With the latest sale, China will have dollar securities outstanding with maturity dates ranging from 2022 to 2096 (the result of a small century bond sold in the 1990s). There will be an increasing variety of maturities off which Chinese corporate debt can price, with sovereign benchmarks at maturities from 2022 to 2048 of at least half a billion dollars each.

The total Chinese dollar bond market now tops $740 billion, according to data compiled by Bloomberg, and issuance so far this year has run at a record pace. On a single day in early November, some six property developers were selling dollar securities.

Earlier this month, China also sold euro debt, the first time since 2004 that it issued in that currency. That deal saw blowout demand, with a majority orders coming from European funds in a region that’s been beset by negative-yielding securities.

The rapid growth of the China Dollar bond market was one of the primary reasons the Chinese central bank expressed worry about local government funding mechanisms in 2018. They quickly moved into a curtail the practice but that effort now appears to be over with demand for overseas debt increasing once more. 

The clearest difference between the parties is on how far their messages are spread by people sharing content voluntarily -- known as “organic” reach. Labour currently leads on this across the three most important social media platforms: Facebook, Twitter and Instagram.

Posts from the Facebook pages of Labour and Corbyn -- largely focused on issues such as the National Health Service and criticizing the government’s austerity program -- have been shared more than twice as many times as those from the Conservatives and from Johnson himself, according to data from CrowdTangle, a social media analytics tool owned by Facebook.

Labour and Corbyn have also garnered about 100% more views of their videos on Facebook and Twitter than the Tories, according to CrowdTangle and a Bloomberg analysis.

Knocking on doors has in many respects been replaced by tapping on phone screens and is arguably more effective considering the willingness of people to spend hours on their phones while being reluctant to open the door to anyone let alone politicians. Google and Twitter have been clear they do not see the risk of being accused of election interference as being worth the revenue from political parties. Facebook seems more willing to engage with politics. 

Today’s art-backed loans have gotten larger and riskier for collectors as the art market has started to shrink. U.S. collectors staked their art to borrow up to $24 billion this year, more than double the level a decade earlier, according to the latest data compiled by the Deloitte accounting firm and ArtTactic, an auction-database company. Some affluent borrowers tap their art like a piggy bank to fund living expenses. Others use the loans to buy more art.

But after a four-year rise, the global art market has started to retrench, with the value of sales down 22% at Christie’s auctions in the first six months of 2019 compared with the same period a year earlier. Last week’s $1.4 billion major fall auctions in New York were a third smaller.

If art values plummet, experts say, collectors may need to sell works for less than they are valued to pay down their loans—or add more pieces to their collateral pool to keep their loans square. If not, they could default on loans and forfeit their art altogether.

“If everyone is taking the same art as collateral—same artists, same bodies of work—and there’s a crisis, everyone may need to sell and you have a big problem,” said Adriano Picinati di Torcello, who issued the Deloitte-ArtTactic report last month.

Borrowing against hard assets has been a major investment theme over the last decade. A friend of mine is even involved in assisting art owners to collateralise their wealth via cryptocurrencies which in summary leverage on leverage. I haven’t heard the term collateralised crypto obligation (CCO) yet but it is certainly a growing field.

Private credit. Private credit fundraising softened in 2018 (down 15 percent versus 2017), but its long-term growth trend remains intact. In fact, 2018 was the second-highest fundraising year in history for the asset class (Exhibit 5). Seven-year trailing fundraising has grown at an average of 9 percent per annum since 2013, outpacing both PE and closed-end real estate growth, on the back of sustained low interest rates and a long economic expansion. Annual returns for private debt have averaged around 10 percent since 2008, with higher yields than are available in public debt. This has been an attractive proposition to more and more investors. A good indication is high-yield spreads, which reached ten-year lows in 2018 before widening again in the fourth quarter.

Private credit funds (and hedge funds, which are not included in our data) are now filling a financing void for many middle-market and sponsor-owned companies, helping sectors and providing security structures avoided by banks. Private credit has also increasingly returned to covenant-light lending as the market has grown hotter: in a recent survey by the Alternative Credit Council, 38 percent of North American private credit lenders reported lower financial covenants in the past year, versus just 8 percent reporting higher covenants.

There are obvious merits to investing in privately held companies. For one thing the reporting requirements are considerably less onerous but there is also cashflow and the ability to invest in growth at an earlier stage; thereby catching more of the base effect as businesses expand. The flip side is these advantages are well understood and the desire to capture yield has reduced returns and driven up prices.

In some ways, the Netherlands has one of Europe's most generous retirement systems: at its core, it represents a basic pay-as-you-go state pension as well as employer-run pension scheme which together provide workers with about 80% of their average lifetime wages when they retire. The US and UK have similar systems, but Dutch pension funds are more generous and must use a lower risk-free rate to value their liabilities, forcing them to hold more assets.

Unfortunately, the lower Dutch risk-free rate is not low enough, and as a result about 70 employer-run pension funds with 12.1m members had funding ratios below the statutory minimum at the end of September, according to the Dutch central bank. And here lies the rub: if funds have ratios below the legal minimum for five consecutive years or have no prospect of recovering to a more healthy level, they must cut their payouts. Interest rates have rebounded slightly in recent weeks, but many funds are still facing cuts.

In other words, in making a select handful of European stockholders rich courtesy of NIRP and QE, Mario Draghi is threatening the pensions of hundreds of millions of retired European workers.

So what, if any, is the solution?

Last week, Rabobank reported that the Minister of Social Affairs is supposedly willing to prevent a large part of the pension benefit cuts of 2020, as the government is reportedly willing to lower the minimum coverage ratio from 100% to 90% for one year. This temporary measure can be seen as a pause button, which buys time for:

Pension funds to hopefully recover over the next year. For pension funds, a rise in their risk-free rate term structure which is used to discount their liabilities (EUR 6m swap rates) would be most helpful
Continuing to work out the details of the Pension Reforms announced in June 2019. Unions, employer representatives and the opposition parties were against pension cuts because this would undermine the goals set out in the Pension Reforms.

The logical result of negative yields is the holders of these assets eventually take a loss. Since pensions generally run a ladder of maturities in an attempt to match cashflows with liabilities the proverbial buck stops with them as the yield-to-worst loss is priced in.

What is CECL?: CECL is a new accounting standard that modifies how companies estimate loan and lease losses, and affects all periods starting after December 15, 2019 (i.e., begins 1Q20). In the midst of the financial crisis in 2008, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) established the Financial Crisis Advisory Group (FCAG). FCAG believes it has identified a “weakness in current GAAP being the delayed recognition of credit losses that results in the potential overstatements of assets,” which ultimately led to its recommendation for this new standard. The new standard requires financial institutions to use a combination of historical information, current conditions and reasonable forecasts to estimate the expected losses over the life of a loan. This is a significant shift from the current methodology, which relies on incurred losses. We note on day one of implementation, there will be a balance sheet adjustment, creating additional general reserves for expected credit losses and negatively impacting capital levels, but implying limited income statement impacts.

Conclusion: We walked away with more questions than answers, and anticipate a significant amount of variability in disclosures amongst the banks given the latitude FASB has provided in the standards. While many questions remain, FASB officials, consultants and management teams alike continue to work through the issues and are refining models as overall understanding of the standards improves. Fortunately, we anticipate regulatory capital relief for the banks as necessary, since capital levels remain elevated and the intent of the new standards was not to increase capital levels at the banks. However, we believe there could be some unintended consequences and potential ripple effects that will create further disruption in the space, potentially shifting assets out of the banking space and into the non-bank space, which has continued to gain share. Ultimately, we remain concerned with the uncertainty around CECL, anticipated volatility around disclosures and capital impacts, as well as potential negative implications on industry demand will serve to provide one more reason for investors to not own the space.

The Current Expected Credit Loss (CECL) regime is another piece of regulation imposed on the banking sector which serves to ensure the overleverage and inappropriate risk management that characterised the industry ahead of the financial crisis is not repeated. One of the primary results of successive waves of regulation has been to pile compliance costs onto the banks but it has also reduced their ability to leverage their balance sheets which has unintended consequences.

The investment data shows how cautious private companies have become, with their spending in the first 10 months of the year at the lowest level since 2016. The continued stability in spending by state-owned firms’ is preventing an even stronger drop in the headline data.

Investment in the property market is one bright spot, with spending by the manufacturing sector barely above the record low recorded in September. Infrastructure investment growth continued to bounce along around 4% as it has all year.

“I’m quite concerned with property investment, the only stable element in fixed-asset investment now,” according to Xue Zhou, analyst at Mizuho Securities Asia Ltd in Hong Kong. “Monetary policy needs to be more supportive on economic growth and there should be more cuts to banks’ reserve ratios to help smaller banks.”

The first couple of months of the year are when the Chinese financial system gets its annual quota for lending and generally makes its full allocation by around Chinese New Year. That sends a surge of liquidity into the market in January and February but the broader question is how much of that is already priced in considering it is so predictable.

“If China, U.S. reach a phase-one deal, both sides should roll back existing additional tariffs in the same proportion simultaneously based on the content of the agreement, which is an important condition for reaching the agreement,” Gao said.

Such an understanding could help provide a road-map to a deal de-escalating the trade war that’s cast a shadow over the world economy. China’s key demand since the start of negotiations has been the removal of punitive tariffs imposed by Trump, which by now apply to the majority of its exports to the U.S.

The US Presidential election is less than a year away. The time to prime the pump so growth is humming by the time people vote is now. China might have suffered more from the tariffs, because it has more to lose, but it is also well aware of the electoral timing the Trump administration is pressured by. That suggests a deal is likely to be signed and it is likely to be valid for at least a year.

The company warned there is doubt about its ability to continue operating. Its shares and bonds have plunged since reporting earnings Nov. 5.

*Based on price assumptions of $55 per barrel for oil and $2.50 per million British thermal units for natural gas as well as no debt reduction, Chesapeake is likely to trip its leverage covenant by the third quarter of next year, if not sooner, CreditSights analysts Jake Leiby and Michael Mistras wrote in
the report.

**They predict Chesapeake will have a free cash flow shortfall of about $50 million in 2020 and finish the year with gross leverage of 4.6 times debt to a measure of earnings, above the 4.25 ratio in its covenant.

Chesapeake dropped significantly over the last couple of days and is now dependent on the kindness of strangers to ease debt covenants if it is to survive. The problem for the company is it is not viable at a shale industry average of $55. Its breakeven might be closer to $70. Meanwhile natural gas prices remain volatile, even after the rebound over the last week which took the price back above $2.50.
 

Federal Reserve officials reduced interest rates by a quarter-percentage point for the third time this year and hinted they may be done loosening monetary policy, at least for one meeting.

The Federal Open Market Committee altered language in its statement following the two-day meeting Wednesday, dropping its pledge to “act as appropriate to sustain the expansion,” while adding a promise to monitor data as it “assesses the appropriate path of the target range for the federal funds rate.”

As with the September statement, the FOMC cited the implications of global developments in deciding to lower the target range for the central bank’s benchmark rate to 1.5% to 1.75%.

Treasuries weakened on the Fed’s announcement, pushing the 10-year yield up briefly to 1.81% from 1.80%. Stocks were little changed and the U.S. dollar gained. Traders also pared wagers on a fourth consecutive rate cut in December.

The Fed has been of the opinion we are in the midst of a mid-cycle slowdown. I think we can think of that as a best-case scenario which is why there is so much uncertainty about the outlook for rates amid the surge in bond prices. Let’s see what the charts tell us.

The wild card is how Treasury may address the elephant in the room. Dealers expect comment on last month’s turmoil in funding markets. And to some extent, the Treasury’s borrowing plans this fiscal year will be viewed, and traded, in light of the Fed’s T-bill purchases to replenish bank reserves. The central bank embarked on the program this month, saying it will run “at least into the second quarter” of 2020 at an initial monthly pace of about $60 billion.

 “They’re taking about half of net issuance next year,” said Gennadiy Goldberg, senior U.S. rates strategist at TD Securities.

Some say the Treasury’s relentless debt sales have contributed to a shortage of reserves in the financial system, which last month forced the Fed to resort to a money-market operation it hadn’t deployed since the financial crisis.

Treasury Secretary Steven Mnuchin has rejected that notion, saying this month that the September upheaval had “nothing to do with our issuance.” But the department is clearly curious about how dealers are coping with growing supply. It sought comment in this month’s survey on “the interaction between primary dealer positions, auction participation, and recent repo market variability.”

The lack of liquidity in the repo market is an anomaly. Whether it is because banks no longer have the liquidity to take advantage of arbitrage opportunities, or because the Treasury’s voracious appetite for funds is soaking up available liquidity, the fact remains there are not enough funds to meet the requirements of the market. That pretty much forces the Fed to step in and provide as much liquidity as required to ensure orderly markets.

