization to bring the disease under control, following a declaration by the WHO that the outbreak was an international emergency. The declaration will “not only coordinate global prevention control measures but enables us to mobilize international resources to respond to the epidemic,” he said.

“Official” figures are just below 10,000. This Lancet article suggests 76000 infections. The death toll is reported at around 200 but if that is the case why are crematoria running 24/7? The biggest challenge the Chinese administration has is their claims of full disclosure are being met with doubt because they have such a poor record of reporting accurate facts about any part of the economy. Little wonder that other countries are taking more forceful measures to isolate the country until the infection rate peaks and begins to decline.  

The ship was bound for La Spezia in the Liguria region, with 1,000 crew and 6,000 passengers, 750 of whom came from China, a port spokesman said.

It is looking like the ill person did not in fact have the coronavirus but the fact that 1/8th of the passengers are from China highlights just how influential Chinese tourists are for the global sector. The cancelling of flights both to and from China is going to have a material effect on all tourist destinations and the longer it lasts the greater the impact will be.

The order deluge meant Austria joined the likes of Spain and Italy in setting demand records this month as investors chase the safety of bonds. Fears that the spread of the coronavirus will derail an economic recovery have sent yields tumbling, fueling a huge jump in the world’s stockpile of
negative-yielding bonds.

Austria’s Treasury ended up placing 3 billion euros of the 10-year bonds Wednesday with a yield of minus 0.111%. For investors, that’s still more appealing than equivalent German debt trading at around minus 0.40%. The European Central Bank has a minus 0.50% deposit facility rate.

“Despite the negative interest rate, the issue was met with very strong demand and the transaction was 10-times oversubscribed,” Markus Stix, managing director of Austria’s Treasury, said in a statement.

The total of negative yielding debt continues to rebound, led by a surge in demand for Eurozone sovereign bonds. The total now sits above $13 trillion and has clearly broken the downtrend evident since August. 

The bond market has confounded investors for the past several years as rates have declined or stayed low when almost everyone expected them to rise. The consensus now is that there won’t be much change in intermediate rates this year, with the 10-year U.S. Treasury yield remaining about 2% because the economy is sluggish and inflation continues to be low. While we agree that traditional economic factors will not drive rates higher, we believe supply and demand will play an important role. The big buyers at the Treasury auctions are the Social Security Administration, the Federal Reserve, Japan and China. The Federal Reserve will probably do some buying, but we should realize that their bond ownership has climbed recently from $3.8 trillion to $4.2 trillion, even as the Fed’s stated objective has been to shrink its balance sheet. China and Japan have been upset with Trump’s trade policy and have been less-than-enthusiastic buyers at recent auctions. The Social Security Administration, which has been a perennial buyer of Treasuries, may pull back since its benefits payments will exceed its inflows in 2020. These conditions suggest to us that the yield on the 10-year U.S. Treasury will move somewhat higher to 2.5% during the year, and that is the ninth Surprise.

Funding social security as the total sum set aside for future liabilities is drawn down is going to represent a significant drag on government finances in the USA for the foreseeable future.

Midst all the alarm regarding corona virus, I was surprised that the financial media has paid so little attention to the following:  https://thesoundingline.com/feds-balance-sheet-has-shrunk-20-billion-since-the-start-of-january/

If an over-extended was looking for an excuse to correct, surely this was it!

Your comment would be appreciated.

Thank you for this question which may be of interest to subscribers. I covered the topic of balance sheet expansion in the Big Picture Friday audio but I’m happy to revisit the question here.

The Fed has added $400 billion to its balance sheet over the last four months by purchasing short-dated Treasuries. That has the same effect on the stock market as the liquidity infusions back in 2017 had. We have just had one of the most inert advances in years where volatility remained low for a prolonged period, just like in 2017.

Economists had a broad range of forecasts for when the Fed would stop buying Treasury bills, though June 2020 received the highest response at 43%. Respondents overwhelmingly expected officials will taper the monthly purchases rather than stop them suddenly. The Fed has been buying $60 billion in T-bills each month since October.

