Category Archives: Bonds

China Sells Dollar Bonds Directly To US Buyers For The First Time, Gets Record Demand

On Thursday, China for the first time sold dollar-denominated bonds directly to US buyers and with the Chinese 10Y offering a record 2.5% pickup in yield compared to 10Y Treasuries, it’s hardly a surprise that demand was off the charts.

The $6 billion bond offering which took place in Hong Kong, drew record demand, in part due to the attractive yield offered by Chinese paper and in part due to China’s impressive recovery from the coronavirus, with an orderbook more than $27 billion, or roughly $10 billion more than an offering of the same size last November, according to the FT, which added about 15% of the offering went to American investors.

The $6BN USD-denominated bond offering was as follows:

  • $1.25BN in 3-year dollar bonds at 0.425%
  • $2.25BN 5-year dollar bonds at 0.604%
  • $2BN 10-year dollar bonds at 1.226%
  • $500MM 30-year dollar bonds at 2.310%

The yield on the 10-year bond was about 0.5% above the equivalent US Treasury, and helped the bond sales receive “a strong reception from US onshore real money investors”, said Samuel Fischer, head of China onshore debt capital markets at Deutsche Bank, which helped arrange the deal. Other arrangers of the bond sale included Standard Chartered, Bank of America, Citigroup, Goldman Sachs and JPMorgan.

What was unique about today’s offering is that unlike previous issuance, “the debt was sold under a mechanism that gave institutional investors in the US the chance to buy in.”

Somewhat surprising is that frictions between Beijing and Washington had no impact “at all” on demand from US buyers, which included an American pension fund, one banker told the FT. In fact, the strategic timing of the bond sale which was arranged by the Chinese government just weeks before Americans head to the polls for the presidential election was meant to show “how tightly the financial systems of the two countries are linked, despite a trade war and tensions over technology and geopolitics.”

“This is the investor community showing confidence in [China’s] recovery,” said another banker on the sale, who added that “US investor participation in Chinese paper is not reduced by any means.”

Analyst responses were broadly enthusiastic about the offering:

Hayden Briscoe, head of fixed income for Asia Pacific at UBS Asset Management, said the bonds would help “set the benchmark” for Chinese corporates such as petrochemical groups Sinopec and Sinochem, which also borrow in dollars.  “A lot of their expenses are in US dollars, and they borrow in the dollar market to match funds to that.”

He added that the bonds benefited from strong demand partly due to their scarcity value. “There’s so few of them and they suit sovereign wealth fund type buyers — they tend to just disappear.”

Source: ZeroHedge

Canadian Government Loses AAA Debt Rating

Surge in debt leads to loss of AAA credit rating in a disturbing blow to Canada’s financial reputation.

As debt continues to surge, Canada has lost their AAA credit rating.

The rating has been downgraded by Fitch Ratings to AA+.

According to Fitch, Canada’s debt is projected to rise from 88.3% of GDP to 115.1% of GDP.

While many countries around the world are adding lots of debt, Canada’s growth before the crisis had already been very weak.

Various measures such as the carbon tax and excessive regulations have severely weakened Canada’s economy, with the energy sector struggling under the boot of government interference. Manufacturing has also been weak, with Canada clearly being seen as an increasingly challenging place to do business.

Additionally, the Liberal government massively increased our debt in good economic times, yet that huge surge of spending didn’t boost the economy.

Source: Spencer Fernando Blog

St. Louis Fed Researchers Say Negative Rates May Be Needed For Economic Recovery

Market Watch: Federal Reserve officials from Chair Jerome Powell on down have been pretty consistent in their scorn toward negative interest rates, even as the market briefly priced in the expectation that U.S. rates would fall below zero.

That criticism takes two forms — one, Fed officials say evidence doesn’t show much effectiveness where they have been tried, and two, negative interest rates might throw markets, such as those for money markets, into turmoil.

So it’s notable, if not a signal of future intention, that a publication from the St. Louis Fed argues in favor of negative interest rates.

Like Rudebusch’s -13.52% Fed Funds target rate?

But don’t get your hopes up for negative mortgage rates. At best, 30-year mortgage rates will shadow the already low 10-year Treasury yield. It really depends on how the 10-year Treasury yield responds.

Lowering the Fed Funds Target rate to negative territory may simply steepen the US Treasury yield curve. Or flatten it like in Japan. Note that the Japanese 10-year sovereign yield is .01% and Japan mortgage rates are around 0.440%.

Ignoring the damage done to savers (how low will CDs and deposit rates drop?), the US will likely not see actual negative mortgages.

Fed Chair Jerome Powell will resist negative target rates.

Source: Confounded Interest

America’s Largest Mall On Verge Of Default After Missing Two Loan Payments

Even before the coronavirus pandemic, US malls were in a crisis, with vacancies in January hitting a record high.

However, in the post-corona world, commercial real estate has emerged as one of the most adversely impacted sectors (perhaps because the Fed has so far refused to bail it out), with the number of new delinquencies soaring to a record high in recent weeks.

The gloom facing malls has also helped push the Big Short trade, which was the CMBX Series 6 BBB- tranche (the one with the most exposure to malls), to a fresh all time low last week.

And now, the implosion of the US retail sector has reached the very top, because according to Bloomberg The Mall of America, the largest US shopping center, has missed two months of payments for a $1.4 billion commercial mortgage-backed security, in confirmation that no business is immune to the devastating consequences of the coronavirus.

“The loan is currently due for the April and May payments,” according to a report filed by the trustee of the debt, Wells Fargo & Co., which is also the master servicer for the loan. “Borrower has notified master servicer of Covid-19 related hardships.”

Mall owners reported rock-bottom April rent collections, including about 12% for Tanger Factory Outlet Centers Inc., roughly 20% for Brookfield Property Partners LP and 26% for Macerich. Retailers and their landlords, hurt by competition from online stores before coronavirus-spurred shutdowns made things worse, are struggling to make rent and mortgage payments.

The 5.6 million-square-foot (520,000-square-meter) mall was ordered closed on March 17, and has announced plans to begin reopening on June 1, starting with retailers, followed later by food services and attractions, such as the mega-mall’s aquarium, cinema, miniature golf course and indoor theme park.

“Reopening a building the size of Mall of America is no small task, but we are confident taking the necessary time to reopen will help us create the safest environment possible,” the mall said in a statement on its website.

The Mall of America is owned by members of the Ghermezian family, whose holdings also include the West Edmonton Mall, a 5.3 million-square-foot complex in their Canadian hometown, and American Dream, a 3 million-square-foot mall in East Rutherford, New Jersey.

Source: ZeroHedge

The “Big Short 2” Hits An All Time Low As Commercial Real Estate Implodes

(ZeroHedge) Back in March 2017, a bearish trade emerged which quickly gained popularity on Wall Street, and promptly received the moniker “The Next Big Short.”

As we reported at the time, similar to the run-up to the housing debacle, a small number of bearish funds were positioning to profit from a “retail apocalypse” that could spur a wave of defaults. Their target: securities backed not by subprime mortgages, but by loans taken out by beleaguered mall and shopping center operators which had fallen victim to the Amazon juggernaut. And as bad news piled up for anchor chains like Macy’s and J.C. Penney, bearish bets against commercial mortgage-backed securities kept rising.

The trade was simple: shorting malls by going long default risk via CMBX 6 (BBB- or BB) or otherwise shorting the CMBS complex. For those who have not read our previous reports (herehereherehereherehere and here) on the second Big Short, here is a brief rundown via the Journal:

each side of the trade is speculating on the direction of an index, called CMBX 6, which tracks the value of 25 commercial-mortgage-backed securities, or CMBS. The index has grabbed investor attention because it has significant exposure to loans made in 2012 to malls that lately have been running into difficulties. Bulls profit when the index rises and shorts make money when it falls.

The various CMBX series are shown in the chart below, with the notorious CMBX 6 most notable for its substantial, 40% exposure to retail properties.

One of the firms that had put on the “Big Short 2” trade back in late 2016 was hedge fund Alder Hill Management – an outfit started by protégés of hedge-fund billionaire David Tepper – which ramped up wagers against the mall bonds. Alder Hill joined other traders which in early 2017 bought a net $985 million contracts that targeted the two riskiest types of CMBS.

“These malls are dying, and we see very limited prospect of a turnaround in performance,” said a January 2017 report from Alder Hill, which began shorting the securities. “We expect 2017 to be a tipping point.”

Alas, Alder Hill was wrong, because while the deluge of retail bankruptcies…

… and mall vacancies accelerated since then, hitting an all time high in 2019…

…  not only was 2017 not a tipping point, but the trade failed to generate the kinds of desired mass defaults that the shorters were betting on, while the negative carry associated with the short hurt many of those who were hoping for quick riches.

One of them was investing legend Carl Icahn who as we reported last November, emerged as one of the big fans of the “Big Short 2“, although as even he found out, CMBX was a very painful short as it was not reflecting fundamentals, but merely the overall euphoria sweeping the market and record Fed bubble (very much like most other shorts in the past decade). The resulting loss, as we reported last November, was “tens if not hundreds of millions in losses so far” for the storied corporate raider.

That said, while Carl Icahn was far from shutting down his family office because one particular trade has gone against him, this trade put him on a collision course with two of the largest money managers, including Putnam Investments and AllianceBernstein, which for the past few years had a bullish view on malls and had taken the other side of the Big Short/CMBX trade, the WSJ reports. This face-off, in the words of Dan McNamara a principal at the NY-based MP Securitized Credit Partners, was “the biggest battle in the mortgage bond market today” adding that the showdown is the talk of this corner of the bond market, where more than $10 billion of potential profits are at stake on an obscure index.

However, as they say, good things come to those who wait, and are willing to shoulder big losses as they wait for a massive payoffs, and for the likes of Carl Icahn, McNamara and others who were short the CMBX, payday arrived in mid-March, just as the market collapsed, hammering the CMBX Series BBB-.

And while the broader market has rebounded since then by a whopping 30%, the trade also known as the “Big Short 2” has continued to collapse and today CMBX 6 hit a new lifetime low of just $62.83, down $10 since our last update on this storied trade several weeks ago.