The pound weakened after U.K. lawmakers rejected Prime Minister Boris Johnson’s plan to fast-track his Brexit accord through parliament.

Britain’s currency dropped against all of its major counterparts, but the losses were contained after the government won an initial vote on the deal. Johnson opened the door to a short extension to his Oct. 31 deadline, saying he would pause legislation and go back to the European Union, after earlier threatening to throw out the deal if lawmakers rejected his plans.

“For now it seems the market is still generally expecting this is a setback, but not a fatal setback, to a negotiated Brexit,” said Jeremy Stretch, head of G-10 currency strategy at Canadian Imperial Bank of Commerce. “There hasn’t been a rapid uptick in no-deal pricing at this point,” he said, referring to a scenario where the U.K. would leave the EU with no divorce deal.

The U.K. currency had rallied more than 8% from September’s low as Johnson secured an agreement with the EU and then lawmakers then forced him to request an extension to the Oct. 31 deadline, reducing that no-deal risk.

Sterling dropped as much as 0.7% after the votes to $1.2869, after rallying Monday to touch $1.3013, the strongest level since May. Against the euro, it fell 0.4% to 86.39 pence.

Parliament today supported the deal which, as expected, excises Northern Ireland economically from the UK. That is not going to be received well by loyalist communities in North Ireland. However, it is likely to be positive for the region’s economy since it will have a toe hold between the UK and the EU and subject to corporate taxes could attract inward investment.

The more that markets internalize this shifting monetary policy sentiment inside central banks, the more that they will unwind the policy expectations that fueled several forces acting to invert the U.S. yield curve, including indirect ones such as the enormous pressure on foreign investors to flee negative yields in Europe and Japan and go into longer-dated U.S. bonds. Look for this phenomenon to also maintain the yield spread between German and U.S. bonds at its current lower range despite what will continue to be relative economic outperformance by the U.S.

Just as I argued in March that it was unwise to react to the inversion of the Treasury yield curve with extreme anxiety about a U.S. recession, it would be premature to celebrate the recent partial reversion as an indicator of significant strengthening of U.S. economic prospects. Instead, both are reminders of the extent to which traditional economic signals have been distorted by a prolonged period of extraordinary central bank policies. And they should also been seen as just one of the unusual consequences of a monetary stance that, imposed for several years on central banks by the lack of proper policy action elsewhere, will now see the hoped-for benefits give way to a broadening and deepening recognition of the unintended consequences and collateral risks.  

An inverted yield curve has been one of the most readily available lead indicators for a US recession for decades. There is always an argument that this time is different and that it only works for the USA’s economy. It is also worth remembering that no US recession has occurred without an inverted yield curve first but is a very small number of false positives. When considering the history of the measure anyone who is willing to buck the historical trend is betting on the signal giving a false positive.

I have to admit I don’t look at the internals of the market all that often because it is the trend rather than the day to day moves which lend some insight into the health of the market. I thought it might be useful to look at some of the most common measures to discern if any clues to market direction are evident.

The Total Number of New 52 Week Highs on the NYSE Index is coming back down towards the lows December 2018 and towards the end of 2015. The significant spike on the upside in late 2017 was an anomaly suggesting a period of underperformance ahead, but generally lows are better predictors of market bottoms than spikes are of tops.

Rather than purchase longer-dated securities, Mr. Powell said officials are now contemplating buying shorter-dated Treasury bills. Officials believe holding long-term securities boosts the economy and financial markets by lowering long-term rates and driving investors into stocks and bonds. They think a portfolio weighted toward shorter-term securities provides less or no stimulus.

The Fed’s plan hasn’t been finalized, but Mr. Powell suggested would be ready by or before officials’ Oct. 29-30 policy meeting. The goal would be to rebuild the level of reserves in the system sufficiently above the low point of less than $1.4 trillion reached last month.

The demise of institutional prop trading and the requirement on banks to hold “Tier 1 capital”/government bonds mean there is no additional liquidity to contain spikes beyond the upper setting for repo rates. The Fed has no choice but to supply that liquidity.

The unusual nature of the forces at play -- and the fact that many of them are geopolitical and emanate from abroad -- makes it more difficult for policy makers to decide how far to go in easing credit.

There’s even a question of how effective rate cuts will be in an economy where business executives fear such dire developments as the breakup of global supply chains.

Powell is expected to deliver his latest thinking on the outlook when he speaks to the National Association for Business Economics in Denver at 2:30 p.m. U.S. East Coast time on Tuesday. He said last week that despite some risks, the U.S. economy is in a “good place,’’ and that the Fed’s job is “to keep it there.’’

Mrs. Treacy’s containers arrived from China over the last few days and I spent most of this morning at Los Angeles port. I have been going to down to the customs warehouses twice a year for four years to help out in the business but also to get a feel for what activity is like at one of the country’s busiest ports of entry.

Multiple surveys show that traders and investors see the U.S.-China trade war as the biggest risk facing markets. Bank of America Merrill Lynch’s latest monthly poll of global fund managers, released in mid-September, revealed that the number of respondents who said trade tensions were the biggest danger outstripped by far those who cited ineffective monetary policy and the potential bursting of the bond bubble. In her first major address as head of the International Monetary Fund, Kristalina Georgieva said Tuesday that the global economy is in a synchronized slowdown, in part due to trade uncertainty. Also on Tuesday, the National Federation of Independent Business said its small-business sentiment index fell to near the lowest level of Donald Trump’s presidency. Even more notable was that the part of the index measuring “uncertainty” plunged to its lowest since February 2016.  “More owners are unable to make a statement confidently, good or bad, about the future of economic conditions,” the group said, with 30% of respondents reporting “negative effects” from tariffs. To cut to the chase, if businesses can’t forecast with any confidence, how can investors or strategists?

U.S. and China trade negotiators are scheduled to meet on Thursday to resume talks. What’s discouraging is that instead of making conciliatory comments, each side seems to be hardening their stances. Chinese officials said Monday that what isn’t on the table from China’s perspective — and never will be — are changes to its laws to protect foreign intellectual property. Later that day, the U.S. placed eight of China’s technology giants on a blacklist over alleged human rights violations against Muslim minorities. In response, China hinted that it might retaliate. Then the news broke that the Trump administration is moving ahead with discussions around possible restrictions on portfolio flows into China. None of this sounds like either side is ready to make a deal.

Political rhetoric amplifying ahead of the start of negotiations have been a trend that has evolved over the last year. Each of the other occasions has ended in disappointment and the market is now pricing in a similar conclusion to the upcoming talks.

On a global level, bonds with a value of about $15 trillion currently trade with a negative yield. What’s going on here?

For every investor today, the starting point must be the bond market. Just a few weeks ago, we had $17 trillion of negative yielding debt. We’re now down to about 15, but even that is way too much. This is investment money that is guaranteed to produce a loss of capital. These extreme levels in today’s bond market can only have three possible explanations. One, the world faces an economic meltdown of epic proportions. Two, the bond market is the biggest bubble we have ever witnessed, and three, we have just experienced a massive buying panic in bonds.

I agree with all three of these points so we then need to address the question of what will happen to deflate the bubble. The answer is inflation which is like kryptonite for the bond market. The only way anyone can justify buying bonds with a negative yield is if they believe the deflationary argument is self-fulfilling. 

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

The one thing we know is the consensus’ in markets seldom reach the worst or best predictions of investors. The rationale for MMT is compelling. The US government is already running a $1 trillion deficit in a boom and needs to pay for that with a large issuance of bonds. Since this is occurring before a crisis, investors logically conclude that trend has to continue in a linear manner. However, we have ample evidence of outcomes eventually working out much differently in reality.

The government considers it’s still not clear whether Germany will plunge into a full-blown recession and, as a result, the full array of remedies may not need to be deployed.

Germany’s five leading research institutes slashed their forecasts for economic growth this year and next, citing trade tensions and Brexit weighing on German industry. GDP is to grow 1.1% in 2020 from a previous forecast of 1.8%, and 0.5% this year from an earlier prediction of 0.8%.

Traditionally, Germany shifts to high alert whenever the global economy looks to be slowing -- the country’s dependence on exports means that it tends to head south with the rest of the world. But with the domestic market still relatively robust and the ECB renewing monetary stimulus, Merkel’s economic team judges that this time the path toward recession is less certain.

On the down side, a prolonged trade war could eventually lead to a much bigger fallout than expected, according to another scenario being considered. That spurred the government to gradually increase investments and bolster the labor market as a preemptive and precautionary measure.

Finance Minister Scholz told ARD TV on Wednesday that economic forecasts are pointing toward a recovery and that there is currently no need for a stimulus program.

“We are well prepared because we have good financial resources and can react, should it really come to an economic crisis but so far it’s just slower growth,” Scholz said.

The bond market has been signallng for a while that all is not well in the global economy. The fact that just about all of Germany’s sovereign debt is trading with a negative yield is as much about the outlook for global growth as it is about the ECB’s negative interest rate policy. The Eurozone has been relying on the strength of the export sector to pull growth higher but the slowdown is exposing the absence of a clear domestic demand story to offset the slowdown in demand.

While clear signalling for the end of the austerity program remains unlikely, there is evidence of fiscal laxity creeping in all over the continent. Italy, France and Spain are already engaged in fiscal stimulus and it is only a matter of time before Germany deploys its balance sheet to support the economy.

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

Germany failed to sell a 2 billion zero coupon bond in August which was a precursor to the reversionary move seen in bond prices. However, the economy is recession and there is no prospect of the ECB raising rates. Instead quantitative easing will further increase the ECB’s holdings of regional sovereigns.

Richard Russell used to say “print or die” and that is exactly what the central banks of the world are going to do. What I find particularly interesting is the comparison with debt levels only being approximating current levels during wartime. That must mean we are in a war but this time it is with ourselves and the contention is about the ability to pay unfunded liabilities.

One would be forgiven for concluding that algorithms have been programed with round numbers in mind. Roundophobia has been a topic of conversation at The Chart Seminar for decades but it is particularly relevant now because so many instruments have paused in the region of big round numbers. I’m greatly looking forward to the next event which will be in London on October 3rd and 4th.

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

The Credit Suisse short-term interest rates (STIR) team have been way out in front of the Fed’s dilemma in needing to support the repo market while also being reluctant to expend its balance sheet. The clear risk is the Fed will have to settle for lower quality assets in order to control the size of its balance sheet.

The typical U.S. home now sells for more than four times the median U.S. income, according to the Joint Center for Housing Studies at Harvard University. Between 1980 and 1999, home prices were closer to three times household income.

• Given the savings rates of the millennial generation born between 1981 and 1996, rental-listing company Apartment List estimates that two-thirds of millennial renters would require at least two decades to save enough for a 20% down payment on a median-priced condo in their market. Just 11% would be able to amass a 20% down payment within the next five years.

• The upshot: Millennial households had an average net worth of about $92,000 in 2016, nearly 40% less than Gen X households (people born between 1965 and 1980) had in 2001, adjusted for inflation, and about 20% less than baby boomer households (born from 1946 to 1964) had in 1989, according to data from the Federal Reserve.

So it’s time to kill the idea that student-loan debt is always “good debt,” to admit that buying a house isn’t always the right move, and to refashion these old expectations. It’s time for a new playbook.

Student debt and the promise of progressive candidates to cancel it are potential election winners as the millennial demographic becomes more influential in US elections.

Futures traders still see about another quarter-point of easing from the Federal Reserve this year, after the central bank cut rates on Wednesday and said it will “act as appropriate” to sustain the economic expansion.

The rate on the January 2020 fed funds futures contract was about 1.63% after the central bank’s announcement. The dot plot accompanying the statement shows policy makers’ median projections are for interest rates to remain on hold this year and next, but the balance of views has shifted more dovishly.

Judging by this level, traders still expect one more cut in either of the Fed’s two remaining decisions this year -- on Oct. 30 and Dec. 11. This estimate of the market’s pricing assumes that the effective funds rate moves toward the middle of the Fed’s new target range of 1.75% to 2%.

The Fed’s balance sheet is belatedly started to expand once more as the liquidity demands of the economy and Treasury market pressure the central bank to provide the funds necessary to ensure an orderly market. That is the most basic requirement for central banks, but the requirement has been exaggerated by the shrinking of investment and commercial bank balance sheets over the last decade. That suggests even without quantitative easing there is a clear need for the Fed to expand its balance sheet.
 

“There’s been a sea change in markets, and it’s one the Fed needed to respond to,” said Lou Crandall of Wrightson ICAP. “In the current market environment, there is just not enough elasticity in the repo market to handle the big seasonal swings of the banking system. The Fed needed to come in now and alleviate the immediate problem, while it is also working on long-term solutions.”

The Fed has considered introducing a new tool, an overnight repo facility, that could be utilized when needed to reduce pressure on key money market rates, but no decisions have been announced.