A scarcity of bank reserves was blamed for an unexpected spike in overnight funding rates in September. This led the fed funds rate to stray briefly out of its target range. The new cash created by the Fed’s T-bill purchases has since relieved that scarcity. The Fed, intent on ensuring an ample supply of reserves, has said it will continue the purchases at least into the second quarter.

The news headlines are full of news about the coronavirus and the number of countries where it has been found continues to rise every day. That injected a degree of caution in the markets that was not present a week ago. The clearest effects are evident in safe haven assets where Treasuries, precious metals and the Dollar have steadied.

Unfortunately, the Fed made a critical design error in its daily interventions. They are offering to supply repo to the dealers at prevailing market rates. In other words, they are giving the dealers every incentive to take repo from the Fed as opposed to the market. In essence, the Fed has become the lender of first resort when it should be the lender of last resort and offer repo at a penalty rate. The Fed should be willing to help a dealer in need, but it should come at a price.

So, after four months of these Fed repo operations, new problems are emerging. More specifically, the Fed might be going too far and oversupplying this market. The effective federal funds rate is signaling there are enough reserves in the banking system. This month it traded at 1.54%, breaking below the interest on excess reserves (IOER) floor of 1.55% for the first time in 14 months. This is happening as the Fed announces it will continue to plow ahead with Treasury bill purchases and supplying hundreds of billions of dollars of repo supply until April, if not later.

What should the Fed do? It has already telegraphed it will raise the IOER rate by five basis points to 1.60% at the Federal Open Market Committee meeting next week. Presumably, it will also raise the repo offered rate by five basis points to 1.60%. Policy makers should raise the repo rate even higher. Stand ready to offer liquidity, but at a penalty rate.

This won’t fix the problems in the repo market; only rule changes can do that. But at least this will allow the Fed to identify how much supply is needed to get the market back in balance rather than risking a loss of control of the federal funds rate altogether.

The Fed should not be looking to permanently insert itself into the repo market via a standing repo facility. Repo is still a credit market, and, in times of stress, it requires a credit decision when deciding who gets a collateralized loan and at what terms. Central banks are not equipped to make these decisions, and their involvement could create a moral hazard, making things worse.

The Fed panicked with their response to the repo market freeze in September. The “short-term” fix introduced had the desired effect and the monetary markets are once again flowing freely. However, the cost has been prohibitive and the big question today is whether this action is an example of what we can expect from the future or is it a once-off deal.

In the next 10 years, demographic changes will have major effects. Millennials, the largest US generation, will be approaching age 50, while the last of the baby boomers will all be at retirement age. Artificial intelligence and virtual reality are expected to be mainstream. Automation will impact the labor force. Environmental disruption will likely continue, and sustainable investing will be mainstream.

Investors see these “mega-trends”— an aging population, technology and automation, diminishing resources— creating opportunities for the future.  In fact, seven in 10 want to take advantage of these trends to seek better returns.

As they look ahead, investors have an opportunity to ensure they are well positioned for the future—a future that will be here before we know it.

…In today’s challenging environment, investors seek various strategies to cope

To cope with this environment, 64% of investors are considering adding high quality stocks to their portfolios, while others would increase diversification and raise cash. Already, investors are holding 25% of their assets, on average, in cash. There is a clear connection between investor confidence and planning. Two-thirds of investors with a long-term plan in place are highly confident they will achieve their goals, compared to only 51% of investors without a plan. In addition, eight in 10 plan to discuss the impact of the US Presidential election with their advisors.

A link to the full report is posted in the Subscriber's Area.

The “challenging environment” rhetoric, that has permeated just about all of the 2020 forecasts I have seen, is more a reflection of what people have in their portfolios rather than the background of markets.

The pound faltered and gilts rallied after inflation data backed up Bank of England policy maker Michael Saunders’ call for urgent stimulus to boost the U.K. economy.