That, in the parlance of our times, is what traders call a “jackpot.”

Why the continued selling? Because it is no longer just retail outlets and malls: as a result of the Covid lock down, and America’s transition to “Work From Home” and “stay away from all crowded places”, the entire commercial real estate sector is on the verge of collapse, as we reported last week in “A Quarter Of All Outstanding CMBS Debt Is On Verge Of Default

Sure enough, according to a Bloomberg update, a record 167 CMBS 2.0 loans turned newly delinquent in May even though only 25% of loans have reported remits so far, Morgan Stanley analysts said in a research note Wednesday, triple the April total when 68 loans became delinquent. This suggests delinquencies may rise to 5% in May, and those that are late but still within grace period track at 10% for the second month.

Looking at the carnage in the latest remittance data, and explaining the sharp leg lower in the “Big Short 2” index, Morgan Stanley said that several troubled malls that are a part of CMBX 6 are among the loans that were newly delinquent or transferred to special servicers. Among these:

  • Crystal Mall in Waterford, Connecticut, is currently due for the April and May 2020 payments. There has been a marked decline in both occupancy and revenue. This loan accounts for nearly 10% of a CMBS deal called UBSBB 2012-C2
  • Louis Joliet Mall in Joliet, Illinois, is also referenced in CMBX 6. The mall was originally anchored by Sears, JC Penney, Carson’s, and Macy’s. The loan is also a part of the CMBS deal UBSBB 2012-C2
  • A loan for the Poughkeepsie Galleria in upstate New York was recently transferred to special servicing for imminent monetary default at the borrower’s request. The loan has exposure in two 2012 CMBS deals that are referenced by CMBX 6
  • Other troubled mall-chain tenants include GNC, Claire’s, Body Works and Footlocker, according to Datex Property Solutions. These all have significant exposure in CMBX 6.

Of course, the record crash in the CMBX 6 BBB has meant that all those shorts who for years suffered the slings and stones of outrageous margin calls but held on to this “big short”, have not only gotten very rich, but are now getting even richer – this is one case where everyone will admit that Carl Icahn adding another zero to his net worth was fully deserved as he did it using his brain and not some crony central bank pumping the rich with newly printed money – it has also means the pain is just starting for all those “superstar” funds on the other side of the trade who were long CMBX over the past few years, collecting pennies and clipping coupons in front of a P&L mauling steamroller.

One of them is mutual fund giant AllianceBernstein, which has suffered massive paper losses on the trade, amid soaring fears that the coronavirus pandemic is the straw on the camel’s back that will finally cripple US shopping malls whose debt is now expected to default en masse, something which the latest remittance data is confirming with every passing week!

According to the FT, more than two dozen funds managed by AllianceBernstein have sold over $4 billion worth of CMBX protection to the likes of Icahn. One among them is AllianceBernstein’s $29 billion American Income Portfolio, which crashed after written $1.9bn of protection on CMBX 6, while some of the group’s smaller funds have even higher concentrations.

The trade reflected AB’s conviction that American malls are “evolving, not dying,” as the firm put it last October, in a paper entitled “The Real Story Behind the CMBX. 6: Debunking the Next ‘Big Short’” (reader can get some cheap laughs courtesy of Brian Philips, AB’s CRE Credit Research Director, at this link).

Hillariously, that paper quietly “disappeared” from AllianceBernstein’s website, but magically reappeared in late March, shortly after the Financial Times asked about it.

“We definitely still like this,” said Gershon Distenfeld, AllianceBernstein’s co-head of fixed income. “You can expect this will be on the potential list of things we might buy [more of].”

Sure, quadruple down, why not: it appears that there are still greater fools who haven’t redeemed their money.

In addition to AllianceBernstein, another listed property fund, run by Canadian asset management group Brookfield, that is exposed to the wrong side of the CMBX trade recently moved to reassure investors about its financial health. “We continue to enjoy the sponsorship of Brookfield Asset Management,” the group said in a statement, adding that its parent company was “in excellent financial condition should we ever require assistance.”

Alas, if the plunge in CMBX continues, that won’t be the case for long.

Meanwhile, as stunned funds try to make sense of epic portfolio losses, the denials got even louder: execs at AllianceBernstein told FT the paper losses on their CMBX 6 positions reflected outflows of capital from high-yielding assets that investors see as risky. They added that the trade outperformed last year. Well yes, it outperformed last year… but maybe check where it is trading now.

Even if some borrowers ultimately default, CDS owners are not likely to be owed any cash for several years, said Brian Phillips, a senior vice-president at AllianceBernstein.

He believes any liabilities under the insurance will ultimately be smaller than the annual coupon payment the funds receive. “We’re going to continue to get a coupon from Carl Icahn or whoever — I don’t know who’s on the other side,” Phillips added. “And they’re going to keep [paying] that coupon in for many years.”

What can one say here but lol: Brian, buddy, no idea what alternative universe you are living in, but in the world called reality, it’s a second great depression for commercial real estate which due to the coronavirus is facing an outright apocalypse, and not only are malls going to be swept in mass defaults soon, but your fund will likely implode even sooner between unprecedented capital losses and massive redemptions… but you keep “clipping those coupons” we’ll see how far that takes you. As for Uncle Carl who absolutely crushed you – and judging by the ongoing collapse in commercial real estate is crushing you with every passing day – since you will be begging him for a job soon, it’s probably a good idea to go easy on the mocking.

Afterthought: with CMBX 6 now done, keep a close eye on CMBX 9. With its outlier exposure to hotels which have quickly emerged as the most impacted sector from the pandemic, this may well be the next big short.

This Goose Is Cooked: “I’ve Never, Ever, Ever Seen Anything Like This Before”

“You have enormous buyers of debt meeting massive coordinated fiscal stimulus by governments across the globe. For bond investors, you’re caught between a rock and a hard place.”

With the Fed buying $622 billion in Treasury and MBS, a staggering 2.9% of US GDP, in just the past five days…

… any debate what to call the current phase of the Fed’s asset monetization – “NOT NOT-QE”, QE4, QE5, or just QEternity – can be laid to rest: because what the Fed is doing is simply Helicopter money, as it unleashes an unprecedented debt – and deficit – monetization program, one which is there to ensure that the trillions in new debt the US Treasury has to issue in the coming year to pay for the $2 (or is that $6) trillion stimulus package find a buyer, which with foreign central banks suddenly dumping US Treasuries

… would otherwise be quite problematic, even if it means the Fed’s balance sheet is going to hit $6 trillion in a few days.

The problem, at least for traders, is that this new regime is something they have never encountered before, because during prior instances of QE, Treasuries were a safe asset. Now, however, with fears that helicopter money will unleash a tsunami of so much debt not even the Fed will be able to contain it resulting in hyperinflation, everything is in flux, especially when it comes to triangulating pricing on the all important 10Y and 30Y Treasury.

Indeed, as Bloomberg writes today, core investor tenets such as what constitutes a safe asset, the value of bonds as a portfolio hedge, and expectations for returns over the next decade are all being thrown out as governments and central banks strive to avert a global depression.

And as the now infamous “Money Printer go Brrr” meme captures so well, underlying the uncertainty is the risk that trillions of dollars in monetary and fiscal stimulus, and even more trillions in debt, “could create an eventual inflation shock that will trigger losses for bondholders.”

Needless to say, traders are shocked as for the first time in over a decade, they actually have to think:

“You have enormous buyers of debt meeting massive coordinated fiscal stimulus by governments across the globe. For bond investors, you’re caught between a rock and a hard place.”

And while equity investors may be confident that in the long run, hyperinflation results in positive real returns if one sticks with stocks, the Weimar case showed that that is not the case. But that is a topic for another day. For now we will focus on bond traders, who are finding the current money tsunami unlike anything they have seen before.

Indeed, while past quantitative easing programs have led to similar concerns, this emergency response is different because it’s playing out in weeks rather than months and limits on QE bond purchases have quickly been scrapped.

Any hope that the Fed will ease back on the Brrring printer was dashed when Fed Chairman Jerome Powell said Thursday the central bank will maintain its efforts “aggressively and forthrightly” saying in an interview on NBC’s “Today” show that the Fed will not “run out of ammunition” after promising unlimited bond purchases. His comments came hours after the European Central Bank scrapped most of the bond-buying limits in its own program.

The problem is that while this type of policy dominates markets, fundamental analysis scrambling to calculate discount rates and/or debt in the system fails, and “strategic thinking is stymied and some prized investment tools appear to be defunct”, said Ronald van Steenweghen of Degroof Petercam Asset Management.

“Valuation models, correlation, mean reversion and other things we rely on fail in these circumstances,” said the Brussels-based money manager. Oh and as an added bonus, “Liquidity is also very poor so it is difficult to be super-agile.”

The irony: the more securities the Fed soaks up, be they Treasuries, MBS, Corporate bonds, ETFs or stocks, the worse the liquidity will get, as the BOJ is finding out the hard way, as virtually nobody wants to sell their bonds to the central bank.

Another irony: normally the prospect of a multi-trillion-dollar government spending surge globally ought to send borrowing costs soaring. But central bank purchases are now reshaping rates markets – emulating the Bank of Japan’s yield-curve control policy starting in 2016 – and quashing these latest volatility spikes.

In effect, the Fed’s takeover of bond markets (and soon all capital markets), means that any signaling function fixed income securities have historically conveyed, is now gone, probably for ever.

“Investors shouldn’t expect to see much more than moderately steep yield curves, since the Fed and its peers don’t want higher benchmark borrowing costs to undermine their stimulus,” said Blackrock strategist Scott Thiel. “That would be detrimental to financial conditions and to the ability for the stimulus to feed through to the economy. So the short answer is, it’s yield-curve control.”

Said otherwise, pretty soon the entire yield curve will be completely meaningless when evaluating such critical for the economy conditions as the price of money or projected inflation. They will be, simply said, whatever the Fed decides.

And with the yield curve no longer telegraphing any inflationary risk, it is precisely the inflationary imbalances that will build up at an unprecedented pace.

Additionally, when looking further out, Bloomberg notes that money managers need to reassess another assumption that’s become widely held in recent years: that inflation is dead. Van Steenweghen says he’s interested in inflation-linked bonds, though timing a foray into that market is “tricky.”