The New York Fed declined to comment on the events of this week.

Actions like the Fed took Tuesday were once commonplace, but stopped being so when the central bank expanded its balance sheet and started using a range of rates to implement its policy in the aftermath of Lehman Brothers’ 2008 collapse.

Securities eligible for collateral in the Fed operation include Treasuries, agency debt and mortgage-backed securities. In an overnight system repo, the Fed lends cash to primary dealers against Treasury securities or other collateral.

Bank balance sheets are not what they used to be. One of the primary results of the heavier regulations imposed on the sector since the financial crisis has been to cut the primary investment banks out of risk taking. That is impeding their ability to provide liquidity when the market needs it and is likely to result in the Federal Reserve intervening more often to assist.

“I think that they were just very impatient in this round of negotiations,” said Marick Masters, a management professor and the director of Wayne State University’s labor studies program.

But there’s a flurry of complicating factors in ongoing negotiations. Union leadership is under increased scrutiny as federal prosecutors continue to unravel a sprawling culture of corruption among former UAW leaders and negotiators.

There also was a strong sense inside and outside the union that a strike was likely, Masters said. Such an outlook could have contributed to the speed with which the strike was called, according to the professor.

“It’s hard to say how far apart they are,” Masters said of the UAW and GM. “But I get the feeling that they are pretty far apart. So you hope that they come to their senses pretty soon. But it certainly has the makings to go on for a very long time with the caveat that when reality sets in, they’re probably going to want to sit down and see what they can do to bring things back together.”

Workers are increasingly agitating for a bigger piece of the pie as stocks close in on all-time new highs and the cost of living increases. That is contributing to the potential for inflationary pressures to reappear despite the widespread fear of deflation that has pervaded sovereign bond markets this year.

The unprecedented revolt took place during a fractious meeting where Bank of France Governor Francois Villeroy de Galhau joined more traditional hawks including his Dutch colleague Klaas Knot and Bundesbank President Jens Weidmann in pressing against an immediate resumption of bond purchases, the people said. They spoke on condition of anonymity, because such discussions are confidential.

Those three governors alone represent roughly half of the euro region as measured by economic output and population. Other dissenters included, but weren’t limited, to their colleagues from Austria and Estonia, as well as members on the ECB’s Executive Board including Sabine Lautenschlaeger and the markets chief, Benoit Coeure, the officials said.

The competition to influence the replacement of Mario Draghi as head of the ECB is heating up. Verbal opposition to the policies announced today came from a number of the countries who were contenders in the race for the top job. Proving your verbal commitment to monetary prudence is almost a pre-requisite in some countries, regardless of the reality once in office. 

The likelihood of U.S. recession before the 2020 election has grown, based on changes in the Treasury yield curve, according to Jeffrey Gundlach, the billionaire money manager and chief executive officer of DoubleLine Capital.

“We should be on recession watch before the 2020 election,” Gundlach said Thursday in London. “We’re getting closer but we’re not there yet.”

The odds of a U.S. recession before the election are 75%, said Gundlach, whose Los Angeles-based firm oversees more than $140 billion, reiterating a prediction he made in August.

The best signal of a recession is not an inverted yield curve, the money manager said. “It’s the inversion occurring and then going away.”

Yields on 2-year Treasuries exceeded those on 10-years in August, forming an inversion, before flipping back this month.

In other comments, Gundlach said:

* He’s turned “neutral” on gold, one of his previously recommended investments. “It’s had a big run.”

* The U.S. and China are unlikely to reach a long-term trade pact before the presidential election.

* It’s a “terrible time” to bet on U.S. housing and homebuilder stocks because of high inventory and weak demand.

The US yield curve spread inverted in August and is now mildly positive. The peculiarity of the spread is it is a reliable lead indicator for US recessions, but the corresponding spread does not provide a reliable lead indicator for other markets even though the rationale for why it should lead is the same.

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The Federal Reserve in particular has stated it is aware of the risks to the economic expansion and is willing to do what is necessary to ensure it persists. This is quite different from what Alan Greenspan was saying in 1998 when he made his irrational exuberance speech.

You wouldn’t know it from benchmarks, but beneath a tranquil surface violent swings are lashing traders along obscure fault lines. Companies like real-estate firms that rose the most in 2019 are plunging, and some that have trailed are being pushed out front. It’s been a mild reckoning for hedge funds and others who have bet on the status quo persisting.

Amid all the churn has been a renewed focus on a quantitative concept known as factor investing, which groups companies not by industry but traits such as how fast their prices move or profits rise. A question gaining currency in the past few days is whether these categories are just handy descriptions of twists in the market -- or are at some level guiding them.

“It seems very mechanical right now,” said John Swarr, investment specialist at Penn Mutual Asset Management, which has $27 billion under management. “If you look within some of these stocks that are being hit the hardest, some are in much better shape than others and yet they’re all being affected similarly,” he said. “It does feel like it’s a rules-based rotation.”

The total of negative yields bonds was at $17 trillion for a brief time at the end of August and has since contracted to $14.3 trillion. That’s a big more in a little less than two weeks.

The failure of the German government to sell a full allocation of bonds and failed auctions at the US Treasury in August were probably the catalysts for sapping investor demand for bonds globally. The unwinding of leveraged long positions now has the scope for meaningfully move bond yields higher with clear upward dynamics evident across multiple markets.

Negative yielding debt is a concept that could only be considered rational by an academic. Given 4,000 years of human history, I’ll bet this is as faulty an idea as there ever has been and that it will be proven to be 100% hokum. Negative yields distort the entire capital asset pricing model. They undermine financial company profit models, pension fund liability assumptions, and seriously work to reduce the attractiveness of lending money and financial liquidity by eliminating the ability to do repo finance. But don’t worry, since the central banks will save the day by buying corporate debt. Isn’t that what the Japan’s central bank did, as well as the ECB? And what have these policies achieved in terms of real economic growth? Very little! And now we have members of the Fed actually discussing and agreeing that a negative rate can be effective and appropriate. In other words, penetrating the zero-rate boundary will broaden their policy options. Again, the Fed is clueless and is working with inadequate and ineffectual sets of econometric models.

Negative rate policies distort the economic and financial market systems. The unintended consequences from these policies will be significant and harmful. To deploy capital successfully, the potential list of companies is most likely very limited. At the very minimum, potential target companies should have extremely strong balance sheets to weather the oncoming economic and financial market tsunami. They should also have strong market positions. My guess few companies, with this limited set of criteria, would be attractively priced. Thus, a high level of liquidity is necessary. Finally, escaping to long-term bonds is similar to investing in equites, since their effective durations have volatility characteristics like those of equities.

Stock markets are waiting with baited breath to hear what the ECB has planned on Thursday. The bond markets have priced in a flotilla of policy easing tools such as negative short-term interest rates, deeper negative deposit rates, a tiered deposit rate to aid the banking sector and a fresh round of quantitative easing. The strong momentum push in bonds to a record total of negative yields priced in all of these initiatives.

He makes $21 an hour, but his wages have not risen in five years. He hopes a new contract will help him and his co-workers keep pace with California's cost of living increases. Prices in California are rising nearly twice as fast as the rest of the country, according to the Labor Department.

"We're on the front lines. We work in the stores. We're pulling in the money," Escarcega said. "We're not being taken care of so that's why we're here."

Escarcega said that going on a strike would be a "last resort" for employees, but that "everybody wants to speak up and get what we deserve."

Grocery workers often have more leverage in negotiations with employers than other retail workers because groceries are perishable and companies can ill-afford work slowdowns, experts say.

Minimum wages in California were $10 in 2016 and have risen increments over the last few years. They are due to hit $15 an hour in July next year. The predictable result of those increases is to cause people who were previously making above minimum wage to demand more money for the same job. It comes down to basic human psychology. No one wants to think of themselves as a minimum wage worker so when the lowest rate rises everyone wants to sustain their buffer to enhance their own feeling of self-worth. That might be considered the push side of the argument.

Concerns about ECB underdelivering keeps the pressure on bunds. A wide range of possible outcomes from Thursday’s meeting slants towards near-term profit taking of very rich valuations.

ECB speakers have been trying to dial back the extreme easing expectations priced by markets to give Draghi some room to surprise, but the hurdle still remains high

Policy makers will need to be aggressive on rates and keep the future path suppressed otherwise a modest depo rate cut risks seeing EUR rates continue to sell off in the near-term given the impact of the lower bound on the curve

From a macro valuation perspective there is room to sell off (with fair value of -0.43%)

Setting the path to go deeply negative on rates and lifting the buying limits on any QE announcement to make it scalable is key to seeing bunds extend the rally in the short term; however, positioning for a disappointment via options is still worth looking at given the difficulty for Draghi to engineer a dovish surprise

The ECB has quite a dilemma in front of it. The short end of the yield curve is sporting negative yields for just about all sovereigns. However, when we look at the shape of the yield curve for individual countries, compared to the Eurozone as a whole, we get two very different pictures.

U.S. stocks edged higher, and Treasuries inched lower after a mixed jobs report fueled bets the Federal Reserve will cut rates in two weeks. The dollar declined.

The S&P 500 headed for its second weekly gain as investors keyed on underlying strength in the report that signaled a solid labor market that isn’t too strong to deter further central bank easing. Megacap technology stocks weighed on benchmarks after New York opened an antitrust probe into Facebook Inc.

The 10-year Treasury yield erased most of its earlier gains, while the dollar headed for its fourth straight fall following the payroll numbers. Chairman Jerome Powell is set to make public remarks Friday. Crude sank toward $55 a barrel in New York.

The bond market has already priced in at least a 25-basis point cut so the soft jobs report confirms the need for additional easier policy. China also cut its bank reserve requirements today in an effort to extend credit. The ECB is expected to announce some form of easing when it meets next week and the region’s bond markets have been busy pricing in a negative short-term interest rate. All of these measures contribute to stimulative measures.

The outlook for the public debut of WeWork, which has racked up billions of dollars in losses in recent years as the company funds grand ambitions, is cooling after the disappointments of other major IPOs this year such as Lyft Inc. and Uber Technologies Inc. That could put pressure on WeWork, which has a mammoth credit line tied to the success of the IPO, as well as SoftBank Group Corp., which invested at a $47 billion valuation earlier this year.

“They would probably price this thing at the more conservative end, maybe in the $20 billion range, given that the company is trying to raise more money,” said Phil Haslett, co-founder of EquityZen, a marketplace for private stock sales.

Potential terms for the share sale are still being discussed, and the eventual valuation could change depending on investor demand, said the people, asking not to be identified because the information is private. A representative for WeWork, whose parent is The We Co., declined to comment.

One of the most memorable moments from a Marcus Evans conference I attended earlier this year was the conversation I had with one of the other delegates at dinner. He was a long/short equity manager at Pimco, but had been recruited by one of his clients to run a venture fund which would be seeded with about $200 million. He was at the conference to make contacts because he hadn’t the foggiest idea how to invest in private companies. His client was being attracted by stories of instant wealth and almost risk-free returns in what has the “no brainer” investment of the last decade.

Apple Inc. on Wednesday joined U.S. companies including Deere & Co. and Walt Disney Co. in a recent sprint to issue new bonds, taking advantage of the steep decline in benchmark interest rates and a surge in investor demand.

Apple launched its first bond deal since 2017, selling $7 billion of debt. All three companies issued 30-year bonds with yields below 3%, a first for the corporate debt market.

Twenty-one companies with investment-grade credit ratings issued bonds totaling about $27 billion on Tuesday, said Andrew Karp, head of investment-grade capital markets at Bank of America Corp. “That’s equivalent to a busy week for us—in one day,” he said. About 20 more companies were expected to issue investment-grade bonds Wednesday.

The issuance boom is one consequence of a rally in debt that has driven down Treasury yields, which fall as bond prices rise, to near-record lows. Spurred by concerns that slowing growth and a mounting trade conflict will end the decadelong global economic expansion, investors have swept up government bonds around the world, pulling yields in many countries into negative territory. Bonds issued by name-brand corporations give investors a relatively safe alternative that still pays more than government bonds.

Anyone with any sense is either refinancing or issuing debt at these levels. There is a cacophony of people talking about the US following Europe and Japan into negative rates. That is a possibility but the bigger question is when? It does not look likely before the end of the year and in the meantime, there is a wave of corporate and sovereign bond issuance for the market to digest.

London, Seattle, Manchester and, um, Xiamen. Some of the world’s priciest housing markets aren’t where you might think. A four-year property boom in China has elevated a collection of little-known cities and turned them into real estate gold.

While that’s been great news for speculators, it’s raising concern about whether China’s educated middle-class is quickly being priced out of these so-called second-tier cities, undermining Beijing’s goal of making them home to the millions moving from rural areas. Another risk is increasingly stretched family budgets: The average household debt-to-income ratio in China soared to a record 92% last year from just 30% a decade ago.