Sterling weakened against the euro and 10-year government bond yields dropped to the lowest in seven weeks after the data fueled bets that the central bank will lower interest rates this year. Money markets are now fully pricing in a full 25-basis-point rate cut for May, compared to November a day ago, and see a 65% chance of a move this month.

Saunders’ view on the need for more accommodative policy comes just days after BOE Governor Mark Carney said Britain’s economic growth had slowed below potential and that the Monetary Policy Committee had discussed the merits of near-term stimulus.

“There is more room for easing expectations to rise should incoming data disappoint and that could keep short-term sterling downside risks intact,” said Manuel Oliveri, a currency strategist at Credit Agricole AG.

The UK is determined to avoid the deflationary environment that has seen negative rates prevail in the Eurozone. That entails a willingness to let inflation run hot. Cutting interest rates now can be justified based on Brexit uncertainty as the end of the transition agreement is clearly within sight on December 1st.

The political backlash that followed crisis-era bank rescues hangs over policy makers’ approach to the current problem, analysts said, even as officials work to ensure the smooth functioning of a key piece of the infrastructure underpinning financial markets. Some fear that lending directly to hedge funds could lead to the perception the Fed is fueling risky bets.

“There’s a strong aversion to fat cat bailouts,” said Glenn Havlicek, chief executive of GLMX, which provides technology to repo trading desks.

Many hedge funds trade in the cash market through sponsored repos. The clearinghouse sits between buyers and sellers to ensure that neither party backs out of the transaction. Records of cleared trades also are publicly available, improving the market’s transparency.

The idea of using the clearinghouse appeals to some investors and analysts because the Fed has had trouble getting cash into the hands of the smaller banks, securities dealers and investors who need it the most.

That is because the Fed trades exclusively with a small group of large banks and securities firms, known as primary dealers. Even among these firms, activity is tightly concentrated. A study recently published by the Bank for International Settlements said that liquidity in the repo market rests in the hands of the four largest banks in the U.S. system.

Every time a central bank reduces interest rates, holds them down for a prolonged period and increases the size of its balance sheet, part of the rationale is to support the kind of speculative activity which can get the growth multiplier moving again. The side effect is to encourage simultaneous financial market speculative activity in both public and private assets.

1. The economy disappoints the consensus forecast, but a recession is avoided. Federal Reserve Chair Powell lowers the Fed funds rate to 1%. Without a comprehensive trade deal in hand, President Trump exercises every executive authority he has to stimulate growth and ward off recession. He cuts payroll taxes to put more money in the hands of consumers.

This year I was struck by how close to consensus the majority of the forecasts are, but the first one is certainly headline grabbing. The consensus in the bond market suggests one additional rate cut this year, not three. If the 9th surprise of Treasury yields at 2.5% were to come to fruition it would represent a massive steepening of the yield curve.

If gold’s implicit prediction is right, it has two implications. The first and most important one is a belief that inflation is at last due to return, after many false alarms. The second is that gold is now settled in a bull market. 

So, is gold good value? The metal doesn’t throw off any income streams, and has very few industrial uses, so it is very hard to come up with a measure of fair value. But the following chart, using data drawn up by Charlie Morris of Catley, Lakewood and May in London, is a heroic attempt to arrive at one. Morris devised a formula for fair value using the consumer price index and the average of 10- and 30-year inflation expectations. This indicator briefly showed that gold was wildly overpriced during the worst of the 2008 crisis, a phenomenon that may have been driven by the illiquid markets of the time, that created an unrealistic inflation forecast. Exclude this incident, and we see a steady bull market for gold from 2005 to 2011, followed by a steady bear market, where it moved to a discount. In the last two years, it looks as though it may have started another bull market. By Morris’ calculations, gold is now about 11% over fair value. 

Gold is still far from the confident prediction of runaway inflation that it briefly produced for a few years after the crisis, even though it is buoyed by safe haven demand at present, along with seasonal interest in gold jewelry, notably from China where the lunar new year is almost here, and by resumed interest from central banks.