Naeimi also said he expects that the coordination by central banks and governments will spike inflation at some stage. “It all adds to the volatility of holding bonds,” he said. But for the time being, he’s range-trading Australian bonds — buying when 10-year yields hit 1.5%, and selling at 0.6%.

That’s right: government bonds have become a daytrader’s darling. Whatever can possibly go wrong.

But the biggest fear – one we have warned about since 2009 – is that helicopter money, which was always the inevitable outcome of QE, will lead to hyperinflation, and the collapse of both the US Dollar, and the fiat system, of which it is the reserve currency. Bloomberg agrees:

Many market veterans agree that faster inflation may return in a recovery awash with stimulus that central banks and governments may find tough to withdraw. A reassessment of consumer-price expectations would be a major setback for expensive risk-free bonds, especially those with the longest maturities, which are most vulnerable to inflation eroding their value over time.

Of course, at the moment that’s hard to envisage, with market-implied inflation barely at 1% over the next decade, but as noted above, at a certain point the bond market no longer produces any signal, just central bank noise, especially when, as Bloomberg puts it, “central bank balance sheets are set to explode further into unchartered territory.” Quick note to the Bloomberg editors: it is “uncharted”, although you will have plenty of opportunity to learn this in the coming months.

Alas, none of this provides any comfort to bond traders who no longer have any idea how to trade in this new “helicopter normal“, and thus another core conviction is being revised: the efficacy of U.S. Treasuries as a safe haven and portfolio hedge.

Mark Holman, chief executive and founding partner of TwentyFour Asset Management in London, started questioning that when the 10-year benchmark hit its historic low early this month.

“Will government bonds play the same role in your portfolio going forward as they have in the past?” he said. “To me the answer is no they don’t — I’d rather own cash.”

For now, Mark is turning to high-quality corporate credit for low-risk income, particularly in the longer maturity bonds gradually rallying back from a plunge, especially since they are now also purchased by the Fed. He sees no chance of central banks escaping the zero-bound’s gravitational pull in the foreseeable future. “What we do know is we’re going to have zero rates around the world for another decade, and we’re going to have the need for income for another decade,” he said.

Other investors agree that cash is the only solution, which is why T-Bills – widely seen as cash equivalents – are now trading with negative yields for 3 months and over.

Yet others rush into the safety of gold… if they can find it. At least check, physical gold was trading with a 10% premium to paper gold and rising fast.

Ultimately, as Bloomberg concludes, investors will have to find their bearings “in a crisis without recent historical parallel.”

“It’s very hard to look at this in a historical context and then apply an investment framework around it,” said BlackRock’s Thiel. “The most applicable period is right before America entered WW2, when you had gigantic stimulus to spur the war effort. I mean, Ford made bombers in WW2 and now they’re making ventilators in 2020.”

Welcome to the New America

Source: ZeroHedge

All T-Bills Up To 3 Months Now Have Negative Yields

There was something strange about today’s continuation rally in stocks: while risk assets soared, the VIX barely moved. In fact the Vix is now roughly where it was on Monday, largely ignoring the move in stocks.

But there was another more sinister move in today’s risk rally, which as we noted earlier, appears to have been mostly a massive short squeeze, in fact the biggest two-day short squeeze in history…

… namely the persistent buying of safe havens such as Treasury’s but more importantly, Bills.

And so, one week after we reported that yields on many T-Bills through 3 months turned negative for the first time since the financial crisis, today virtually all Bills maturing around July had a negative yield.

Needless to say, a scramble for both cash-equivalents (i.e. Bills) and stocks is rather unorthodox, and sparked debate among Wall Street desks what may be behind it. One answer that emerged is that for those who did not have faith in today’s stock rally and wanted to allocate their funds elsewhere, yet in the absence of available physical gold as a result of the unprecedented scarcity described yesterday, the one place where investors could find “cash equivalent” securities was among the short T-Bill maturities.

If this theory is correct, it would mean that the pent up demand for physical gold is unprecedented and any newly available precious metal will be quickly snapped up as soon as it is available, which in light of the unprecedented expansion in central bank balance sheets as virtually every state is now pursuing helicopter money, is hardly that surprising.

Source: ZeroHedge

S&P Downgrades Ford To Junk – Biggest Fallen Angel Yet

Given where Ford’s CDS was trading – more in line with B1/BB- rated American Axle – it should hardly come as a surprise that S&P has finally bitten the bullet and downgraded Ford debt to junk.

Via S&P,

The decision to downgrade Ford Motor Co. from investment grade to speculative grade reflects that the company’s credit metrics and competitive position became borderline for the investment-grade rating prior to the coronavirus outbreak, and the expected downturn in light-vehicle demand made it unlikely that Ford would maintain the required metrics.

Ford Motor Co. announced it is suspending production at its manufacturing sites in Europe for four weeks and halting production in North America to clean these facilities and boost containment efforts for the COVID-19 coronavirus. We expect Ford’s EBITDA margin to remain below 6% on a sustained basis and believe that its free operating cash flow to debt is unlikely to exceed 15% on a consistent basis.

Ford has drawn $13.4 billion on its corporate credit facility and $2 billion on its supplemental credit facility. We believe the company’s current cash position stands at about $36 billion.

We are downgrading our long-term issuer credit rating to ‘BB+’ from ‘BBB-‘. At the same time, we are assigning issue-level ratings of ‘BB+’ on Ford’s unsecured debt.

We are also placing the ratings on Credit Watch with negative implications, which reflects at least a 50% chance that we could lower the ratings depending on factors such as the duration of the plant shutdowns, the rate of cash burn, and the adequacy of Ford’s liquidity position.

This S&P move follows Moody’s cutting Ford’s long-term corporate family rating to Ba2 from Ba1 earlier in the day.

With a total amount of public bonds & loans outstanding around $95.8 billion, according to data compiled by Bloomberg, Ford has just become one of the largest fallen angels yet.

Will this sudden large fallen angel lead to further repricing in the junk bond market, just as the market is dead-cat-bouncing on Fed intervention?

Perhaps of most note, the downgrade to junk means – we think – that this disqualifies Ford debt from The Fed’s corporate-bond-buying bandwagon – which is likely to make the cliff for Ford debt even more dramatic (especially after rallying so hard the last two days).

Source: ZeroHedge

2007 Redux – Mortgage Fund Considers Asset-Sale After “High Number Of Margin Calls”

On the day when The Fed unveils it will be buying agency MBS and CMBS (along with IG corporate debt) in unlimited size “to maintain the smooth functioning of markets,” The Wall Street Journal reports that for at least one major mortgage investor – it could be too late.

For a sense of the scale of collapse in CMBS markets alone, here is CMBX Series 6 BBB- tranche (a popular hedge fund “next big short” trade that is heavily exposed to malls/retail)…

And mortgage markets are becoming notably illiquid (hence The Fed’s unlimited injections)…

And the infamous ‘basis’ trade in ETF land, is extreme…

All of which has left an investment fund focused on mortgage investments struggling to meet margin calls from lenders.

WSJ’s Greg Zuckerman reports that the AG Mortgage Investment Trust, a real-estate investment trust operated by New York hedge fund Angelo, Gordon & Co., is among those feeling pressure, the company said, and, in the latest sign of turmoil in crucial areas of the credit markets, is examining a possible asset sale.

“In recent weeks, due to the turmoil in the financial markets resulting from the global pandemic of the Covid-19 virus, the company and its subsidiaries have received an unusually high number of margin calls from financing counter parties,” AG Mortgage said Monday morning.

The company said it had met “or is in the process of meeting all margin calls received,” though it acknowledged missing the wire deadline for some on Friday.

On Friday evening, the company “notified its financing counter parties that it doesn’t expect to be in a position to fund the anticipated volume of future margin calls under its financing arrangements in the near term,” AG Mortgage said in its statement, which said the company is in discussions with its lenders “with regard to entering into forbearance agreements.”

It’s stock has collapsed…

As have the Preferreds…

Concern about losses in mortgage bonds could feed turmoil in the overall mortgage market that ultimately drives up borrowing costs for consumers looking to buy homes and refinance. Mortgage rates have risen in recent weeks, despite a fall in benchmark rates.

All of which sounds ominously similar to July 2007, when two Bear Stearns hedge funds (Bear Stearns High-Grade Structured Credit Fund and the Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund) – exposed to mortgage-backed securities and various other leveraged derivatives on same – crashed and burned and started the dominoes falling…

Source: ZeroHedge

“We’re About Halfway There” – Historic Carnage Everywhere Sparked By Dollar Margin Call Panic

It was definitely a ‘deer’ day…

Stocks down, Bonds down, credit down, gold down, oil down, copper down, crypto down, global systemically important banks down, and liquidity down

Today was the worst day for a combined equity/bond portfolio… ever…

https://www.zerohedge.com/markets/escalating-dollar-crisis-sparks-global-turmoil-were-about-halfway-there

Coronavirus Has Spurred a Global Race for Cash, and It’s Roiling Markets

Coronavirus has started a race into cash for all types of market participants. That has fueled rallies in reserve currencies—especially the dollar.

The U.S. dollar is approaching its highest level on record against other leading global currencies, according to the Bloomberg Dollar Spot Index. The index was up 1.1% in early trading Wednesday, and has climbed 6.5% in the past nine days. And derivatives markets indicate that even investors and banks in countries with their own major reserve currencies want to secure dollars.

Banks, companies, and investors have many good reasons to rush to secure dollar liquidity. Many businesses are facing the prospect of a steep decline in revenue as federal and local governments ask their constituents to stay home to prevent the spread of coronavirus.

That means businesses could struggle to keep paying leases, wages, and other costs. Workers (especially hourly workers) could struggle to pay their own living expenses. And banks could be met with withdrawal requests and surging demand for credit denominated in dollars.

“[The economic] front line in the crisis is the damage the pandemic is wreaking on companies in exposed sectors and on the economy more widely as the crisis spreads,” wrote Kit Juckes, a strategist at Société Générale. “So while market participants scramble [to] deleverage, the banks need money to lend to companies whose cash flow situation has changed almost overnight.”