“A property bubble is foaming up in many places in China,” said Chen Gong, the chief researcher at independent strategic think tank Anbound Consulting. “Prices are starting to look
abnormal when compared to residents’ income.”

When something sounds crazy, that’s usually because it is. Xiamen is a smallish city, by Chinese standards, in Fujian. It’s a long way from any of the other coastal metropolis’ stature so its rise as one of the most expensive places in the world to buy property is further evidence of another bubble inflating in financial assets, this time in China.

At the end of last year, a return of inflation was assumed to be inevitable with the 10-year Treasury yield trading comfortably above 3%, commodity prices recovering, wages marching higher, full employment and high capacity utilisation. The perspective could not be more different today.

Interminable deflation has been priced in to Treasury yields as they test the lows of the last eight years. Commodity prices are under pressure, the trade war has resulted in a number of export dependent nations flirting with recessions, purchasing managers indices suggest contracting manufacturing activity and an inverted yield curve has started the clock on the next recession. Meanwhile gold has exploded on the upside to complete a six-year base formation.

What is likely to happen to the price of precious metals if a bubble in equities arises for all the reasons that you have stated. Precious metals appear to fall each day that equities perform well. Which sectors/countries are the likely leaders If there is an equities bubble or will we need to wait for the charts to tell us?

Gold has rallied impressively to complete a six-year base. The catalyst for that move was the perception the ECB is about to move interest rates below zero. That spurred a massive move in bonds that has created a situation where $17 trillion in nominal bonds are trading with negative yields in Europe and Japan.

Reserve Bank of Australia comments in 2019/20 corporate plan released on website Friday.

“Over 2019/20 to 2022/23, the structure of the Australian economy will continue to evolve and economic shocks -- which, by definition, are not forecastable -- will occur. Movements in asset values and leverage may be more important for economic developments than in the past given the already high levels of debt on household balance sheets”

“Especially in the context of weak growth in household income, high debt levels could complicate future monetary policy decisions by making the economy less resilient to shocks”

“The flexible medium-term inflation target is the centerpiece of the monetary policy framework in Australia and has been well established for more than two decades. Since the early 1990s, it has provided the foundation for the bank to achieve its monetary policy objectives by providing an anchor for inflation expectations. The bank will remain alert to new developments that may have a bearing on the framework for monetary policy”

The Australian Dollar remains in a medium-term downtrend, moving to a new closing low today. With energy and iron-ore prices declining and the domestic housing market in a parlous condition the RBA may be required to embark on the same counter deflationary measures other developed markets have endured over the last decade.

For the first time since 2009, S&P 500′s dividend is yielding more than 30-year Treasury bonds.

The only other similar inversion in the past four decades came in March 2009 — a low point of the financial crisis, according to data from Bespoke Investment Group. But it might bode well for stocks as investors have few other options to find yields.

“For an investor looking to hold something for the long term, it makes equities relatively attractive,” says Bespoke’s Paul Hickey. 

The contraction in government bond yields, globally, have driven demand for higher yielding assets. It has been one of the primary factors in containing risk in the high yield sector and it is also likely to continue to represent a major factor in the ability of the primary indices to continue to hold in the region of their peaks.

Since then, we have had a mirror-like symmetrical reversal (a dis/deflationary blow-off). Look at the current inflation rates at the current cyclical peaks (i.e. not much inflation despite the world economy and financial markets being near a peak and despite all the central banks’ money printing) and imagine what they will be at the next cyclical lows. That is because there are strong deflationary forces at work as productive capacity has increased greatly. These forces are creating the need for extremely loose monetary policies that are forcing central banks to drive interest rates to such low levels and will lead to enormous deficits that are monetized, which is creating the blow-off in bonds that is the reciprocal of the 1980-82 blow-off in gold. The charts below show the 30-year T-bond returns from that 1980-82 period until now, which highlight the blow-off in bonds.

Today’s 7-year auction of Treasuries came in well below expectations suggesting at least some reticence to participate at decade-low yields. The effect on yields was minimal but we did see a pause in the run-up in gold.

With just over two months until Johnson’s self-imposed deadline to leave the European Union with or without a deal on Oct. 31, every day is going to count. And since Johnson wants a new Queen’s Speech to set out his government’s legislative agenda, which is usually followed by five days of debate, it will be more like two weeks of parliamentary time lost.

While suspensions of as much as two months were common in the 19th century, most prorogations of Parliament in recent decades have lasted for less than a week. Johnson’s suspension for 35 days will be the longest since the 1970s, according to the House of Commons library.

The U.K. doesn’t have a written constitution and, within reason, governments can do whatever they like as long as they have a parliamentary majority. But given that a number of ex-ministers -- including former Chancellor of the Exchequer Philip Hammond and Theresa May’s Justice Secretary David Gauke, have already attacked his move, that is far from guaranteed.

Exiting the EU and retaking the ability to set its own rules and regulations is a once in a generation opportunity to recast the UK’s economy as a pro-growth engine for innovation and trade. Grasping that opportunity is the only way the UK will make a success of Brexit, so it is imperative that the raft of measures proposed in September is not simply a commitment to double down on spending without a plan to grow.

So-called tappable equity grew by more than $335 billion during the quarter. The total is 26% more than the mid-2006 peak of $5 trillion. Roughly 45 million mortgage holders have excess equity, and half of them have mortgage rates higher than 4.25%, making a refinance not only possible but attractive. The average rate on the 30-year fixed is now around 3.6%. The majority of these borrowers also have top credit scores.

Falling mortgage rates over the past several months have caused a surge in overall refinance activity, but despite the record housing wealth, homeowners have been highly conservative about taking cash out. In 2006, 89% of refinances were cash-out, according to Freddie Mac. In 2012, when home prices crashed, that share dropped to 12%. But even now, with prices back above their previous peak and mortgage rates much lower, cash-out refinances are just 61% of the total pool of refinances.

“I think you’re seeing a little bit of reluctance both on the side of lenders and on the side of borrowers,” said Andy Walden, director of market research at Black Knight. “If you look at lending, guidelines are a little bit tighter than they were back in 2006, but even given those lending restrictions, I think you’re seeing more conservative behavior on behalf of homeowners as well, as folks have the remembrance of the financial crisis in the rearview mirror.”

I was at an end-of-summer party on Saturday night and conversation turned to mortgage refinancing. About half of the people I was talking with had used low rates over the last 18 months to refinance at about 3.5% while the rest had not done so yet. Mortgage rates have done a round trip from 3.5% to 5% and back again over the last year and there is still scope for the rate to move lower. That is going to put additional cash in the pockets of the people most likely to invest in the stock market.

Gold and silver futures rose on Tuesday (http://www.marketwatch.com/story/gold-higher-but-silver-sets-the-pace-2019-08- 7), with gold settling at a level not seen since 2013, and silver scoring its highest finish in more than two years. Prices for the precious metals got a boost from losses in the U.S. stock market, a drop in Treasury bond yields and a weaker dollar--all of which helped lift the metals' investment appeal. December gold climbed by $14.60, or 1%, to settle at $1,551.80 on Comex. That was the highest most-active contract settlement since April 2013, according to FactSet data. September silver added 51.2 cents, or 2.9%, to end at $18.153 an ounce, the highest since April 2017

The continued compression of government bond yields is creating significant demand for gold as a hedge against competitive currency devaluation. That is now starting to be manifested in other precious metals with silver playing catch up and platinum beginning to garner attention.

Inflows into the foreign RRP facility are a case in point. Just as an inversion is forcing foreign central banks to latch on to the Fed for collateral, an inversion would force primary dealers and banks to latch on to the Fed for reserves, as weak demand for Treasuries from ultimate investors drives growing dealer inventories. The optics of what we just described are odd…

…as they imply the conflicted existence of two uncapped facilities: a foreign RRP facility that sterilizes reserves and adds to collateral supply and a standing repo facility or an asset purchase facility built to add reserves and absorb collateral. That makes no sense…

…it has to be one or the other. If the standing o/n repo facility or an asset purchase facility (or “mini-QEs”) are the future, an uncapped foreign RRP facility must be the past. Whether the Fed provides a technical fix with or without an uncapped foreign RRP facility, we don’t think a technical fix is the right solution for the problems caused by the inversion. All this brings us back to the rationale for more rate cuts – a series of rate cuts (see here).

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The US Treasury has a substantial funding requirement this year with upwards of $600 billion in bonds maturing. Coupled with the increased demand for collateral from the reverse repo facility and the increased deficits agreed to as a way of avoiding a government shutdown that suggests significant bond issuance. Ensuring that issuance comes at as a low of yield as possible and with as long a maturity as possible is likely behind speculation on 50-year and 100-year bond issuance.

“Trade policy uncertainty seems to be playing a role in the global slowdown and in weak manufacturing and capital spending in the United States,” Powell said in the text of his remarks Friday to central bankers gathered at the Kansas City Fed’s annual symposium in Jackson Hole, Wyoming. “We will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2% objective.”

It is looking like the learning curve for a newly installed Fed chair is about 18 months. Today’s measured statement from Jerome Powell did an excellent job of placating investor fears while leaving open the optionality of how much to cut by. The Fed has made clear they will cut rates if they need to but will not hurry. However, the simultaneous announcement by China that they are increasing tariffs on $75 billion of US goods is likely to be prove the catalyst for deeper cuts.

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The massive move we have seen in European sovereign bonds is definitely representative of a buyer’s panic but the broader question is who is panicking? Pension funds and insurance companies spring to mind. What are they panicking about? There is a real prospect we are going to see the ECB announce negative short-term rates as well as a raft of additional measures which are clearly designed to boost liquidity but will come at the expense of savers. That suggests what we are seeing is potentially a buy the rumour and sell the news phenomenon.

“This shows that there is less demand for 30-year bonds at negative yields,” said Marco Meijer, a senior fixed-income strategist at BNP Paribas SA. Still, Meijer doesn’t “see yields rising a lot in Europe.”

The whole of Germany’s yield curve is now below zero -- the first major market exhibiting such a trait -- meaning the government is effectively being paid to borrow out to 30 years. That’s a reflection of dwindling expectations for inflation and growth over the coming years, while the European Central Bank is widely forecast to introduce a new wave of monetary stimulus next month.

The sale comes as Germany is priming the pumps for extra spending should an economic crisis hit. While the nation is confined to strict laws on running a fiscal deficit, Finance Minister Olaf Scholz suggested Germany could muster 50 billion euros ($55 billion) should a recession hit. The economy contracted in the second quarter.

 

Bond market investors are not quite yet willing to be the Turkeys that vote for Christmas. Even the most bullish of momentum traders can see that locking in a zero return, at best, for maturities out to 2049 does not make for sense for long-term investors. However, it is also worth remembering that this situation is occurring in a global slowdown where growth is still positive. It portends even lower yields during a contraction.

While Conte’s resignation adds to the uncertainty, bond investors welcomed the fact that an alternative coalition is still on the table, while the chance of snap elections in the fall diminished somewhat. Yields on 10-year Italian bonds touched 1.31%, the lowest level since 2016, while the spread over German bonds -- a key gauge of risk in the nation -- dropped to 200 basis points for the first time in nearly two weeks.

Salvini pulled his support from the governing alliance with the anti-establishment Five Star Movement this month, saying the coalition no longer has a working majority. The 46-year-old anti-immigration hardliner has been seeking to cash in on strong poll ratings and upended the political establishment with a mid-summer power grab while parliament was in recess.

At stake is whether Italy’s mountain of public debt -- a chronic concern for both European officials and international investors -- will be managed by a right-wing ideologue set on confrontation with Brussels. Salvini on Tuesday promised Italians 50 billion euros ($55 billion) of tax cuts and public spending if he can take control of the government.

There was a certain inevitability about the collapse of the merger between right and left-wing populists. In fact, some might reason it is amazing it lasted this long. Italian politics is not noted for the longevity of its administrations. Annual elections are the price to pay as the political establishment strains to come to terms with giving a voice a population at odds with the continued adherence to decades of fiscal austerity.

Frankly, there is a lot to like about the WeWork opportunity. Yes, a $47 billion valuation seems way too high, particularly given the fact the company is on pace to make only about $440 million in gross profit this year (i.e. excluding all buildout and corporate costs), and given the huge recession risk. At the same time, this is a real business that provides real benefits to companies of all sizes, and those benefits are only growing as the nature of work changes to favor more office work generally and more remote work specifically. And, critically, there is no real competition.

The problem is that the “unsavoriness” I referred to above is hardly limited to the fact that WeWork can stiff its landlords in an emergency. The tech industry generally speaking is hardly a model for good corporate governance, but WeWork takes the absurdity an entirely different level. For example:

WeWork paid its own CEO, Adam Neumann, $5.9 million for the “We” trademark when the company reorganized itself earlier this year.