On the supply side, gold-mining groups are merging, creating a reasonable hope of avoiding over-supply in the near future. So, if this move in gold prices is confirmed by a move down in real yields, followed even by an increase in inflation, then this could be part of a bull market to match the one from 2005 to 2011. The critical question is whether the gold market proves to be right this time in its forecast of inflation.

Gold is often viewed as a hedge against inflation but that is a largely a corollary to its prime position as a monetary barometer. The foreign markets are relative value oriented. One can’t really say a currency is strong or weak unless it is compared to whatever it can be converted into. All fiat currencies are subject to the tendency of governments to print with abandon at the first sign of trouble. Gold does best in periods when competitive devaluation becomes a factor, which is exactly what we have today; with a growing trend of synchronised monetary and fiscal stimulus. Inflation is a side effect of that profligacy.

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The surge in repo rates was not a blip. It was the result of a combination of factors that conspired to drain liquidity from a vital part of the financial system. The solution has been for the Fed to step in as lender of first and last resort because traditional market makers are constrained by regulation and requirements to hold higher cash reserves.

Iraqi Prime Minister Adel Abdul-Mahdi condemned the targeted killing as a violation of the terms underpinning the U.S. troop presence in the country.

Mr. Abdul-Mahdi said he had submitted a formal request for parliament to convene in order to adopt necessary measures “to protect Iraq’s dignity and sovereignty.” He didn’t say what those measures would be.

The killing of the two men is likely to mark the beginning of a dangerous new chapter in the rivalry between the U.S. and Iran, which escalated after supporters of an Iran-backed Shiite militia attempted to storm the U.S. Embassy in Baghdad earlier this week. Mr. Mohandes was deputy leader of the Popular Mobilization Forces, an umbrella group that led the embassy attack.

Anyway we look at it, the geopolitical risk premium just racketed up. Iran’s response to losing the commander of the Revolutionary Guard can be expected to be bloody and will probably splash around the entire region considering how broad Iran’s terrorist network is.

“The data will probably prove to be an anomaly, but the initial market reaction is that it’s bad enough to at least consider the possibility of a Fed rate cut,” said Chris Low, chief economist at FHN Financial. “The combination of geopolitical tensions on top of unexpectedly weak data increases the likelihood of a 2020 Fed rate cut.”

Yields on 10-year Treasuries dropped as much as 8 basis points to 1.79% and remain within 2 basis points of that level. Rates on their German counterparts were down 6 basis points at minus 0.28%. Yields tumbled in most major markets around the world.

I agree that it is unlikely the Iran news is enough to justify a rate cut but the bond market rallied nonetheless. 10-year Treasury yields are now testing the sequence of higher reaction lows evident since September, having found paused in the region of the trend mean. A sustained move above 2% will be required to signal a return to supply dominance beyond the short term.

Disinflation has reigned since 1980, but real interest rates were positive until the last decade.  But for 10 years now, real 10-year Treasury note yields have been flat at zero (see my Nov. 19, 2018 column, “Zero Real Yields Are Tripping Up Investors”).  This and the flat yield curve have pushed state pension funds and other investors far out on the risk curve in search of real returns, bidding up stocks to vulnerable levels.
 
Earlier, the Fed was run by Ph.D. economists who clung to widely-held theories even though they didn’t work. Fed Chairman Jerome Powell is proving to be much more practical, backing away from rigid Fed policies such as the 2% inflation target and a zero-bound policy rate as well as unsuccessful forward guidance.

In this different economic climate, it’s hard to time the end of the current recovery. Still, it will end, due either to Fed overtightening or a financial crisis, like the 2000 dot-com blow-off or the 2007-2009 subprime mortgage collapse. In the current excess supply-savings glut-deflationary world, it’s likely a recession will unfold due to a shock before the Fed overtightens.

The distortions quantitative easing and other extraordinary monetary measures have created will be debated for decades. There is no arguing with the fact that relationships between asset classes which were reliable lead indicators in the past are less relevant in an environment where central banks are manipulating the yield curve. However, we need to remember that bull markets thrive on liquidity and price charts tell us what people are doing with their money.