The cash grab is echoing through markets in some striking ways. Even the lowest-risk markets—Treasuries and municipal bonds for example—have seen steep losses as investors move into cash. Benchmark 10-year and 30-year bond yields posted their steepest single-session jump since 1982 on Tuesday.

“This matters on a day-to-day basis for the [currency] market because liquidity stress, and a rush to get hold of dollar liquidity in particular, sends the dollar higher against everything,” Juckes wrote.

The widespread bid for liquidity has shown up in fund-flows data as well. Mutual funds in nearly every sector of markets lost billions of dollars in investor funds over the week ended March 11, the latest data reported by Refinitiv Lipper.

Taxable bond funds saw outflows of $11 billion that week, while equity funds lost $3.2 billion of cash and municipal (tax-exempt) bond funds lost $1.7 billion.

Money-market funds, on the other hand, brought in piles of cash. Investors put a net $87 billion into the sector as a whole over the week ended March 11, according to Refinitiv, the biggest inflow on record.

Within that category, even prime funds, or the money-market funds that buy short-term corporate debt, lost money over the week ended March 11, according to data from ICI.

Government money-market funds pulled in $97 billion, their second-biggest inflow on record, Refinitiv data show. The biggest week was in Sept. 2008, at the height of the financial crisis.

The results for the week ended March 18 won’t be out until Thursday. But if the steep declines in stocks, longer-term Treasuries, and corporate bonds are any indication, investors are still racing for the exits.

“That need for funds to flow into the economy isn’t going away any time soon,” Juckes wrote. “The result is that while direct financial effects of this crisis might be less acute than in ‘08, they will continue being felt for a long time.”

Source: by Alexandria Scaggs | Barrons

Collapse Review

We just witnessed a global collapse in asset prices the likes we haven’t seen before. Not even in 2008 or 2000. All these prior beginnings of bear markets happened over time, relatively slowly at first, then accelerating to the downside.

This collapse here has come from some of the historically most stretched valuations ever setting the stage for the biggest bull trap ever. The coronavirus that no one could have predicted is brutally punishing investors that complacently bought into the multiple expansion story that was sold to them by Wall Street. Technical signals that outlined trouble way in advance were ignored while the Big Short 2 was already calling for a massive explosion in $VIX way before anybody ever heard of corona virus.

Worse, there is zero visibility going forward as nobody knows how to price in collapsing revenues and earnings amid entire countries shutting down virtually all public gatherings and activities. Denmark just shut down all of its borders on Friday, flight cancellations everywhere, the planet is literally shutting down in unprecedented fashion.

Source: by Sven Henrich | Northman Trader

These Are The Banks With Most Energy Exposure

With energy junk bonds crashing

… amid a (long-overdue) investor revulsion to the highly levered energy sector, much of which is funded in the high yield market, as crashing oil prices bring front and center a doomsday scenario of mass defaults as shale companies are unable to meet their debt and interest payment obligations, investor focus is shifting up the funding chain, and after assessing which shale names are likely to be hit the hardest, with many filing for bankruptcy if oil remains at or below $30, the next question is which banks have the most exposure to the energy loans funding these same E&P companies.

Conveniently, in a note this morning looking at the impact of plunging interest rates on bank profitability, Morgan Stanley also lays out the US banks that have the highest exposure to energy in their Q4 loan books.

With VIX Hitting 50, The Fed Must Now Step In Or A Catastrophic Crash Is Inevitable

With stocks tumbling, the VIX has, predictably, soared, briefly tipping above 50 intraday on Friday and last trading above 46, surpassing the levels hit during the Volmageddon in Feb 2018 and the highest level since the US credit rating downgrade in August 2011.

Just as dramatic is the accelerating VIX term structure inversion, which has pushed the curve to the steepest backwardation since the financial crisis…

More at ZeroHedge Here

The Seizure In Credit Markets Is About To Get A Lot More Attention…

Gundlach Was Right – Even Investment Grade Credit Markets Are Crashing Today

It appears, as Jeff Gundlach warned last night, that the seizure in credit markets is about to get a lot more attention…

“The bond market is rallying because The Fed has reacted the seizure in the corporate bond market – which is not getting enough attention.”

The Fed cut rates, he added, “in reaction to even the investment being shutdown for 7 business days.

Gundlach noted that Powell’s background in the private equity world – rather than academic economist land – has meant that his reaction function is driven by problems in the corporate bond market as “this will be problematic for the buyback aspect of the stock market.”

As HY is already at its widest since 2016…
And that’s why Gundlach is long gold:

I turned bullish on gold in the summer of 2018 on my Total Return webcast when it was at 1190. And it just seems to me, as I talked about my Just Markets webcast, which is up on DoubleLine.com on a replay, that the dollar is going to get weaker.

And the dollar getting weaker seems to be a policy. And the Fed cutting rates, slashing rates is clearly going to be dollar negative. And that means that gold is going to go higher.

Source: ZeroHedge

Recession 2020: 5 Reasons It Will Be Worse Than 2009

In this recession 2020 video YOU are going to discover 5 reasons (NO ONE IS TALKING ABOUT) the next recession will be far worse than the 2008/2009 recession. The Fed has created so much mal investment, by keeping interest rates artificially low, we now have the EVERYTHING BUBBLE. Stocks are in a bubble, bonds are in a bubble, housing is in a bubble and the 2020 recession (which the data suggests is highly probable) will be the pin that pricks them all.

We’ve had recessions in the US every 6-8 years throughout our history, and we’re currently 10 years into an expansion which makes the US due for a recession in 2020. While not all recessions are devastating, because the debt bubbles are so much bigger now than in 2009, the next recession has the potential to be the worst by far.

Subprime Auto Loans Explode, “Serious Delinquencies” Spike To Record

Nearly a quarter of all subprime auto loans are 90+ days delinquent. Why?

Auto loan and lease balances have surged to a new record of $1.33 trillion. Delinquencies of auto loans to borrowers with prime credit rates hover near historic lows. But subprime loans (borrowers with a credit score below 620) are exploding at a breath-taking rate, and they’re driving up the overall delinquency rates to Financial Crisis levels. Yet, these are the good times, and there is no employment crisis where millions of people have lost their jobs.

All combined, prime and subprime auto-loan delinquencies that are 90 days or more past due – “serious” delinquencies – in the fourth quarter 2019, surged by 15.5% from a year ago to a breath-taking historic high of $66 billion, according to data from the New York Fed released today:

Loan delinquencies are a flow. Fresh delinquencies that hit lenders go into the 30-day basket, then a month later into the 60-day basket, and then into the 90-day basket, and as they move from one stage to the next, more delinquencies come in behind them. When the delinquency cannot be cured, lenders hire a company to repossess the vehicle. Finding the vehicle is generally a breeze with modern technology. The vehicle is then sold at auction, a fluid and routine process.

These delinquent loans hit the lenders’ balance sheet and income statement in stages. In the end, the combined loss for the lender is the amount of the loan balance plus expenses minus the amount obtained at auction. On new vehicles that were financed with a loan-to-value ratio of 120% or perhaps higher, losses can easily reach 40% or more of the loan balance. On a 10-year old vehicle, losses are much smaller.

As these delinquent loans make their way through the system and are written off and disappear from the balance sheet, lenders are making new loans to risky customers, and a portion of those loans will become delinquent in the future. This creates that flow of delinquent loans. But that flow has turned into a torrent.

Seriously delinquent auto loans jumped to 4.94% of the $1.33 trillion in total loans and leases outstanding, above where the delinquency rate had been in Q3 2010 as the auto industry was collapsing, with GM and Chrysler already in bankruptcy, and with the worst unemployment crisis since the Great Depression approaching its peak. But this time, there is no unemployment crisis; these are the good times:

About 22% of the $1.33 trillion in auto loans outstanding are subprime, so about $293 billion are subprime. Of them, $68 billion are 90+ days delinquent. This means that about 23% of all subprime auto loans are seriously delinquent. Nearly a quarter!

Subprime auto loans are often packaged into asset-backed securities (ABS) and shuffled off to institutional investors, such as pension funds. These securities have tranches ranging from low-rated or not-rated tranches that take the first loss to double-A or triple-A rated tranches that are protected by the lower rated tranches and generally don’t take losses unless a major fiasco is happening. Yields vary: the riskiest tranches that take the first lost offer the highest yields and the highest risk; the highest-rated tranches offer the lowest yields.

These subprime auto-loan ABS are now experiencing record delinquency rates. Delinquency rates are highly seasonal, as the chart below shows. In January, the subprime 60+ day delinquency rate for the auto-loan ABS rated by Fitch rose to 5.83%, according to Fitch Ratings, the highest rate for any January ever, the third highest rate for any month, and far higher than any delinquency rate during the Financial Crisis:

But prime auto loans (blue line in the chart) are experiencing historically low delinquency rates.

Why are subprime delinquencies surging like this?

It’s not the economy. That will come later when the employment cycle turns and people lose their jobs. And those delinquencies due to job losses will be on top of what we’re seeing now.

It’s how aggressive the subprime lending industry has gotten, and how they’ve been able to securitize these loans and selling the ABS into heavy demand from investors who have gotten beaten up by negative-interest-rate and low-interest-rate policies of central banks. These investors have been madly chasing yield. And their demand for subprime-auto-loan ABS has fueled the subprime lending business.

Subprime is a very profitable business because interest rates range from high to usurious, and customers with this credit rating know that they have few options and don’t negotiate. Often, they might not do the math of what they can realistically afford to pay every month; and why should they if the dealer puts them in a vehicle, and all they have to do is sign the dotted line?

So profit margins for dealers, lenders, and Wall Street are lusciously and enticingly fat.

Subprime lending is a legitimate business. In the corporate world, the equivalent is high-yield bonds (junk bonds) and leveraged loans. Netflix and Tesla belong in that category. The captive lenders, such as Ford Motor Credit, GM Financial, Toyota Financial Services, etc., or credit unions, take some risks with subprime rated customers but generally don’t go overboard.