That reorganization created a limited liability company to hold the assets; investors, however, will buy into a corporation that holds a share of the LLC, while other LLC partners hold the rest, reducing their tax burden.

WeWork previously gave Neumann loans to buy properties that WeWork then rented.
WeWork has hired several of Neumann’s relatives, and Neumann’s wife would be one of three members of a committee tasked to replace Neumann if he were to die or become permanently disabled over the next decade.

Neumann has three different types of shares that guarantee him majority voting power; those shares retain their rights if sold or given away, instead of converting to common shares.

WeWork by all accounts creates spaces where people might actually want to work. That’s no mean feat. It’s not cheap but it is laudable. I spent a couple of days a week popping in and out of the Luxembourg Regis office between 2000 and 2003 and it was a pretty grim experience despite the prime location on Boulevard Royal. I would never have volunteered to work there full time if there was a better alternative available.

See yield chart middle page 1.  How low (negative) can govt credit yields (-1%) go till the financial system freezes over?  Serious Q……………this negative yield stuff wasn’t taught in Economics 101.

There must be an absolute level of negative rates that destroys money velocity (V) as it means no one puts money in the bank anymore and lending gets restricted.  At -10% I wouldn’t lend to UBS.  What happens at say -5%?  Assuming a real rate of 3%, bank lending -after a margin of say 2%- would essentially be FREE (0%).  But what does that do to banking system integrity (banks make money but less of it as their margins collapse; their deposit base shrinks as they struggle to increase/ attract deposits………….not only do depositors go on strike but existing depos are decreased annually by negative yields!)….and what about regulatory oversight?….would CBs and regulators afraid of imprudent lending caused by needy borrowers at 0% step in to restrict the very process that they are trying to encourage via making money so cheap?  i.e. will they try to stop “BAD” lending.  How will they judge/enforce?

And where does inflation fit into this calculus?...without any inflation the interest rate structure/ yield curve that might restore banking margins is hard to normalize/ become positive again.

Or should governments everywhere borrow vast sums at negative rates for 50 years to finance a massive infrastructure spend (highways, 5G, clean energy, railways etc.) i.e. “GOOD” lending?  Wouldn’t this raise rates and restore normality?  Then what debt / GDP levels are prudent (see Italy)?  I recall Argentina’s 100-year bond issue in 2017 at 7.9%, 3x over-subscribed by famished yield scavengers.

Investment implications

• Negative bond yields unattractive versus investment in high quality equities paying well covered dividends, though it is certainly not a good world for poor quality companies who don’t
• How is any of this bad for gold, whose carry cost is collapsing?

 

Just sharing some thoughts, largely written out of confusion

I think we are all in a state of disbelief at the willingness of investors to pour trillions into bonds with a negative yield. I have long wondered at the absence of any discussion of bond market convexity over the last decade. After all, shouldn’t we all have an interest in the sensitivity of bonds to changes in interest rates?

Concho Resources Inc., long considered one of the Permian’s premier operators, was forced to scale back activity after drilling almost two dozen wells too closely together. That move by the Midland, Texas-based producer spooked investors across the industry, with Evercore ISI predicting the “carnage” would have a lasting impact.

Concho’s problem with well spacing highlights the challenges of fracking so-called child wells: Too close to the “parent,” and output is less prolific; too far apart, and companies risk leaving oil in the ground.

Exxon and Chevron say they aren’t as exposed to those problems. Because of their size relative to smaller independent producers, the oil giants are able to lock up acreage, giving them room to be more conservative in their well spacing.

The lower for longer nature of oil pricing over the last few years and probably for the foreseeable future suggests smaller independent oil drillers and producers need to concentrate a lot more on containing costs. That suggests there is scope for consolidation within the Permian where the larger better capitalised companies are likely to have an advantage.

Counting all kinds of debt, including mortgages, consumers aren’t nearly as debt-burdened as they once were. In the fourth quarter of 2007, the last year before the financial crisis struck, households devoted 13.2% of their disposable income to debt service. In the first quarter of 2019, that number was 9.9%, largely due to low interest rates.

Partly because of widespread refinancing, mortgage payments since the start of 2017 have claimed the smallest slice of disposable personal income in decades, in the low 4% range, according to Fed data.

Lifestyle creep hits most families. As soon as incomes increase people eat out more, buy more clothes, spoil the kids or indulge in more after school activities, buy a better car and move to a better neighbourhood. That all works out as long as incomes keep up with expectations. It is also why the throwaway remark “a recession is when your neighbour loses his job, a depression is when you lose yours” rings so true. Of course in today’s economy it might be more correct to state it’s a recession when your spouse loses their job and a depression when you both do.

Latest reports have highlighted a distinct slowdown in growth in the housing sector since the start of the year. Despite a clear need for more houses this is not converting to actual sales. In fact, price drops have become commonplace in the second-hand market, and sales of properties over €500,000 have shown a 21 per cent drop since the start of the year.

All of this points to an affordability issue for buyers, and a gradual market realisation that prices need to be adjusted accordingly. Add to this fears over Brexit and Central Bank mortgage lending restrictions and the slow 2 per cent growth in number of mortgage drawdowns in the first quarter begins to make sense. Compare this with growth rates in 2018 of about 20 per cent.

Meanwhile, the throughput of housing stock for sale is strong. “June and July have been unseasonably strong with the flow of stock coming through,” said Angela Keegan, managing director of property website MyHome.ie. “It’s possible people are more confident about the market because, remember, if they are selling they are buying too. We know interest rates are not going up in the near term and there are excellent fixed-rate mortgages available too.”

Declining demand for higher priced homes suggests consumers and investors are trimming their expectations for continued economic strength. There is no country likely to do worse from a hard Brexit than Ireland.

It will be for historians to parse whether the backstop gambit was an historic mistake or a masterful stroke. Meanwhile the stock market is rolling over and the housing market is softening. That occurring against a background where interest rates are close to zero and the ECB is about to restart QE.

The move will add to fears that the region’s economic slowdown is being driven by more structural factors akin to Japan’s “lost decade.” Germany’s bond market is widely perceived as being one of the world’s safest, with investors lured in by the liquidity and credit quality offered. Funds still looking to extract a positive return from European sovereign assets have been forced further out the yield curve or into riskier debt markets such as Italy.

“It underlines that the hunt for yield, or rather hunt to avoid negative yields, is accelerating day by day,” said Arne Lohmann Rasmussen, head of fixed-income research at Danske Bank A/S. “It just makes things more complicated.”

Yields on 30-year bunds fell almost 10 basis points to -0.002%. Those on 10-year securities dropped five basis points to -0.50%, also a record low and below the European Central Bank’s -0.40% deposit rate.

Investors are paying the German and Swiss governments to take their money at every maturity and in Japan out to 15-year maturities. Bond investors have concluded the only possible way to manage the debts and unfunded liabilities that have built up over decades is with money printing. That will be facilitated by central banks buying the newly minted bonds and that contributes to the momentum move. The victims are currencies which is why gold is rallying.

President Donald Trump abruptly escalated his trade war with China, announcing that he would impose a 10% tariff on $300 billion in Chinese imports that aren’t yet subject to U.S. duties.

The new tariff will be imposed beginning Sept. 1, Trump said in a tweet Thursday that broke a tentative trade cease-fire between the world’s two biggest economies. The 25% tariff already imposed on $250 billion in Chinese goods will remain in place, he said.

A draft list of $300 billion worth of targets published by the Trump administration in May included a raft of consumer and technology goods, including most of Apple Inc.’s major products such the IPhone, along with toys, footwear and clothing. The final list hasn’t yet been released.

“These are the tariffs on many of the consumer goods that were spared in the previous tariff rounds,” said Neil Dutta, head of economics at Renaissance Macro Research in New York, in a note. “This is a small hit to growth but will likely be more obvious to consumers. Keep in mind that margins have come in somewhat already, not sure firms can simply eat the cost.”

Jay Powell’s statement yesterday that the cut to interest rates was more of a mid-cycle insurance cut than a response to the end of the credit cycle led to some unwinding of bets on a 50-basis point but. As the news was digested this morning the majority of markets were in positive territory and at one point has almost completely unwound yesterday’s decline. That was until President Trump announced additional tariffs. That is going to set off a scramble for inventory ahead of the busy fourth quarter retail period.

The fact that foreign money managers are delving into Canadian municipal bonds -- which account for just 1% of trading in the country’s C$2 trillion public sector fixed-income market -- is a testament to how hungry they’ve become for high quality, higher-paying assets in a world where at least $13.8 trillion of debt is now in negative-yield territory. Throw in the fact Canada has given little indication it will follow the global move toward easier monetary policy, and the market is fast becoming a magnet for sophisticated investors seeking to boost returns.

“If you’re sitting in the Middle East, Asia or Europe and you’ve got all this negative yielding debt, it makes a lot of sense to look for the hidden gems such as these excellent quality municipals,” said Avi Hooper, a portfolio manager at Invesco, which has $1.2 trillion under management, including bonds issued by the city of Montreal. “One has always to be careful with the liquidity of course. Big institutional investors are not going to get involved with $50 million deals.”

The paradox of the bond markets is the biggest debtors tend to have the most liquid bonds. Better credits don’t tend to borrow as much and therefore tend to have less liquid issues. Ahead of the credit crisis companies like General Motors and Hypovereinsbank had their own yield curves because they had outstanding debt at every maturity that was highly liquid. At the time no one seemed to pay much attention to the fact that they had so much debt it represented a threat to repayment of principal.

Samsung has since closed all but one of its smartphone plants in China. It now assembles around half of the handsets it sells worldwide in Vietnam. Samsung’s subsidiaries in the country, which employ around 100,000 people, accounted for nearly a third of the company’s $220 billion in sales last year.

A Samsung spokeswoman said about 90 percent of those sales involved goods shipped from Vietnam to other countries. That implies Samsung alone accounted for a quarter of Vietnam’s exports in 2018, although even that might not fully capture the company’s effect on the wider economy. Samsung’s success in Vietnam helped convince many of its South Korean suppliers that they needed to be here, too.

“When you are a big company and you move to a place, everything follows you,” said Filippo Bortoletti, the deputy manager in Hanoi at the business advisory firm Dezan Shira.

Some Vietnamese business owners say the blessings are mixed, though. Foreign giants, they say, come to Vietnam and work largely with vendors they already use elsewhere, leaving little room in their supply chains for local upstarts.

Samsung has 35 Vietnamese suppliers, the spokeswoman said. Apple declined to comment.

When Samsung first set up in the country, it bought some of the metal fixtures used on its assembly lines from a local firm, Vietnam Precision Mechanical Service & Trading, or VPMS. But then more of Samsung’s South Korean partners started coming into the country, and after a year, Samsung and VPMS stopped working together, said Nguyen Xuan Hoang, one of the Vietnamese company’s founders.

Price and quality were not the issue, Mr. Hoang said, over the hissing and clanging of machinery at his factory near Bac Ninh. The problem was scale: Samsung needed many more fixtures than VPMS could deliver.

The sheer scale of China’s manufacturing operations is not going to be easily repeated elsewhere. However, no one ever thought China would achieve the manufacturing might it now possesses either. The history of major manufacturing hubs is they evolve where labour, land, transportation and electricity are cheapest and where the tax and regulations are most lax.

Hope all is well.

 I had a question about the comment you made at the end of your video today. You mentioned that the indicator that we should focus on which will lead to this current cycle unwinding is Private equity and the success of their investments, plus on government debt and the deficits they are building.

Are you able to expand on what we can track (tangibly) for these 2 issues?

Thanks v much

Thank you for this question. I am very conscious of the temptation of generals to always be fighting the last war. In 2005 and 2006 there was some talk of a housing bubble in the USA but few people understood just how massive the liar loans problem was. Consumers had become extraordinarily overleveraged. As interest rates ground higher the first signs of trouble appeared in the underperformance of banks, rising credit card delinquencies and the collapse of leveraged hedge funds at major investment banks. The big question we need to ask is whether it will be these factors which are most relevant in this cycle?

Let’s think about the economy as made up of consumers, corporations and the government. After a decade of extraordinary monetary policy total debt has gone up but the US consumer has been de-levered while corporations and the government have seen their debt loads balloon.

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

The global economy has slowed meaningfully, Germany is flirting with a recession and China’s economy is suffering from the trade war. All other factors being equal it would be very hard for the Fed to continue to raise rates against that background. The upward pressure that would put on the Dollar would unwind any relative strength argument that is supporting the USA’s growth differential. Therefore, the Fed is at the top of the interest rate cycle and regardless of whether they cut by 25 or 50 basis points tomorrow, a new trend of cuts rather than hikes is emerging.

Fitch Ratings Ltd. followed on Friday by cutting its outlook for Africa’s most industrialized economy to negative. JPMorgan Chase & Co. said the same day that a rally in the rand since the start of June was more to do with a supportive global environment than improvements in conditions locally.