South Korea’s won has surged through the pack to become the best-performing Asian currency for December after being the outright worst over the previous 11 months.

The catalysts behind its revival: the agreement of an initial trade deal between the U.S. and China -- South Korea’s two largest trading partners -- and improving local data that suggest that economy is turning the corner following a series of interest-rate cuts.

The won has jumped 1.7% this month after President Donald Trump said Dec. 13 the U.S. and China had reached a phase-one trade deal, helping to limit any further escalation of the dispute that has pummeled emerging-market assets this year.

Investors are clearly willing to give a trade deal the benefit of the doubt and that is now being reflected in the outperformance of Asian and European markets relative to Wall Street. The recent weakness of the US Dollar is an additional indication of capital moving out of US assets.

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Currencies are always a relative value argument so it is not so much about whether one currency is strong or weak but rather which is more attractive compared to the rest. There is no single fundamental that governs the foreign exchange market which leaves a great deal of room for argument about how persistent trends are likely to be. However, I think there have been three clear points in favour of the US Dollar over the last couple of years which are now worth re-examining.

Japan’s Topix index advanced, set for its best quarterly gain since 2016, after the latest economic data out of the U.S. indicated the labor market is solid.

Banks contributed most to the benchmark measure’s Friday gains. The Nikkei 225 Stock Average slipped 0.4% to 23,837.72, as 30 of its components traded without rights to receive the next dividend, including Canon Inc. and Japan Tobacco Inc. Next Monday will be the last trading day of the year.

The Topix extended its gain for the quarter to 9.2%, the biggest such increase in three years. Japanese equities have rallied since September, bolstered by signs of easing tensions between the U.S. and China.

U.S. jobless claims fell to a three-week low of 222,000 in the week ended Dec. 21, in another sign of health in the U.S. economy. Major U.S. equity indexes climbed to fresh records Thursday in holiday-thinned trading.

The Yen tends to strengthen when investors are worried and seeking a safe haven. With worries about trade and geopolitics easing, demand for the Yen is moderating and that is helping to stoke demand for equities.

Before we examine the fourth year, remember back to the stat from the third year; since WWII there had never been a down year.  The fourth year is also tilted to the positive, but not quite as unblemished.  Bush vs. Gore at the turn of the century saw a 9.1% loss.  And then 2008 witnessed a blistering 37% decline with the Great Financial Crisis.

Yet what's interesting about both dates is that they coincided with the end of a protracted bull market.  Will 2020 prove the same?  It certainly feels like that might be a possibility.  But I warn that before those two declines, there had also not been a post-WWII fourth year of the Presidential cycle that had fallen either.  From 1948 to 2000, the returns were all to the green side of the ledger.

Perhaps both declines (2000 and 2008) were the result of a Federal Reserve bent on slowing down the economy. With Powell & Co. increasingly looking willing to let the economy run hot, the fiscal pumping from a President (and party) wanting to get re-elected might keep a bid to risk assets.

The priming of the economic pump and the Fed’s complicity in keeping monetary policy on the easy side during the last 12 months of the Presidential election cycle has been a factor in the US markets for almost a century. It also serves as evidence that Modern Monetary Theory is not all that modern. Where it differs from history is in scale rather than substance.

We are heading into the last week of the year. Therefore, when people come back from their break in early January, it is the trading activity that occurs this week which will have the strongest bearing on their perception of where value is to be found in the first quarter of 2020.

It is quite normal for trends that begin in the last week of the year to persist into the first quarter so I thought it would be useful to simply highlight the markets exhibiting a new condition of relative strength or weakness right now.

The DJ Euro STOXX 50 found support in the region of the upper side of a six-month range at the beginning of December and continues to push up towards its 2015 peak.

The U.K. has the luxury of a deep investor base that hoovers up long-dated, fixed-income assets to make sure it can meet its future pension and insurance liabilities. So much so that the yield on 50-year Gilts is lower than that of their 30-year counterparts, meaning there’s a so-called inversion at the long end of the U.K. yield curve:

The average duration of British government debt is much longer than that of its main counterparts; it’s about 14 years, compared to nearly nine years for German bunds and less than seven years for U.S. Treasuries. There is evidently investor demand in the U.K. for longer stuff, but it requires a genuine commitment from the government to stay the course and not leave any ultra-long issue stranded at the end of the yield curve.