The most aggressive in this sector are lenders that specialize in subprime lending. These lenders include Santander Consumer USA, Credit Acceptance Corporation, and many smaller private-equity backed subprime lenders specializing in auto loans. Some sell vehicles, originate the loans, and either sell the loans to banks or securitize the loans into ABS.

And they eat some of the losses as they retain some of the lower-rated tranches of the ABS. Some banks are exposed to these smaller lenders via their credit lines. The remaining losses are spread around the world via securitizations. This isn’t going to take down the banking system though a few smaller specialized lenders have already collapsed.

But demand for subprime auto loan ABS remains high. And as long as there is demand from investors for the ABS, there will be supply, and losses will continue to get scattered around until a decline in investor demand imposes some discipline.

Source: by Wolf Richter | ZeroHedge

And Again: The Fed Monetizes $4.1 Billion In Debt Sold Just Days Earlier

Over the past week, when looking at the details of the Fed’s ongoing QE4, we showed out (here and here) that the New York Fed was now actively purchasing T-Bills that had been issued just days earlier by the US Treasury. As a reminder, the Fed is prohibited from directly purchasing Treasurys at auction, as that is considered “monetization” and directly funding the US deficit, not to mention is tantamount to “Helicopter Money” and is frowned upon by Congress and established economists. However, insert a brief, 3-days interval between issuance and purchase… and suddenly nobody minds. As we summarized:

“for those saying the US may soon unleash helicopter money, and/or MMT, we have some ‘news’: helicopter money is already here, and the Fed is now actively monetizing debt the Treasury sold just days earlier using Dealers as a conduit… a “conduit” which is generously rewarded by the Fed’s market desk with its marked up purchase price. In other words, the Fed is already conducting Helicopter Money (and MMT) in all but name. As shown above, the Fed monetized T-Bills that were issued just three days earlier – and just because it is circumventing the one hurdle that prevents it from directly purchasing securities sold outright by the Treasury, the Fed is providing the Dealers that made this legal debt circle-jerk possible with millions in profits, even as the outcome is identical if merely offset by a few days”

So, predictably, fast forward to today when the Fed conducted its latest T-Bill POMO in which, as has been the case since early October, the NY Fed’s market desk purchased the maximum allowed in Bills, some $7.5 billion, out of $25.3 billion in submissions. What was more notable were the actual CUSIPs that were accepted by the Fed for purchase. And here, once again, we find just one particular issue that stuck out: TY5 (due Dec 31, 2020) which was the most active CUSIP, with $4.136BN purchased by the Fed, and TU3 (due Dec 3, 2020) of which $905MM was accepted.

Why is the highlighted CUSIP notable? Because as we just showed on Friday, the Fed – together with the Primary Dealers – appears to have developed a knack for monetizing, pardon, purchasing in the open market, bonds that were just issued. And sure enough, TY5 was sold just one week ago, on Monday, Dec 30, with the issue settling on Jan 2, just days before today’s POMO, and Dealers taking down $17.8 billion of the total issue…

… and just a few days later turning around and flipping the Bill back to the Fed in exchange for an unknown markup. Incidentally, today the Fed also purchased $615MM of CUSIP UB3 (which we profiled last Friday), which was also sold on Dec 30, and which the Fed purchased $5.245BN of last Friday, bringing the total purchases of this just issued T-Bill to nearly $6 billion in just three business days.

In keeping with this trend, the rest of the Bills most actively purchased by the Fed, i.e., TP4, TN9, TJ8, all represent the most recently auctioned off 52-week bills

… confirming once again that the Fed is now in the business of purchasing any and all Bills that have been sold most recently by the Treasury, which is – for all intents and purposes – debt monetization.

As we have consistently shown over the past week, these are not isolated incidents as a clear pattern has emerged – the Fed is now monetizing debt that was issued just days or weeks earlier, and it was allowed to do this just because the debt was held – however briefly – by Dealers, who are effectively inert entities mandated to bid for debt for which there is no buyside demand, it is not considered direct monetization of Treasurys. Of course, in reality monetization is precisely what it is, although since the definition of the Fed directly funding the US deficit is negated by one small temporal footnote, it’s enough for Powell to swear before Congress that he is not monetizing the debt.

Oh, and incidentally the fact that Dealers immediately flip their purchases back to the Fed is also another reason why NOT QE is precisely QE4, because the whole point of either exercise is not to reduce duration as the Fed claims, but to inject liquidity into the system, and whether the Fed does that by flipping coupons or Bills, the result is one and the same.

Source: ZeroHedge

Yield Curve Steepest In 14 Months: What Happens Next?

The Fed, reportedly, took action in 2019 – with its massive flip-flop, cutting rates drastically and expanding its balance sheet at the fastest pace since the financial crisis –  in order to ‘fix’ the yield curve which had dropped into the media-terrifying inverted state… but what investors (and The Fed) appear to have forgotten (or choose to ignore) is that it is now much more concerning.

The last few months have seen the yield curve steepen dramatically, up 35bps from August’s -5bps spread in 2s10s to over 30bps today – the steepest since October 2018…

Source: Bloomberg

That is great news, right? No more recession risk, right?

Wrong!

 

While investors buy stocks with both hands and feet, we take a look at how risk assets perform after the curve flattens and/or inverts. According to back tests from Goldman, while risky assets in general can have positive performance with a flat yield curve, risky asset performances tend to be lower. This is consistent with Goldman’s base case forecast combining low (but positive) returns from here given the lack of profit growth and a less favorable macro backdrop.

What is far more notable, as ZeroHedge showed most recently last July, is that since the mid-1980s, significant stock draw downs (i.e. market crashes) began only when term slope started steepening after being inverted.

And remember, the yield curve’s forecasting record since 1968 has been perfect: not only has each inversion been followed by a recession, but no recession has occurred in the absence of a prior yield-curve inversion. There’s even a strong correlation between the initial duration and depth of the curve inversion and the subsequent length and depth of the recession.

So, be careful what you wish for… and celebrate; because as history has shown, the un-inverting of the yield curve is when the recessions start and when the markets begin to reflect reality.

Source: ZeroHedge

World Economy Haunted by Risk Just Got a Double Shot in the Arm (How Long Before Mortgage Rates Rise??)

(Bloomberg) — Two of the biggest hurdles constraining the world economy have just been cleared.

Its a double shot of economic love!

Dogged for most of 2019 by trade tensions and political risk that hammered business confidence, the outlook for global growth will enter 2020 on a firmer footing after the U.S. and China struck a partial trade deal and outlook for Brexit cleared somewhat.

“The China trade deal and U.K. election result have taken out a major tail risk overhanging markets and companies,” said Ben Emons, managing director for global macro strategy at Medley Global Advisors in New York. “Business confidence should see a large boost that could see a restart of global investment, inventory rebuild and a resurgence of global trade volume.”

Like financial markets, most economists had factored in some kind of phase-one trade agreement between the world’s largest economies when projecting the world economy would stabilize into 2020 after a recession scare earlier this year.

But at a minimum, the agreement between President Donald Trump and President Xi Jinping means some of the more dire scenarios being contemplated just a few months ago now appear less likely. 

Bloomberg Economics estimated in June that the cost of the U.S.-China trade war could reach $1.2 trillion by 2021, with the impact spread across the Asian supply chain. That estimate was based on 25% tariffs on all U.S.-China trade and a 10% drop in stock markets.

Both the VIX and TYVIX are near historic lows.

With this bevy of good news, how long before residential mortgage rates rise??

Of course, forecasting is difficult … like forecasting your second wife.

Source: Confound Interest

“It’s About To Get Very Bad” – Repo Market Legend Predicts Dollar Funding Market Crash In Days

“No matter what the market does from now until year end, there is simply not enough cash and/or liquidity to allow the plumbing of the market to cross into 2020 without a crisis”

For the past decade, the name of Zoltan Pozsar has been among the most admired and respected on Wall Street: not only did the Hungarian lay the groundwork for our current understanding of the deposit-free shadow banking system – which has the often opaque and painfully complex short-term dollar funding and repo markets – at its core…

  (larger image)

… but he was also instrumental during his tenure at both the US Treasury and the New York Fed in laying the foundations of the modern repo market, orchestrating the response to the global financial crisis and the ensuing policy debate (as virtually nobody at the Fed knew more about repo at the time than Pozsar), serving as point person on market developments for Fed, Treasury and White House officials throughout the crisis (yes, Kashkari was just the figurehead); playing the key role in building the TALF to backstop the ABS market, and advising the former head of the Fed’s Markets Desk, Brian Sack, on just how the NY Fed should implement its various market interventions without disrupting and breaking the most important market of all: the multi-trillion repo market.

In short, when Pozsar speaks (or as the case may be, writes), people listen (and read).

Continue reading

The Student Loan Bubble – Gambling With Your Future

(SchiffGold) Have you heard? The Democrats are going to fix the student loan mess! They’ve brought up the issue in almost every  Democratic Party presidential debate. All we need is a good government program and we can easily solve this $1.64 trillion problem.

Never mind that government programs caused the problem in the first place.

The student loan bubble continues to inflate. Student loan balances jumped by $32.9 billion in the third quarter this year, pushing total outstanding student loan debt to a new record. Student loan balances have grown by 5.1% year-on-year.

Over the last decade, student loan debt has grown by 120%.  Student loan balances now equal to 7.6% of GDP. That’s up from 5.1% in 2009. This despite the fact that college enrollment dropped by 7% between 2010 and 2017, with enrollment projected to remain flat.

In a nutshell, we have fewer students borrowing more money to finance their educations.

Before the government got involved, college wasn’t all that expensive. It was government policy that made it unaffordable. And not only did it manage to dramatically drive up the cost of a college education, but it also succeeded in destroying the value of that degree. Peter Schiff summed it up perfectly:

Before the government tried to solve this ‘problem,’ it really didn’t exist.”

Peter isn’t just spouting rhetoric. Actual studies have shown the influx of government-backed student loan money into the university system is directly linked to the surging cost of a college education.

Millions of Americans carrying this massive debt burden is a big enough problem in-and-of-itself. But it becomes an even more significant issue when you realize the American taxpayer is on the hook for most of this debt. Education Secretary Betsy Devos admitted that the spiraling level of student debt has “very real implications for our economy and our future.”