“We now believe levels are stretched enough to enter outright rand shorts,” JPMorgan analysts including London-based Anezka Christovova and Robert Habib in New York said in a note. “South Africa’s fundamental picture remains very challenging with a ballooning fiscal deficit and structurally low growth.”

Citigroup Inc. recommended to clients on Monday that they short the rand against the Turkish lira. The Wall Street bank’s analysts see the latter strengthening about 7% versus the South African currency over the next three months.

The mismanagement of utilities in emerging markets whether in South Africa or Venezuela is often one of the most apparent signs of low or deteriorating standards of governance. Utilities provide essential services but are mostly state run, they have reliable cashflows and the cost of upkeeping vital pieces of infrastructure can be delayed for years without apparent loss of service. That makes them perfect candidates for political rent seeking or theft.

and Jill Ward for Bloomberg may be of interest to subscribers. Here is a section:

Despite years of exceptional ECB support, the euro-area economy is in the throes of a slowdown in growth and inflation remains weak. In Germany, typically the region’s stalwart, manufacturing is mired in a slump as trade tensions weigh on exports and auto factories struggle to cope with changes in the industry.

With borrowing costs at historic lows, Draghi has repeatedly stressed the need for structural reforms, and he reiterated that call at a press conference in Frankfurt on Thursday.

“Monetary policy has done a lot to support the euro area and continues to do a lot,” he said. “If there were to be a significant worsening in the euro-zone economy, it’s unquestionable that fiscal policy, a significant fiscal policy, becomes of the essence.”

Just before Draghi spoke, German Finance Minister Olaf Scholz brushed off warning signals for Europe’s largest economy, saying the government has no concrete plans to spur economic growth.

“We are not in a situation that makes it necessary or wise to act as if we were in a crisis, we are not,” he said in an interview with Bloomberg Television.

There was a little “sell the rumour to buy the news” evident in Euro trading this morning. The rally did not hold through the close and looks like little more than some steadying in the region of the previous lows.

“But if demand growth is not sufficient, the board is prepared to provide additional support by easing monetary policy further,” he said. “Whether or not further monetary easing is needed, it is reasonable to expect an extended period of low interest rates. On current projections, it will be some time before inflation is comfortably back within the target range.”

Lowe’s speech, which made the case for maintaining the RBA’s current policy framework despite prolonged low inflation, was his most explicit that further easing remains on the table. The Reserve Bank cut rates in June and July to a record low of 1% and signaled at the time that it would wait to see how the easing filtered through the economy.

Since then, consumer confidence has actually fallen and the currency has risen -- the latter due to an easing bias among major central banks -- in contrast to RBA’s hopes. Indeed, the Federal Reserve is expected to cut as soon as next week. Westpac Banking Corp. Chief Economist Bill Evans on Wednesday predicted Lowe and co. would cut in October and February to push the cash rate to 0.5%.
 

Australia’s administration is attempting to forestall the decline in domestic property prices by cutting interest rates, embarking on an aggressive fiscal stimulus and implementing direct supports for the property market.

The proposed budget deal would lift spending caps for the next two years by a combined $320 billion, which over the next decade will result in $1.7 trillion of additional projected debt. Negotiators explicitly chose not to extend the Budget Control Act (BCA) caps, which will expire in 2021. The Congressional Budget Office (CBO) will thus assume discretionary spending rises with inflation after 2021 in its baseline, leading to roughly $1.5 trillion more of outlays through 2029. Netting interest and offsets brings the total cost to $1.7 trillion.

2. The Budget Deal Would Cost Nearly As Much As the Tax Cuts

While we and many others have decried the cost of the unpaid-for 2017 tax law, passing this deal would enshrine nearly as much debt as the tax cuts did. According to CBO, the 2017 tax law will cost $1.9 trillion over a decade, including the dynamic effects from economic growth and interest. We project that the proposed budget deal will enshrine $1.7 trillion of debt over a decade, including interest. As a result, lawmakers will have added almost as much to the debt with this round of spending increases as they did with tax cuts.

This is what Modern Monetary Theory looks like. They don’t ring a bell when slipping through trillions of additional spending, but the effect is the same. It is never really that much of a hurdle to get politicians to spend more. The question is only ever over what to spend the money on. Admittedly, they do occasionally adopt a posture of fiscal probity but it never lasts very long and the debt totals just continue to increase. The big point is this deal to increase spending received cross party support and is a foretaste of what the next US administration plans regardless of hue.

Since the referendum, he has retreated from public politics, offering only the occasional blog post, often thousands of words long, setting out his views about government, technology and educational systems, but especially on why he believed the government was making a mess of Brexit.

His tone was often contemptuous: Brexit Secretary David Davis was “thick as mince, lazy as a toad and vain as Narcissus.” Pro-Brexit MPs were “useful idiots” who spent their time “spouting gibberish.”

In 2018 he described Theresa May’s approach to Brexit as a “surrender” and said that Article 50 -- the divorce process with the EU -- was triggered too early, akin to “putting a gun in your mouth and pulling the trigger.’’ He said the success of Brexit won’t be known for decades, and tweeted in 2017 that there are “possible branches of the future’’ where leaving will have been an error.

Cummings’s main thesis is that Britain’s system of government is “systematically dysfunctional” and designed to keep the U.K. as closely tied to the EU as possible. He’s called for a radical shake-up of Whitehall, saying Brexit cannot be delivered without it.

As I’ve said on many occasions before, the only way to negotiate is to project a credible argument that you are willing to walk away if you do not get what you want. In a two-way negotiation, where the opposing party believes they have a superior position, it is the only price discovery tactic that has any hope of working. It finally appears the UK administration has got the message.

The US Trade Weighted Broad Dollar Index continues to trade in the region of its all-time peak. A sustained move below 125 will be required to signal more than temporary resistance in this area.

The second quarter will probably provide more evidence how damaging zero or negative rates are for an industry that at its core depends on clients paying to borrow money. Revenue at eight of Europe’s top lenders is set to decline 2.7% on average from a year earlier, according to filings and analyst estimates. That compares with a 0.5% gain for the top U.S. peers, many of which still managed to post record earnings after nine interest rate increases by the Federal Reserve since late 2015.

“The focus for European banks is really on revenue,” said Jonathan Tyce, an analyst at Bloomberg Intelligence. “Rates are set to go down, which means lower loan loss provisions, but that doesn’t make up for the loss in revenue. All this keeps bringing you back to costs.”

And here is a section on Deutsche Bank

Deutsche Bank (July 24) unveiled its biggest overhaul in decades this month, including a plan to exit its underperforming stock trading business. The move was partly driven by low interest rates and the company now assumes that European short-term rates will rise to just 0% in 2021. Deutsche Bank also offered insight into second-quarter earnings with a 5.9% slide in revenue. Costs and profit figures fell short of expectations, even before the bank said it expects 3 billion euros of restructuring charges in the period. Deutsche Bank says about 75% of the investment banking businesses it wants to keep will have a top five market position, and the release this week will 

The basic business model of banks, borrowing short-term to lend long-term, doesn’t work if there is no spread. It is complicated by negative deposit rates which see banks pay a fee to sustain Tier 1 capital ratios. The most LTRO program was paltry in comparison to the previous one and therefore represented a tightening of credit conditions for European banks.  This week’s earnings announcements will give us some insight into how they are faring.

Our paper builds on recent empirical work. Focusing exclusively on ageing, Anderson et al (2014), Yoon et al (2014) and Bobeica et al (2017) find significant deflationary effects from an increasing share of older population cohorts. Juselius and Takáts (2015) and Aksoy et al (2015) take the age structure more fully into account and find that an increase in the number of dependants, young and old, is generally inflationary. Juselius and Takáts (2015) also show that the deflationary effects of ageing found in previous studies are driven primarily by the very old (80+ year old) cohort. A common feature of these studies, as noted above, is that they rely exclusively on post-war data, which makes it difficult to separate the age structure effect in inflation from other global secular factors that may be related to trend inflation.

The uncovered link is policy-relevant, because global ageing will substantially increase the share of the old-age population in almost all countries (eg Goodhart et al (2015)). Increased longevity and stagnant or declining birth rates will affect both advanced and emerging economies. While slow, such large-scale demographic shifts have the potential to materially affect trend inflation. For instance, we find that accounting for the age structure leads to substantially lower estimates of endogenous inflation persistence. Hence, past historical periods of high inflation persistence might have reflected, in part, persistent demographic changes. This implies that the role of conventional endogenous drivers, such as inflation expectations, may have been overstated. If so, this could account for the current conundrum with well-anchored long-term inflation expectations and persistently low inflation rates. The stability of the relationship furthermore suggests that this may help us forecast longer-term inflation trends, as previously noted by McMillan and Baesel (1990) and Lindh and Malmberg (2000). Our estimates indicate that inflationary pressures are likely to rise in future due to the increasing share of older population cohorts and a declining share of younger ones, which has not been emphasized in the literature.

I found this a fascinating report not least because it runs contrary to the accepted view, right now, that inflation is not something we need concern ourselves with.  

Can you please expand on this statement from Friday's commentary:

"There is potential we are currently at the trough in global growth which could support the stock market in its breakout."

Expectations for global growth has been pegged back on successive occasions over the last 18 months as the trade tensions rose between the USA and Canada, Mexico, the EU, Japan, South Korea and most pointedly with China. More recently, the increasingly taut relationship between Japan and South Korea has been making headlines.

Hope you are doing well. I just thought you may find interesting this Financial Times story on gold - 

In particular, it has a chart showing that “the correlation between the growing volume of negative-yielding bonds and the rising value of gold is striking.” And, also, “Gold as a zero-yielding asset will look even more attractive versus an asset that is guaranteed to lose money,” said Paul Wong, a former senior portfolio manager at Sprott Asset Management.

Thank you for this link and I am enjoying some warmer weather by playing tennis with my children in the afternoons. It’s a been a long cool spring in Southern California and considerably wetter than any we’ve seen since we moved here. It looks like the long winter of discontent with precious metals is over too.

One of the best ways to think about gold, in an environment where an increasingly large chunk of global sovereign debt is trading with negative yields, is as a zero-coupon perpetual bond. It rises in value as yields decline and most particularly as the risk of competitive currency devaluation becomes more realistic.

That will happen at the same time that there will be greater internal conflicts (mostly between socialists and capitalists) about how to divide the pie and greater external conflicts (mostly between countries about how to divide both the global economic pie and global influence). In such a world, storing one’s money in cash and bonds will no longer be safe. Bonds are a claim on money and governments are likely to continue printing money to pay their debts with devalued money. That’s the easiest and least controversial way to reduce the debt burdens and without raising taxes. My guess is that bonds will provide bad real and nominal returns for those who hold them, but not lead to significant price declines and higher interest rates because I think that it is most likely that central banks will buy more of them to hold interest rates down and keep prices up. In other words, I suspect that the new paradigm will be characterized by large debt monetizations that will be most similar to those that occurred in the 1940s war years.

So, the big question worth pondering at this time is which investments will perform well in a reflationary environment accompanied by large liabilities coming due and with significant internal conflict between capitalists and socialists, as well as external conflicts. It is also a good time to ask what will be the next-best currency or storehold of wealth to have when most reserve currency central bankers want to devalue their currencies in a fiat currency system. 

Most people now believe the best “risky investments” will continue to be equity and equity-like investments, such as leveraged private equity, leveraged real estate, and venture capital, and this is especially true when central banks are reflating. As a result, the world is leveraged long, holding assets that have low real and nominal expected returns that are also providing historically low returns relative to cash returns (because of the enormous amount of money that has been pumped into the hands of investors by central banks and because of other economic forces that are making companies flush with cash). I think these are unlikely to be good real returning investments and that those that will most likely do best will be those that do well when the value of money is being depreciated and domestic and international conflicts are significant, such as gold. Additionally, for reasons I will explain in the near future, most investors are underweighted in such assets, meaning that if they just wanted to have a better balanced portfolio to reduce risk, they would have more of this sort of asset. For this reason, I believe that it would be both risk-reducing and return-enhancing to consider adding gold to one’s portfolio. I will soon send out an explanation of why I believe that gold is an effective portfolio diversifier.

Delayed gratification is not exactly popular. The world runs instead on a “what have you done for me lately” mentality. Nobody understands that better than politicians. When it comes to elections, they get very good at making promises and the only ones that ever seem to get fulfilled are commitments to spend more. Sure, there are occasionally efforts to rein in spending, but they never tend to last that long. That has been particularly true of more developed countries where poor demographics highlight the issue of unfunded liabilities in stark terms.

Investors have heard this refrain before, that just a scant few pull the pack. And it’s easy to see their outsize influence: Microsoft, Apple, Amazon.com and Facebook Inc. account for more than 20% of the S&P 500’s returns this year. That number is even starker for the tech-heavy Nasdaq 100, for instance, where those four companies account for about 50% of gains.