Doing a 100-year deal in concert with more 30- to 50-year issuance would make sure there was plenty of interest at various maturities at the long end of Gilts. A century bond could rapidly build scale into the tens of billions of pounds with quarterly auctions, perhaps with a coupon of about 1.5% (by comparison, Austria’s 100-year issue went for 1.17% back in June). This would be a super-cheap way to really commit to some of the biggest infrastructure projects, such as connecting rail links properly in the north of England.

Borrowing vast sums at record low rates makes sense if the proceeds are invested in growth promoting endeavours like education, critical infrastructure and primary research. If invested in glamour projects and growth hindering strategies like high cost energy or military hardware then the benefits which accrue will be less impressive. One way or another, fiscal austerity is over and that means the government will have a growing and ongoing funding requirement.

In addition to a significant increase in Chinese agricultural purchases in exchange for tariff relief, officials have also said a phase-one pact would include Chinese commitments to do more to stop intellectual-property theft and an agreement by both sides not to manipulate their currencies.

Put off for later discussions are knotty issues such as longstanding U.S. complaints over the vast web of subsidies ranging from cheap electricity to low-cost loans that China has used to build its industrial might.

The new duties, which were scheduled to take effect at 12:01 a.m. Washington time on Sunday unless the administration says otherwise, would hit consumer goods from China including smartphones and toys.

Even amid the positive signs on trade, Chinese foreign minister Wang Yi highlighted the other confrontations between the two sides. On Friday in Beijing, Wang said that U.S. actions had “severely damaged the hard-earned basis for mutual trust” and left the relationship in their “most complex” state since the two sides established ties four decades ago.

China has been the primary target of the USA’s tariff regime and its economy has suffered as a result. The European exporters that rely on Chinese demand to fuel growth have also been deeply impacted by the tariffs and the removal of this as a concern represents a significant improvement in prospects.

A link to the full report is posted in the Subscriber's Area. 

Corporations have jumped at the once in a generation opportunity to borrow at record low levels in record amounts. That has understandably increased leverage ratios. Equity is generally more expensive that fixed income as a source of capital, so buybacks have been a logical financial engineering solution to reduce the average cost of capital.

This box focuses on the distribution of liquid assets in the US banking system and how it became an underlying structural factor that could have amplified the repo rate reaction. US repo markets currently rely heavily on four banks as marginal lenders. As the composition of their liquid assets became more skewed towards US Treasuries, their ability to supply funding at short notice in repo markets was diminished. At the same time, increased demand for funding from leveraged financial institutions (eg hedge funds) via Treasury repos appears to have compounded the strains of the temporary factors. Finally, the stress may have been amplified in part by hysteresis effects brought about by a long period of abundant reserves, owing to the Federal Reserve's large-scale asset purchases.

And

Since 17 September, the Federal Reserve has taken various measures to supply more reserves and alleviate repo market pressures. These operations were expanded in scope to term repos (of two to six weeks) and increased in size and time horizon (at least through January 2020). [icon]  The Federal Reserve further announced on 11 October the purchase of Treasury bills at an initial pace of $60 billion per month to offset the increase in non-reserve liabilities (eg the TGA). These ongoing operations have calmed markets.

It is easy to point the finger for the surge in repo rates last September at the feet of the big US four banks. However, that would be to ignore the fact banks have been forced, through the imposition of greater financial regulations, to hold more treasuries as insurance against another calamity. The low participation in the repo market by its traditional market markets created a dearth of liquidity. The US Treasury’s desire to increase its cash holdings, following the increase in Federal debt limit, was probably the catalyst for the subsequent squeeze.

The additional supply reduction would take the kingdom’s production down to levels not seen on a sustained basis since 2014, according to data compiled by Bloomberg.