The student loan program is not only burying students in debt, it is also burying taxpayers and it’s stealing from future generations.”

This is yet another bubble created by government. Despite the campaign rhetoric coming out of the Democratic Party presidential primary debates, it seems highly unlikely Congress will do what is necessary to address the growing student loan bubble. And the Democrats’ solution seems to be to simply erase the debt – as if you can just make more than $1 trillion vanish without serious implications.

Like all bubbles, this one will eventually pop.

The bottom line is that the student debt bubble will ultimately impact US markets and average Americans.

Source: ZeroHedge

Fed Gives Up On Inflation, Welcome To The United States Of Japan

On Wednesday, the Fed cut rates for the third time this year, which was widely expected by the market.

What was not expected was the following statement.

I think we would need to see a really significant move up in inflation that’s persistent before we even consider raising rates to address inflation concerns.
– Jerome Powell 10/30/2019

The statement did not receive a lot of notoriety from the press, but this was the single most important statement from Federal Reserve Chairman Jerome Powell so far. In fact, we cannot remember a time in the last 30 years when a Fed Chairman has so clearly articulated such a strong desire for more inflation.

Why do we say that? Let’s dissect the bolded words in the quote for further clarification.

  • “really significant”– Powell is not only saying that they will allow a significant move up in inflation but going one better by adding the word significant.
  • “persistent”– Unlike the prior few Fed Chairman who claimed to be vigilant towards inflation, Powell is clearly telling us that he will not react to inflation that is not only well beyond a “really significant” leap from current levels, but a rate that lasts for a period of time.
  • “even consider”– If inflation is not only a really significant increase from current levels and stays at such levels for a while, they will only consider raising rates to fight inflation.

We are stunned by the choice of words Powell used to describe the Fed’s view on inflation. We are even more shocked that the markets or media are not making more of it.

Maybe, they are failing to focus on the three bolded sections. In fact, what they probably think they heard was: I think we would need to see a move up in inflation before we consider raising rates to address inflation concernsSuch a statement would have been more in line with traditional “Fed-speak.”

There is an other far more insidious message in Chairman Powell’s statement which should not be dismissed.

The Fed just acknowledged they are caught in a “liquidity trap.”

Continue reading

Global Debt & Liquidity Crisis Update: Fed Injects $134BN In Liquidity, Term Repo Oversubscribed Amid Month-End Liquidity Panic

‘The volume of billions being lent into existence from nothing by the Fed to bail banks out will go parabolic. It must, otherwise credit will freeze, asset prices will fall, forced bank depositor bail-ins will ensue’

With stocks threatening to close in the red, late on Wednesday the Fed sparked a furious last hour rally…

… when in a statement published at 1515ET, precisely when the S&P ramp started, the New York Fed confirmed it would dramatically increase both its overnight and term liquidity provisions beginning tomorrow through November 14th.

The Desk has released an update to the schedule of repurchase agreement (repo) operations for the current monthly period.  Consistent with the most recent FOMC directive, to ensure that the supply of reserves remains ample even during periods of sharp increases in non-reserve liabilities, and to mitigate the risk of money market pressures that could adversely affect policy implementation…

As we noted yesterday, that was a massive 60% increase in the overnight repo liquidity availability (from $75 billion to $120 billion) and a 28% jump in the term repo provision (from $35 billion to $45 billion).

“It’s just more evidence the Fed will not back off as year-end gets closer,” said Wells Fargo’s rates strategist, Mike Schumacher. “The Fed wants to take out more insurance. You had repo pick up last week. That might not have gone over too well.”

And now we know that there was good reason for that, because according to the latest, just concluded Term Repo operation, a whopping $62.15BN in securities were submitted to the Fed’s 14-day operation, ($47.55BN in TSYs, $14.6BN in MBS), resulting in a 1.38x oversubscribed term operation, the second consecutive oversubscription following Tuesday’s Term Repo, when $52.2BN in securities were submitted into the Fed’s then-$35BN operation.

This was the highest uptake of the Fed’s term repo operation since Sept 26.

But wait there’s more, because while the upsized term-repo saw the biggest (oversubscribed) uptake in one month, demand for the Fed’s overnight repo also soared, with dealers submitting 89.2BN in securities for the newly upsized, $120BN operation.

In total, between the $45BN term repo and the $89.2BN overnight repo, the Fed just injected a whopping $134.2BN in liquidity just to make sure the US banking system is stable. That, as the Fed’s balance sheet soared by $200BN in the past month rising to just shy of $4 trillion.

Meanwhile, funding tensions weren’t evident only in repo, but also in the Fed’s T-Bill POMO, where as we noted yesterday, demand for liquidity has also been increasing with every subsequent operation, peaking with yesterday’s operation.

Needless to say, if the funding shortage was getting better, none of this would be happening; instead it appears that with every passing day the liquidity shortage is getting worse, even as the Fed’s balance sheet is surging.

The only possible explanation, is someone really needed to lock in cash for month end (the maturity of the op is on Nov 7) which is when a “No Deal” Brexit may go live, and as a result one or more banks are bracing for the worst. The question, as before,  remains why: just what is the source of this unprecedented spike in liquidity needs in a system which already has $1.5 trillion in excess reserves? And while we await the answer, expect stocks to close pleasantly in the green as dealers transform their newly granted liquidity into bets on risk assets.

‘The powers that shouldn’t be would rather us experience a mad max world while they hide in luxury bunkers, than allow us a treasury issued gold backed currency, absent a central bank once again’

Source: ZeroHedge

Global Debt & Liquidity Crisis Update: Repo Locking Up Again As Overnight Fed Operation Oversubscribed, Repo Rate Jumps

‘The Fed is an outpost of a foreign power that controls our economy, most of our politics and our financial future. It’s an instrument of the Rothschild global cabal. It always has been since 1913’

First it was supposed to be just a mid-month tax payment issue coupled with an accelerated cash rebuild by the US Treasury. Then, it was supposed to be just quarter-end pressure. Then, once the Fed rolled out QE4 while keeping both its overnight and term repo operations, the mid-September repo rate fireworks which sent the overnight G/C repo rate as high as 10% was supposed to go away for good as Powell admitted the level of reserves was too low and the Fed launched a $60BN/month Bill POMO to boost the Fed’s balance sheet.

Bottom line: the ongoing repo market pressure – which indicated that one or more banks were severely liquidity constrained – was supposed to be a non-event.

Alas, as of this morning when the Fed’s latest repo operation was once again oversubscribed, it appears that the repo turmoil is not only not going away, but is in fact (to paraphrase Joe Biden) getting worse, because even with both term and overnight repos in play and with the market now expecting the Fed to start injecting copious liquidity tomorrow with the first Bill POMO, banks are still cash starved.

To wit: in its latest overnight operation, the Fed indicated that $80.35BN in collateral ($74.7BN in TSYs, $5.65BN in MBS) had been submitted into an operation that maxed out at $75BN, with a weighted average rate on both TSY and MBS rising to 1.823% and 1.828% respectively.

While it was clear that the repo market was tightening in the past week, with each incremental overnight repo operation rising, today was the first oversubscribed repo operation since September 25, and follows yesterday’s $67.6BN repo and $20.1BN term repo.

But the clearest sign that the repo market is freezing up again came from the overnight general collateral rate itself, which after posting in the 1.80%-1.90% range for much of the past two weeks, spiked as high as 2.275% overnight and was last seen at 2.15%, well above the fed funds upper range…

‘The powers that be would rather us experience a mad max world while they hide in luxury bunkers, than allow a treasury issued gold backed currency, absent a central bank once again’

Source: ZeroHedge

Fed Announces QE4 One Day After BIS Warns QE Has Broken The Market

Following Fed Chair Powell’s surprising announcement today that the Fed was resuming Permanent Open Market Operations after a 5 year hiatus, just as we said last month that it would (see “The Fed Will Restart QE In November: This Is How It Will Do It“)…

… there was a brief debate whether the Fed’s soon to be permanent expansion in its balance sheet is QE or not QE. The answer to this semantic debate simple: Powell defined Quantitative Tightening as removing reserves from the system. Thus, by that simple definition, adding reserves to the system on a permanent basis via permanent open market operations, i.e., bond purchases, is Quantitative Easing. Incidentally, the repo market fireworks were just a smokescreen: the real reason why the Fed is resuming QE is far simpler: the US has facing an avalanche of debt issuance and with China and Japan barely able to keep up, someone has to buy this debt. That someone: the Fed.

And just to shut up anyone who still wants to call the upcoming $400BN expansion in the Fed’s balance sheet, as represented in the following chart by Goldman…

… QE-Lite, here is JPMorgan comparing what is coming with what has been: at a $21BN in monthly 10Yr equivalent TSY purchases, the “upcoming” operation is the same size as QE1.

Yet semantic bullshit aside, what is most infuriating about Powell’s “shocking” announcement (which we previewed a few weeks ago) is that it took place just one day after the central banks’ central bank, the Bank of International Settlements, finally caught up with what we first said in 2009 – for economists being only 10 years behind the curve is actually not terrible – and wrote that “the unprecedented growth in central banks’ balance sheets since the financial crisis has had a negative impact on the way in which financial markets function.”

Ignoring the fact that central bank policies are responsible for such phenomena as Brexit and Trump, as it is the flawed monetary policy of the past decade that made the rich richer beyond their wildest dreams by expanding the biggest asset bubble in history, while destroying the middle class…

… it is disgusting that even as the Fed’s own supervisor admits that its balance sheet expanding policies have broken the market – something this “tinfoil” conspiracy blog has been saying since 2008 – the Fed is doing even more of the same, ensuring that the market will be more broken than ever!

So what was this startling epiphany? According to the BIS, while the immediate impact of this massive balance sheet expansion had eased the severe market strains created by the 2008 financial crisis, there had been several negative side-effects. These included a scarcity of bonds available for investors to purchase, squeezed liquidity in some markets, higher levels of bank reserves and fewer market operators actively trading in some areas.

In short: last month’s repo crisis is a direct consequence of central banks’ own actions. as Scott Skyrm explained earlier.