But Bessembinder and his team, including two co-authors from Hong Kong Polytechnic University and Goeun Choi of Arizona State, are among the first to look at the phenomenon long-term. The best-performing 306 firms accounted for about three-quarters of global net wealth creation during the 28-year period of the study, they found. Just 811 companies could be framed as accounting for all of it.

Their findings echo Bessembinder’s previous work. In looking at nearly nine decades of U.S. stock and bond performance, he found that out of 26,000 stocks, about 58% underperform Treasury bills in their lifespan.

There are two lessons from this data. The first is it has been hard to outperform bonds during one of the greatest bull markets in history. With forty years of history that is a lot of empirical data to base conclusions on. However, it also assumes the status quo remains intact indefinitely.

Powell told Senators that the so-called “neutral rate,” or policy rate that keeps the economy on an even keel, is lower than past estimates have put it -- meaning monetary policy has been too restrictive.

“We’re learning that interest rates -- that the neutral interest rate -- is lower than we had thought and I think we’re learning that the natural rate of unemployment is lower than we thought,” he said. “So monetary policy hasn’t been as accommodative as we had thought.”

Federal Reserve officials in fact marked down their estimate of the longer-run policy rate to 2.5% in June, from 2.8% in March.

Investors fully expect a quarter-point cut at the Fed’s July 30-31 gathering, according to pricing in interest-rate futures, though odds were dialed back a bit after a stronger-than-expected U.S. inflation report earlier on Thursday.

The Fed keeps downgrading its expectations for what the neutral rate of interest is. In other words, their guesstimate of the optimal level to contain inflation but support full employment. That is the rationale used to justify the move to lower rates which has already been priced in.

Powell carefully explained the reasons why the policy committee has shifted its views this year, and noted that “crosscurrents have reemerged, creating greater uncertainty.” Despite a current trade war truce with China, he continued to stress downside risks to the outlook.

“Uncertainties about the outlook have increased in recent months,” Powell said in the text of his remarks. “Economic momentum appears to have slowed in some major foreign economies, and that weakness could affect the U.S. economy. Moreover, a number of government policy issues have yet to be resolved, including trade developments, the federal debt ceiling, and Brexit.”

He noted that policy makers are carefully monitoring developments including the risk that weak readings on inflation could be “even more persistent than we currently anticipate.”

In addition, Powell pointed to a slowdown in business investment, decelerating global growth, and declines in housing investment and manufacturing output.

“It strongly suggests they’re going to be inclined to ease at the meeting later this month,” Michael Feroli, chief U.S. economist at JPMorgan Chase & Co., said in a Bloomberg Television interview. “He continued to highlight the uncertainties that are weighing on the outlook rather than highlighting the better jobs report.”

The Fed has been saying for a decade that they are going to be data dependent. However, that leaves a lot of leeway over what kind of data they will be swayed by. This graphic of the rate at which people are voluntarily quitting their jobs overlaid with the Fed Funds Rate suggests the domestic US consumer is confident about the economy but the Fed is still getting ready to cut rates.

The house in Tolleson is one of several thousand around the city that Opendoor and two competitors—listings giant Zillow Group Inc. and Offerpad Inc.—have bought since 2014 in an attempt to perfect programmatic house flipping. Last year, they bought nearly 5,000 houses in the metro area, roughly one in every 20 existing homes sold. They’re after real-estate transaction fees and anything they can make on reselling the property. Margins are low, so volumes must be high.

The majority of mortgage lending in the USA is performed by non-bank lenders i.e. shadow banks. These kinds of highly leveraged business models work in an upswing but tight margins, acute price sensitivity represent significant medium-term threats. Then there is the fact that by running a volume model, real estate AI companies are contributing to flow but could suffer in a downturn as liquidity evaporates.

The number of euro-denominated junk bonds trading with a negative yield -- a status until recently associated with ultra-safe sovereign borrowers -- now stands at 14, according to data compiled by Bloomberg. At the start of the year there were none. Cheap money policies since the financial crisis have kept interest rates at, or near, all-time lows for the last decade.

That’s prompted many investors to buy riskier assets that yield enough for them to meet their liabilities, driving bond markets higher and yields lower. The European Central Bank said on Monday it’s ready to add more stimulus to the euro zone, indicating that an end to the age of ultra-low borrowing costs is far from over.

Wimbledon is on the TV and the air conditioning is humming so we are definitely in summer but negative yield on junk bonds suggest we are in silly season.

Negative yields on a sovereign can be at least partially justified by their appeal as safe havens. Junk bonds carry that moniker because of the unreliability of cash flows. It took me a while to corroborate the claims made in this article and while I could not find negative yielding bonds for all of the issuers there are definitely instances of junk bonds that have been bid up to these levels.

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Every mania has a contradiction at its centre. In the 1980s, it was the Imperial Palace in Tokyo really was worth more than the entire state of California. In the 1990s it was earnings don’t matter. In 2000s it was CDS could absolve everyone of default risk. In this decade it is that no one loses money from negative yields.

An EU attempt to compel Switzerland to agree to the treaty by denying the country’s bourse recognition under EU equivalence rules seems to have had little or no impact, with the benchmark SMI Index closing at a record high on Tuesday. There may be more salvos to come.

The EU could up the ante by refusing to revise an agreement on technical barriers to trade, which would hit several companies, notably in the medical-technology sector. There’s also Switzerland’s participation in EU research programs like Horizon 2020, which would thwart universities and research and development activity.

“They’re in a position where they’re highly dependent on the EU - just look at the map,” said Nicholas Veron a senior fellow at the consultancy Bruegel in Brussels.

Like Brexit
Switzerland’s issues with the EU are not that different from those of Brexit backers in the U.K. Many in Switzerland are upset about high levels of immigration and regard the 28-member bloc as a dysfunctional bureaucracy. Unlike the U.K., however, Switzerland was never part of the bloc, and instead has a special relationship based on 120 agreements, which the EU now wants to consolidate and streamline into one new treaty.

That’s proved to be a contentious undertaking. The EU made concessions on a dispute arbitration panel, but with labor unions up in arms about wages -- fearing they would face downward pressure in high-income Switzerland -- Bern wouldn’t sign on to the so-called framework deal. Certainly not ahead of a general election in October.

How much of the increasing acrimonious relationship between the EU and Switzerland is about the new treaty and how much is about the impending Swiss election and the desire to look strong and independent to a wavering population?

This chart is one of my favorites that I’ve made in a while, as not only does it contain a lot of interesting information but I also learned a lot by making it. Here are a few of the most important takeaways:

1. At high interest rates the coupon is most important, and at low rates capital appreciation is king

2. Short and intermediate term bonds (typically capped at about 10 years) are much less sensitive to interest rates at all levels than long term bonds

3. Low-interest 30-year bonds are very volatile! In fact, the range of returns is similar to what you might expect from the stock market.

4. Note that the spread of total returns for long term bonds is not symmetrical. Because they are increasingly more sensitive with every drop in rates, for the same +/-1% change they actually have more upside than downside.

5. One thing that’s not obvious from the chart is that interest rate sensitivity declines as bonds age. A new 30-year bond will start on the red line. When it only has 15 years left, it has the volatility of the green line. And when it only has 5 years left it has the predictable tight range of the purple line. Just like people, bonds get less active as they mature.

But if you take only one point away from this post let it be this:

Because of convexity, bonds have way more income potential at very low or even negative rates than most people realize.

This is one of the more explanatory and informative reports I have seen on the bond markets and helps to explain the continued momentum driven move despite the fact nominal yields are at objectively unattractive levels. However, it is also worth considering that the most compelling arguments for the success of a momentum strategy almost always appear during the acceleration phase of a bull market

In moving from Washington to Frankfurt, Lagarde will be tasked with driving monetary policy in a 19-nation economy which Draghi has already signaled will need more help, likely in the form of lower interest rates and possibly with the resumption of quantitative easing. Inflation is running at barely half the ECB’s goal of just under 2% despite years of negative rates and 2.6 trillion euros ($3 trillion) of bond purchases.

Investors will likely bet that as a seasoned crisis-fighter, Lagarde will share Draghi’s taste for aggressive and innovative monetary policy, especially as her appointment means the more hawkish Bundesbank President Jens Weidmann misses out.

Financial markets are already pricing an ECB rate cut by September, in line with predictions by ECB watchers at Bloomberg Economics and Goldman Sachs Group Inc.

Lagarde last week described the world economy as hitting a “rough patch” and advised central banks to continue to adjust their policies in response. In June 2014, she said she would “certainly hope” the ECB would conduct QE if inflation stayed sluggish -- months before it announced it would do so.

Christine Lagarde fits the bill of a credible dove. Her candidacy ensures the ECB is moving back toward quantitative easing and negative interest rates. That’s good news for the liquidity fuelled bull market.

The Switzerland-based BIS, which promotes cooperation among the world’s monetary officials, used its annual economic report to urge politicians to “ignite all engines” to overcome a global soft patch. They should make structural reforms and strengthen fiscal and macroprudential measures, instead of relying on ever-lower interest rates in a debt-fueled growth model that risks turbulence ahead.

“The continuation of easy monetary conditions can support the economy, but make normalization more difficult, in particular through the impact on debt and the financial system,” the BIS said. “The narrow normalization path has become narrower.”

U.S.-led protectionism has dented economic confidence and slowed growth, forcing central banks to prepare to ease policy again even if they haven’t yet returned to their pre-crisis settings. The Federal Reserve and the European Central Bank are expected to cut interest rates this year, while nations including Australia, Russia, India and Chile have already started.

Economists at Citigroup Inc. estimate that while fiscal policy in the major industrial countries will be expansionary this year it will be less so in 2020 as past measures in the U.S. wear off.

There is a confluence of factors that are leading to support for Modern Monetary Theory. On the one hand we have central banks stating that the fuel from monetary accommodation is not as effective any longer. They are telling governments to engage in fiscal stimulus and decluttering of the regulatory environment to boost growth. Governments for their part are saying to central banks that they will pursue massive deficit spending if interest rates don’t shoot up immediately afterwards.

“This is really important,” said Torsten Slok, chief economist at Deutsche Bank Securities, who expects a rate cut in July. “For many years, the Fed has been arguing that monetary policy was easy and accommodative and supporting growth and inflation. After a decade of easy monetary policy, the Fed has decided that policy is no longer stimulative.”

Reasons listed for the lower neutral rate include ongoing fallout from the financial crisis, weaker productivity, continued slackness in the labor market and an aging population, which when combined leave the economy structurally weaker and so more vulnerable to rate hikes.

The upshot is the Fed may have to lower rates if it wants to boost expansion to offset global headwinds, including slow global growth and trade disruptions from President Donald Trump’s tariff battles.

Powell will give his view of policy in a speech on Tuesday to the Council on Foreign Relations in New York.

The trend of the Fed Funds Rate is downwards. There is a clear succession of lower major rally highs since the early 1980s and the failure of the Treasury yield to hold the move above 3% late last year suggests another lower high is now in place. If we accept the conclusion the peak of the interest cycle has now passed the next big question is just how low can rates go?

The deflationary cancer is now so deeply lodged in the eurozone that it would take helicopter money or People's QE -- monetary financing of public works -- to fight off any future global slump. Such action would violate the Lisbon Treaty and would test to destruction Germany's political acquiescence in the euro project.

In truth QE in Europe has always worked chiefly through devaluation. The euro's trade-weighted index fell 14 percent a year after Mr. Draghi first signalled in 2014 that bond purchases were coming. That was powerful stimulus. When the euro climbed back up the eurozone economy stalled.

It takes permanent suppression of the exchange rate to keep euroland going. As the Japanese have discovered, it is very hard for an economy with near zero inflation and a structural trade surplus to stop its exchange rate from rising unless it resorts to overt currency warfare. That is exactly what Mr. Trump is not going to allow.

Every avenue of monetary stimulus is cut off in the eurozone. Only fiscal stimulus a l'outrance -- 2 or 3 percent of GDP -- will be enough to weather a serious crisis. That too is blocked.

“The ECB has masked the fragility over the last seven years and nobody knows when the hour of truth will come,” said Jean Pisani-Ferry, economic adviser to France's Emmanuel Macron and a fellow at the Bruegel think tank.

“There is no common deposit scheme for banks. Cross-border investments are retreating. The vicious circle between banks and states could come return any moment,” he said.

Mario Draghi's rhetorical coup in July 2012 worked only because he secured a partial approval from Germany for the ECB to act as lender-of-last resort for Italy's debt (under strict conditions). That immediately halted an artificial crisis. The situation today is entirely different. The threat is a deflationary slump. The ECB has no answer to this.