After the announcement, Prince Abdulaziz predicted that Saudi Aramco, which just completed an IPO at a valuation of $1.7 trillion, would soon soar above the $2 trillion. The kingdom plans to pump 9.7 million barrels a day, he said. That’s a reduction of about 300,000 barrels a day from its output in November and 100,000 below the year-to-date average, according to data compiled by Bloomberg.

There was always a risk that Saudi Arabia would attempt to massage energy prices in order to get the valuation for Saudi Aramco they desired. The IPO priced yesterday at $1.7 trillion which will represent a $25 billion windfall for the kingdom. If the price pops on the upside following the IPO that will give a windfall to the large numbers of domestic investors, many connected to the ruling class, who invested in the IPO. That is obviously a desirable outcome from a domestic perspective for Saudi Arabia.

In Brazil, the inflation pick-up comes as economists and company executives sound the alarm on rising meat prices due to dwindling supply. China, the world’s top meat consumer, doubled pork imports and shipped in 63% more beef in October than a year earlier as the country struggles to ease shortages due to African swine fever.

“The food price shock has arrived” in Brazil, said Leonardo Costa, an economist at Rosenberg Associados. “We’re increasing our 2019 inflation call to 4% because the increase in food and
beverage costs will be even stronger in December.”
 

If inflation is rising, and this appears to be a global phenomenon that will reduce the ability of central banks to continue to cut interest rates. That was certainly a factor in the RBI’s decision to hold rates steady in India today and similar decisions are likely across emerging markets as the full impact of higher food prices rolls through.

The research departments of major asset managers are currently putting out their expectations for what to expect in 2020. There is a great deal of commonality in what is being predicted. The reality is many investors went to cash a year ago and were slow to reinvest. They continue to feel shy about being fully committed and still feel a great deal of uncertainty. That it being reflected in the views being espoused in predictions for 2020.

The cost of dollar funding for non-American banks can change rapidly because it’s sensitive to monetary conditions in the U.S. and abroad. September’s repo turmoil showed the speed with which a spillover could occur between dollar funding and currency markets. Within a day of the sudden surge in the overnight rate on Treasury repurchase agreements that began Sept. 16, the cost to borrow greenbacks while lending euros for a week almost doubled.

For DoubleLine’s Campbell, “the analysis of currency mismatches and asset/liability funding mismatches is an integral part of our investment process as we evaluate these risks on a country-by-country and security-by-security basis.”

At issue is what might happen when foreign banks get caught in a liquidity squeeze, and their sources of dollar funding dry up quickly, he added.

“When we go through the next downturn, a lot of activities are going to be exposed as being problematic,” he said. “The risk is that it could contribute to an even bigger fall in economic activity.”

The IMF first started worrying about the mismatch in Dollar funding requirements and supply back in June. The freezing up of the repo market in October vindicated the view that supply of Dollars was inadequate for the needs of the global economy. The willingness of the Fed to step in and provide $300 billion, to date, is a clear indication they are aware of the problem this condition represents and will act accordingly.

Linking his trade agenda with his Fed criticism in an early morning tweet, he said the two South American countries “have been presiding over a massive devaluation of their currencies, which is not good for our farmers.”

The president’s action amounts to retaliation against two nations that have become alternative suppliers of soybeans and other agricultural products to China, grabbing market share away from the U.S. Rural voters, including farmers, are a key constituency for Trump as he heads into the 2020 presidential elections.

While the steel tariffs could crimp trade, the Latin American countries gain much more shipping crops to Chinese buyers. In the first 10 months of the year, Brazil has shipped $25.5 billion in farm products including soybeans and pork to China. That’s more than 10 times the value of steel and iron product sold to the U.S.

This action is as much about the persistent strength of the Dollar as it is about pandering to farm voters in swing states. The US Dollar has been trending higher against the vast majority of international currencies for the last few years. The growth differential the USA has enjoyed has been one factor in that strength but the Fed’s policy of balance sheet contraction and hiking interest rates was more important.