“Lower trading volumes and price volatility, compressed credit spreads and flatter term structures may reduce the attractiveness of investing and dealing in bond markets,” the BIS said in the Monday report. “Some players may leave the market altogether, resulting in a more concentrated and homogenous set of investors and fewer dealers.”

This “could result in market malfunctioning when large central bank balance sheets are eventually unwound”, the BIS warned, adding that “it could make it more difficult for reserves to be redistributed effectively between market participants.” Of course, the BIS was clearly joking because even five-year olds know balance sheets will never be unwound.

Additionally, the BIS went on to point out that negative impacts have been more prevalent when central banks hold a larger share of outstanding assets, as the FT reportedmajor central banks’ holdings of domestic sovereign bonds range from 20% of outstanding paper at the US Fed to over 40% in Japan.

But the BIS said these side-effects had so far only rarely affected financial conditions in such a way as to impede central banks’ monetary policymaking, though it added that the full consequences were unlikely to become clear until major central banks started to shrink their balance sheets.

Worse, the BIS noted that regulations demanding liquidity at large banks might discourage the banks from offering to lend out their reserves — a source of same-day liquidity — into overnight markets. This is similar to what the large banks themselves have said in the last month. But the BIS also noted that since the financial crisis, risk management practices might have changed within the banks themselves.

Sadly, the Fed – which is fully aware of all of this – decided to ignore everything the BIS warned about, and by launching more POMO/QE/”don’t call it QE”, just ensured that the next financial crisis will be the last one.

“So looks like the banks are being re-capitalized, (bailed out) and lower rates are coming, zero or negative.. well.. now the banks can borrow cash for zero, or less directly from the Fed., then shell out loans and credit cards at exorbitant rates to We The People… oh… you are not supposed to know this… (don’t share)…”

Source: ZeroHedge

The Repo Market Incident May Be The Tip Of The Iceberg

(Daniel Lacalle) The Federal Reserve has injected $278 billion into the securities repurchase market for the first time. Numerous justifications have been provided to explain why this has happened and, more importantly, why it lasted for various days. The first explanation was quite simplistic: an unexpected tax payment. This made no sense. If there is ample liquidity and investors are happy to take financing positions at negative rates all over the world, the abrupt rise in repo rates would simply vanish in a few hours.

Let us start with definitions. The repo market is where borrowers seeking cash offer lenders collateral in the form of safe securities.  Repo rates are the interest rate paid to borrow cash in exchange for Treasuries for 24 hours.

Sudden bursts in the repo lending market are not unusual. What is unusual is that it takes days to normalize and even more unusual to see that the Federal Reserve needs to inject hundreds of billions in a few days to offset the unstoppable rise in short-term rates.

Because liquidity is ample, thirst for yield is enormous and financial players are financially more solvent than years ago, right? Wrong.

What the Repo Market Crisis shows us is that liquidity is substantially lower than what the Federal Reserve believes, that fear of contagion and rising risk are evident in the weakest link of the financial repression machine (the overnight market) and, more importantly, that liquidity providers probably have significantly more leverage than many expected.

In summary, the ongoing -and likely to return- burst in the repo market is telling us that risk and debt accumulation are much higher than estimated. Central banks believed they could create a Tsunami of liquidity and manage the waves. However, like those children’s toys where you press one block and another one rises, the repo market is showing us a symptom of debt saturation and massive risk accumulation.

When did hedge funds and other liquidity providers stop accepting Treasuries for short-term operations? It is easy money! You get a  safe asset, provide cash to borrowers, and take a few points above and beyond the market rate. Easy money.  Are we not living in a  world of thirst for yield and massive liquidity willing to lend at almost any rate?

Well, it would be easy money… Unless all the chain in the exchange process is manipulated and rates too low for those operators to accept even more risk.

In essence, what the repo issue is telling us is that the Fed cannot make magic. The central planners believed the Fed could create just the right inflation, manage the curve while remaining behind it, provide enough liquidity but not too much while nudging investors to longer-term securities. Basically,  the repo crisis -because it is a crisis- is telling us that liquidity providers are aware that the price of money, the assets used as collateral and the borrowers’ ability to repay are all artificially manipulated. That the safe asset is not as safe into a recession or global slowdown, that the price of money set by the Fed is incoherent with the reality of the risk and inflation in the economy, and that the liquidity providers cannot accept any more expensive “safe” assets even at higher rates because the rates are not close to enough, the asset is not even close to be safe and the debt and risk accumulated in other positions in their portfolio is too high and rising.

The repo market turmoil could have been justified if it had lasted one day.  However, it has taken a disguised quantitative easing purchase program to mildly contain it.

This is a symptom of a larger problem that is starting to manifest in apparently unconnected events, like the failed auctions of negative-yielding eurozone bonds or the bankruptcy of companies that barely needed the equivalent of one day of repo market injection to finance the working capital of another year.

This is a symptom of debt saturation and massive risk accumulation.  The evidence of the possibility of a major global slowdown, even a synchronized recession,  is showing that what financial institutions and investors have hoarded in recent years,  high-risk, low-return assets, is more dangerous than many of us believed.

It is very likely that the Fed injections become a norm, not an anomaly, and the Fed’s balance sheet is already rising. Like we have mentioned in China so many times, these injections are a symptom of a much more dangerous problem in the economy. The destruction of the credit mechanism through constant manipulation of rates and liquidity has created a much larger bubble than any of us can imagine. Like we have seen in China, it is part of the zombification of the economy and the proof that unconventional monetary measures have created much larger imbalances than the central planners expected.

The repo crisis tells us one thing. The collateral damages of excess liquidity include the destruction of the credit transmission mechanism, disguising the real assessment of risk and, more importantly, leads to a synchronized excess in debt that will not be solved by lower rates and more liquidity injections.

Many want to tell us that this episode is temporary. It has happened in the most advanced, diversified and competitive financial market. Now imagine if it happens in the Eurozone, for example.  This is, like the inverted yield curve and the massive rise in negative-yielding bonds, the tip of a truly scary iceberg.

Source: by Daniel Lacalle

Dollar Shortage Returns As Repo Usage Rises To Highest In A Week

This was the third consecutive increase in repo op usage, the highest in a week and the second highest since the start of the month.

Global Debt & Liquidity Crisis Update: NY Fed Announces Extension Of Overnight Repos Until Nov 4, Will Offer 8 More Term Repos

The Fed’s “temporary” liquidity injections are starting to look rather permanent…

Anyone who expected that the easing of the quarter-end funding squeeze in the repo market would mean the Fed would gradually fade its interventions in the repo market, was disappointed on Friday afternoon when the NY Fed announced it would extend the duration of overnight repo operations (with a total size of $75BN) for at least another month, while also offering no less than eight 2-week term repo operations until November 4, 2019, which confirms that the funding unlocked via term repo is no longer merely a part of the quarter-end arsenal but an integral part of the Fed’s overall “temporary” open market operations… which are starting to look quite permanent.

This is the statement published today by the NY Fed:

In accordance with the most recent Federal Open Market Committee (FOMC) directive, the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York will conduct a series of overnight and term repurchase agreement (repo) operations to help maintain the federal funds rate within the target range.

Effective the week of October 7, the Desk will offer term repos through the end of October as indicated in the schedule below. The Desk will continue to offer daily overnight repos for an aggregate amount of at least $75 billion each through Monday, November 4, 2019.

Securities eligible as collateral include Treasury, agency debt, and agency mortgage-backed securities. Awarded amounts may be less than the amount offered, depending on the total quantity of eligible propositions submitted. Additional details about the operations will be released each afternoon for the following day’s operation(s) on the Repurchase Agreement Operational Details web page. The operation schedule and parameters are subject to change if market conditions warrant or should the FOMC alter its guidance to the Desk.  

What this means is that until such time as the Fed launches Permanent Open Market Operations – either at the November or December FOMC meeting, which according to JPMorgan will be roughly $37BN per month, or approximately the same size as QE1…

… the NY Fed will continue to inject liquidity via the now standard TOMOs: overnight and term repos. At that point, watch as the Fed’s balance sheet, which rose by $185BN in the past month, continues rising indefinitely as QE4 is quietly launched to no fanfare.

And remember: whatever you do, don’t call it QE4!

Trader Gregory Mannarino breaks it down… 

Source: ZeroHedge

Global Debt & Liquidity Crisis Update: Emergency Capital Injections From $75B Per Day Now Required To Keep The Banking System From Seizing (video)

The Fed is scheduled to pump ‘at least’ $75B in Emergency Capital Injections every day, between today and October 10th, to presumably keep the entire banking system from locking up.

Please, read it for yourself (here)

This means at a minimum, the Fed is prepared to inject nearly three times more money into the system in two weeks than during the entire TARP program between 2008-2012.

What happens after October 10th?

Global Debt & Liquidity Crisis Update: Thomas Cook Files for U.S. Bankruptcy Protection

Just like That: Roughly 600,000 travelers are stranded around the world after the British travel provider Thomas Cook declares bankruptcy…

StudioPortoSabbia/Shutterstock

Thomas Cook, a 178-year-old British travel company and airline, declared bankruptcy early Monday morning, suspending operations and leaving hundreds of thousands of tourists stranded around the world.

The travel company operates its own airline, with a fleet of nearly 50 medium- and long-range jets, and owns several smaller airlines and subsidiaries, including the German carrier Condor. Thomas Cook still had several flights in the air as of Sunday night but was expected to cease operations once they landed at their destinations.

Condor posted a message to its site late Sunday night saying that it was still operating but that it was unclear whether that would change. Condor’s scheduled Monday-morning flights appeared to be operating normally.

About 600,000 Thomas Cook customers were traveling at the time of the collapse, of whom 150,000 were British, the company told CNN.

The British Department for Transport and Civil Aviation Authority prepared plans, under the code name “Operation Matterhorn,” to repatriate stranded British passengers. According to the British aviation authority, those rescue flights would take place until October 6, leading to the possibility that travelers could be delayed for up to two weeks.

Initial rescue flights seemed poised to begin immediately, with stranded passengers posting on Twitter that they were being delayed only a few hours as they awaited chartered flights.

The scale of the task has reports calling it the largest peacetime repatriation effort in British history, including the operation the government carried out when Monarch Airlines collapsed in 2017.