Markets thought they heard a replay of "whatever it takes" in Mr. Draghi's speech and hit the buy button. But economists heard another note in Sintra: a plaintive appeal for EMU fiscal union before it is too late.

The exhausted monetary warrior was telling us that the ECB cannot alone save the European project a second time.

It is arguable how much the USA needs an interest rate cut with full employment, compressed bond yields and a consumer which is in rude health. Low yields are spurring a mortgage refinancing binge and the decline in oil prices is also putting money in people’s pockets.

While inflation near the goal and a strong labor market are the most likely outcomes, “uncertainties about this outlook have increased,’’ the Federal Open Market Committee said in the statement following a two-day meeting in Washington. “In light of these uncertainties and muted inflation pressures, the Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion.”

The FOMC vote was not unanimous, with St. Louis Fed President James Bullard dissenting in favor of a quarter-point rate cut. His vote marked the first dissent of Powell’s tenure as chairman.

Policy makers were starkly divided on the path for policy. Eight of 17 pencilled in a reduction by the end of the year as another eight saw no change and one forecast a hike, according to updated quarterly forecasts.

In the statement, officials downgraded their assessment of economic activity to a “moderate” rate from “solid” at their last gathering.

The pivot toward easier monetary policy shows the Fed swinging closer to the view of most investors that President Donald Trump’s trade war is slowing the economy’s momentum and that rates are too restrictive given sluggish inflation.

This statement tees up a rate cut in July. That is what the bond market has been pricing in and it got confirmation of that assumption today. Investor focus will now turn to the expectation that another cut will follow in September.

I am enjoying the commentary as usual. 

I had two questions for which I would be grateful for your opinion:

I don't understand why gold should be priced differently in different currencies. One would have thought that the market would arbitrage out the differences. 

The second one is more general and applies to looking at long term trends such as that for oil versus the stock market. Could it not be argued that technology changes such as the advent of green energy or electric cars or indeed new modes of producing oil (fracking, oil sands etc) render these charts ineffective as predictors of future price action?

I thank you and look forward to hearing from you in due course. 

Thank you for these questions which I’m sure will be of interest to other subscribers. Gold is a commodity and subject to supply and demand fundamentals just like everything else but it is also a monetary metal. That means it tends to trade more like a currency than a commodity.

The figures come a day before the BOE’s latest policy decision. As many central banks around the world shift into a more dovish mode, U.K. officials have been trying to push in the other direction, repeating a message that interest rates may have to rise more than the market currently anticipates if there’s a smooth Brexit.

Investors haven’t taken much heed given the continuing uncertainty over Britain’s exit from the European Union. Certainly in the short term, the latest inflation figures give policy makers breathing space to wait and keep interest rates on hold.

The BOE expects inflation to fall back below target this year. In May, it forecast that price growth would average 2.1% this quarter, easing to about 1.6% by late 2019.

The Bank of England is protective of its independence, especially amid the continued contentious discussion about the merits or otherwise of Brexit. Nevertheless, with central banks all over the world signalling a willingness to cut rates, it seems foolhardy of the Bank of England to continue to signal its willingness to raise rates.

ECB President Mario Draghi appeared to set a low bar for action on Tuesday when he said additional stimulus will be needed “in the absence of any improvement” to the outlook for growth and inflation. He specifically cited rate reductions as an option, sending the euro lower and prompting money markets to price in a 10 basis-point cut by December.

Investors subsequently brought forward their expectations to September after Bloomberg’s report. Commerzbank now predicts such a policy step in July.

“Draghi is going to finish his tenure with a cut,” said Claus Vistesen, chief euro-zone economist at Pantheon Macroeconomics. “The door is now open and I don’t see how they can not walk through it.”

There is a first principles question that governments have no appetite to grasp. “How do you recover from a debt bust?” We know what the answers are. You default, recapitalise and try not to make the same mistake again. The problem in Europe is the creditors are Northern European pension funds and the debtors were peripheral banks, who have had much of their debt absorbed by their respective governments. The prospect of debt forgiveness, therefore, has massive issues of moral hazard and was untenable politically, even though it remains necessary if the debt mountains are to be dealt with and growth prospects renewed.

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

This is a robust defense of Shiller P/E which, at 30, is at it second highest peak in history; surmounted only by the Tech Bubble. Let’s for a moment consider that it would be unwise to expect the best performers of the last decade to be the best performers of the next decade. After all, it only makes sense when we consider the base effect. It is obviously more difficult to double from a market cap of $1 trillion than from $1 billion.

That’s all put the economy on track for its weakest fiscal year since the last recession in 1991. Even the Reserve Bank, which rarely wades into political territory, is urging more government stimulus after cutting interest rates for the first time in almost three years.

But whether boxed in by his sunny disposition or pledges to deliver a budget surplus made ahead of the government’s shock re-election last month, Frydenberg appears unfazed. While he’ll push to pass tax cuts when parliament resumes on July 2 and ramp up infrastructure spending, that’s about it, leaving the heavy lifting of stimulus to the central bank.

“I’ve found the treasurer to be remarkably sanguine,” said Danielle Wood, an economist at the Grattan Institute, an independent think tank in Melbourne. “When you’ve got the central bank governor coming out and talking about perhaps moving to stimulatory fiscal policy as well as the need for more long-term structural reforms, I’d be hoping for a more substantive response.”

The RBA cutting interest rates to previously unimagined levels, with more to come, is a bonus for consumers with floating rate mortgages, but the wider concern is about the health of the Chinese economy which Australia depends on for export demand growth.

The policy mix of tighter monetary policy and looser fiscal policy provides a steroid-like boost to currencies.   This is what the US had under Reagan-Volcker.  It is was the policy mix in Germany after the Berlin Wall fell that led to the ERM crisis of the early 1990s and then Maastricht Treaty and the euro.  It helped fuel the dollar's gains last year.  Now that policy mix is reversing.  Fiscal policy is tightening, and monetary policy is poised to loosen.  That policy mix is associated with under-performing currencies.  

The third significant dollar rally since the end of Bretton Woods is in jeopardy.  Coordinated intervention marked the end of both the Reagan-Volcker and Clinton-Rubin dollar rallies.  Intervention in the foreign exchange market won't be necessary; the self-proclaimed "Tariff Man" has found another way the proverbial cat can be skinned.  

The last phase of a significant dollar rally has been marked by the movement of interest rate differentials against the US.  This been happening.   The two-year differential between the US and Germany peaked last November a little above 355 bp, which appears to be a modern extreme. It finished last week below 250 bp, the lowest in more than a year.   Similarly, the US two-year premium peaked against the UK around the same time a little shy of 220 bp.  It is now approaching 125 bp.   Against Japan, last November, the US two-year premium of nearly 310 bp was the largest in 11 years.  It is threatening to break below 200 bp.  

Quantitative tightening has been the single most important factor in the Dollar’s strength over the last 18 months. Reducing the size of the Fed’s balance sheet has contracted the supply of Dollars and created a supply inelasticity-based argument to support the currency.

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

The response of the stock market last week to the whiff of easing rhetoric from the Federal Reserve suggests investors are still willing to give the benefit of the doubt to the positive effect loose monetary and potentially fiscal policy can have on asset prices and by extension the economy.

Bond traders’ conviction that the Federal Reserve will cut interest rates within months in response to a weakening growth outlook and escalating trade tensions firmed after a batch of weaker-than-expected U.S. jobs data.

Fed funds futures show a quarter-point cut almost fully priced in for July, and indicate about 70 basis points of easing by the end of 2019. The two-year Treasury yield fell as much as 11 basis points to 1.77%, close to the 2019 low reached Wednesday, and it was on course for its fifth weekly decline.

The last time that happened was back in July 2016, when the U.S. central bank’s target range was 2 percentage points lower than right now.

Lead indicators for future problems are flashing orange. If the Fed were to persist in its policy of continuing to raise rates and reducing the size of the balance sheet it would contribute to recession risk. If it steps on the monetary accelerator once more it risks further inflating a bubble, not least in the nonbank lending and private equity sectors.

At the Marcus Evans conference I attended at the beginning of this week one of the speakers, R. McFall Lamm, formerly chief strategist at Deutsche Asset Management and now at Stelac Private Equity made a couple of interesting points about the yield curve.

While Draghi is using similar tactics to U.S. Federal Reserve Chair Jerome Powell in promising to react to any deterioration in the outlook, the challenge is that he’s seen as having less room for maneuver. ECB rates are still at record lows and the balance sheet hasn’t started to be wound down.

Moreover, he has less than five months left in office and there’s no clear sign who his successor will be, nor whether they’ll have the same commitment to the radical measures that hallmarked the Italian’s eight-year term.

“The market believes Draghi’s take on inflation is wishful thinking,” said Christoph Rieger, head of fixed-rate strategy at Commerzbank AG, which predicts the ECB will cut the deposit rate toward the end of this year and extend its low-rate pledge to mid-2021. “The talk about contingencies is cheap, but to reverse the decline in inflation expectations he will have to walk the walk.”

The ECB only ended their QE program in December so it is going to take some time to rebuild appetite for additional easing measures. The market is convinced of the need, particularly with German, Italian and French PMI’s in negative territory, however the ECB is unwilling to act prematurely.

 

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

The Federal Reserve aggressively tightened policy last year by both raising rates and reducing the size of its balance sheet simultaneously. That has had more of an effect on international growth than domestic growth but the underperformance of the banking and industrial sectors is a testament to slowing activity. We are at the point in the cycle where we can expect easier policy. The big question is whether the Fed will act soon enough to avoid negative economic figures.

A link to the full report and a section from it are posted in the Subscriber's Area.

The commonality in the compression of global sovereign yields is a clear sign bond investors, everywhere, have concluded we are at the top of the interest rate cycle. If interest rates are unlikely to rise, they can fall and the big question is when that is likely to happen.

According to the new parliament’s seat distribution based on preliminary results, 15 PINE parties throughout the European Union made gains in the election and 12 lost seats. In total, they gained just 25 seats – 3.3% of the total of 751. Without Italy, they would have come out even with the 2014 result. In a small number of countries there has been no change in PINE support.

The rise of Italian nationalism and what one could call an anti-establishment revolution there make the country the EU’s biggest trouble spot for the next legislative period. It’s unclear what the bloc can do about it except wait for Italians to become disappointed in Matteo Salvini’s League (and the national conservative Brothers of Italy, or FDI, party) – something that might come with painful economic side-effects.

The U.K. is the other obvious problem, but perhaps a receding one – either because Brexit will eventually happen or because it won’t. Last week’s election delivered a net loss of seats to British PINE parties. The success of Nigel Farage’s Brexit Party was as spectacular as the downfall of his former project, the U.K. Independence Party, and the ruling Conservatives faced a catastrophic loss that doesn’t augur well for them in the next general election. All this is for the British voters to sort out, though: The EU can hardly help at this point and it’s wise for it to wait out the crisis.

Other than the two obvious hot spots, eastern Europe remains somewhat problematic for the “ever closer union” project because of the strength of Hungary’s Fidesz and Poland’s Law and Justice (PiS). These aren’t exactly euroskeptical parties, but they are focused on not giving up any more national sovereignty, and they’re resolutely illiberal. The parties work to defang the independent media and build up propaganda machines that make them immune to scandals (PiS survived a whole strong of them in the run-up to the European election) and they tighten the political control of the courts.

The European election results reflect a rumbling sense of discontent but did not deliver the ground swell of support for populist or ant-EU to upend the centrist status quo. If we look under the surface there is a clear battle going on, but the opposition is split between populists and, the left leaning, Green movement which has allowed the centrist bloc to continue to hold sway.

Last October there was a full hike priced in, but now those expectations have completely collapsed to the point where there is two cuts already embedded into the Eurodollar futures curve.

Although it’s not quite this simple, to make money at the short end, the Fed will have to cut more than twice in the next year and a bit. Could that happen? For sure. No doubt about it. Maybe the economy hits a real air pocket and the Fed cuts aggressively. Or there is some geopolitical event and the Fed is forced to slash rates.

But the point to ask yourself is whether that is a good bet? I contend that with everyone leaning so heavily one way, the surprise will not be how much money they make, but instead if things don’t play out exactly as ominously as forecasted, how quickly the trade goes sour.

There is little room for error. Or put it another way, the global economy better collapse as quickly as these bears believe as even a lengthening of the process will make their trade unprofitable.

And in case you are bullish the long end of the curve and believe a slow-to-cut Fed is your best friend, don’t forget what Tariff Man has done to inflation. Next year should see a rise of 50 basis points across the board to core inflation. Sure commodities are falling hard, but that helps more with China’s inflation situation than with America’s.

The bond market is indeed pricing in rate cuts by the end of the year. The big question is how much of that is hedging of fears about the potential for a slowing global economy and resulting US Dollar outperformance and how much is about the need for an end to quantitative tightening in order to fend off fears about an impending recession?