Costs of the flights were expected to be covered by the ATOL, or Air Travel Organiser’s License, protection plan, a fund that provides for repatriation of British travelers if an airline ceases operations.

Airplanes from British Airways and EasyJet would be among those transporting stranded passengers home, according to The Guardian, as well as chartered planes from leasing companies and other airlines. Thomas Cook Airlines’ destinations included parts of mainland Europe, Africa, the US, the Caribbean, and the Middle East. Airplanes were being flown to those destinations on Sunday night, according to the BBC.

Global debt and liquidity crisis discussion…

Source: by David Slotnick | Business Insider

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Thomas Cook refund website sees 40,000 claims on day one

First Ever Triple Bubble in Stocks, Real Estate & Bonds – With Nick Barisheff

We are living in an age of records in the financial world. The stock market is in its longest bull market in history and near all-time highs.  The world has more debt than ever before while interest rates are near record lows, and some are negative in many countries for the first time ever.  Nick Barisheff, CEO of Bullion Management Group (BMG), is seeing a dark ending for the era of financial records. Barisheff explains,

“I have been in the business for 40 years, and this is the first time we have had a simultaneous triple bubble, a bubble in real estate, stocks and bonds all at the same time.  In 1999, it was a stock bubble. In 2007, it was a real estate bubble. This time, we’ve got a triple simultaneous bubble.  So, when we have the correction, it’s going to be massive. Value calculations on equities say it’s worse than 1999, and in some cases worse than 1929. The big problem is this triple bubble is sitting on a mountain of debt like never before.”

What is going to be the reaction to this record bubble in everything crashing?  Barisheff says, “I think you are going to be getting riots in the streets.  It’s already happening in California. CalPERS is the pension fund administrator for a lot of the pension funds in California. So, already retired teachers, firefighters and policemen that are sitting in retirement getting their pension checks all got letters saying sorry, your pension checks from now on are going to be reduced by 60%.  How do you get by then?”

What happens if the meltdown picks up speed and casualties?  Barisheff says,

“I think the only option will be for the government is to print more money and postpone the problem yet a little bit longer, but that leads to massive inflation and eventually hyperinflation.  Every fiat currency that has ever existed has always ended in hyperinflation, every single one.  Since 1800, there have been 56 hyper inflations. Hyperinflation is defined as 50% inflation per month.  That’s where we are going and what other choice is there?”

So, what do you do?  Barisheff says,

“In the U.S. dollar since 2000, gold is up an average of 9.4% per year. In some countries, it’s up 14% and so on.  If you take the overall average of all the countries, the average increase is 10% a year.  Every time Warren Buffett is on CNBC, he seems to go out of his way to disparage gold, but if you look at a chart of Berkshire Hathaway and gold, gold has outperformed Berkshire Hathaway. . .  Everybody worships Warren Buffett as the best investor in the world, and gold has outperformed his fund in U.S. dollars.  I would not disparage gold if I were him. I’d keep quiet about it.”

There is a first for Barisheff, too, in this financial environment.  He says for the first time ever, he’s “100% invested in gold” as a percentage of his portfolio.  He says the bottom “is in for gold,” and “the bottom is in for silver, too.”

Barisheff contends that with the record bubbles and the record debt, both gold and silver will be setting new all-time high records as well in the not-so-distant future.

Join Greg Hunter of USAWatchdog.com as he goes One-on-One with Nick Barisheff, CEO of BMG and the author of the popular book “$10,000 Gold.”

Goldman Sachs Has Just Issued An Ominous Warning About Stock Market Crash In October

Are we about to see the stock market crash this year?  That is what Goldman Sachs seems to think, and it certainly wouldn’t be the first time that great financial chaos has been unleashed during the month of October.  When the stock market crashed in October 1929, it started the worst economic depression that we have ever witnessed.  In October 1987, the largest single day percentage decline in U.S. stock market history rocked the entire planet.  And the nightmarish events of October 2008 set the stage for a “Great Recession” that we still haven’t fully recovered from.  So could it be possible that something similar may happen in October 2019?

The storm clouds are looming and disaster could strike at any time.  This is one of the most critical times in the history of our nation, and most Americans are completely unprepared for what is going to happen next.

The Man Who Accurately Predicted The Collapse In Bond Yields Reveals “There Is A Lot More To Come”

Earlier this week ZeroHedge wrote that after decades of waiting, for Albert Edwards vindication was finally here – if only outside the US for now – because as per BofA calculations, average non-USD sovereign yields on $19 trillion in global debt had, as of Monday, turned negative for the first time ever at -3bps.

So now that virtually every rates strategist is rushing to out-“Ice Age” the SocGen strategist (who called the current move in rates years if not decades ago) by forecasting even lower yields (forgetting conveniently that just a year ago consensus called for the 10Y to rise well above 3% by… well, some time now), what does the man who correctly called the unprecedented move in global yields – which has sent $17 trillion in sovereign debt negative – think?

In a word: “There is a lot more to come.

Although the tsunami of negative yields sweeping the eurozone has attracted most attention, yields have also plunged in the US with 30y yields falling to an all-time low just below 2%. For many this represents a bubble of epic proportions, driven by QE and ripe for bursting.

Here Edwards makes it clear that he disagrees , and cautions “that there is a lot more to come.”

What does he mean?

As Albert explains, “when you see the creeping advance of negative bond yields throughout the investment universe, you really start to doubt your sanity. For me it is not so much that 10Y+ government bond yields are increasingly negative, but when European junk bonds go negative I really start to scratch my head.” And as we wrote in “Redefining “High” Yield: There Are Now 14 Junk Bonds With Negative Yields“, there certainly is a lot of scratching to do.

One thing Edwards isn’t scratching his head over is whether this is a bond bubble: as he explains, his “own view is that this government bond rally is not a bubble but an appropriate reaction to the market discounting the next recession hitting the global economy from all over leveraged corners of the world (including China), with close to zero core inflation and precious few working tools left at policymakers’ disposal.”

This means that “the bubbles are not in the government bond market in my view. They are in corporate equities and corporate bonds.

If Edwards is correct about the focus of the next mega-bubble, it is very bad news for risk assets as the “global deflationary bust will wreak havoc with financial markets”, prompting Edwards to ask a rhetorical question:

Does anyone seriously believe that in the next global recession equity markets will not collapse? Do market participants really believe fiscal stimulus and helicopter money will save us from a gut wrenching global bust that will make 2008 look like a picnic? Has the longest US economic cycle in history beguiled investors into soporific complacency? I hope not.

He may hope not, but that’s precisely what has happened in a world where for over a decade, even a modest market correction has lead to central banks immediately jawboning stocks higher and/or cutting rates and launching QE.

So to validate his point that the rates market is not a bubble, Edwards goes on to show that “US and even euro zone government bond yields are not in fact overextended – certainly not on a technical level – but also that fundamentals should carry government bond yields still lower.”

In his note, Edwards launches into an extended analysis of the declining workweek for both manufacturing and total workers, and explains why sharply higher recession odds (which we recently discussed here), are far higher than consensus expected.

But what we found most notable was his technical analysis of the ongoing collapse in 10Y Bund yields. As Edwards writes, “looking at the chart for German 10Y yields (monthly plot) their decline to close to minus 0.7% does not seem so extraordinary – merely the continuation of a downtrend within very clearly defined upper and lower bounds (see chart below).”

As Edwards explains referring to the chart above, “the bund yield has remained in the lower half of that band since 2011, but there is good reason for that as the ECB has struggled with a moribund euro zone economy and core inflation consistently undershooting its 2% target.”

Still, even Edwards admits that the pace of the recent decline in bund 10Y yields is indeed unusually rapid (with a 14-month RSI of 26, middle panel).

And although this suggests a pause in the decline in yields is technically warranted, the MACD (bottom panel) doesn’t look at all stretched. After a pause (data allowing), 10Y bunds could easily fall to the bottom of the lower trend line (ie below -1.5%) without any great technical excess being incurred.

His conclusion: “This market certainly doesn’t look like a bubble to me.”

Shifting attention from Germany to the US, Edwards writes that unlike the 10Y German bund yield, “the US 10Y has mostly occupied the top half of its wide downtrend band since 2013.”

That is fairly unsurprising given the stronger US economy together with Fed rate hikes. Technically the RSI is much less extended to the downside than the bund, but like Germany the MACD could still have a long way to fall. The bottom of the lower downtrend is around minus 0.5% by the end of 2020.

It is Edwards’ opinion that “we are on autopilot until we get” to 0.5%.

But wait, there’s more, because in referring to the charting of Pictet’s Julien Bittle (shown below), Edwards points out the right-hand panel which demonstrates how far US 10Y yields might fall over various time periods after hitting a cyclical peak. “He shows that on average we should expect a decline of 1-1½ pp from the trend line, which takes us pretty much to zero (see slide).” Personally, Edwards says, he is even “more bullish than that!”

Edwards then points us to the work of Gaurav Saroliya, Director of Macro Strategy at Oxford Economics who “certainly doesn’t think that QE is depressing bond yields.” In this particular case, Saroliya uses a simple model which fits US 10Y bond yields with trend growth and inflation reasonably accurately (see left hand chart below). As Edwards notes, “given the demographic situation, inflation is likely to remain subdued.”

In conclusion Edwards presents one final and classic Ice Age chart to finish off.

As the bearish – or is that bullish… for bonds – strategist notes, “the last few cycles have seen a sequence of lower lows and highs for nominal quantities (along with bond yield and Fed Funds). I have used a 4-year moving average and have added where I think we may be heading in the next downturn and rebound – and more importantly where I think the market is now thinking where we are heading.”

Referring to the implied upcoming plunge in nominal GDP, Edwards explains that “that is why this is not a bond bubble. It is the next phase of The Ice Age. And it is here.”

One last note: is it possible that Edwards’ apocalyptic view is wrong? As he admits, “of course” he could be wrong: “And given my dystopian vision for the global economy, equity and corporate bond investors, I sincerely hope I am.”

Source: ZeroHedge

Entire German Yield Curve Drops Below Zero For First Time Ever

Somewhere, Albert Edwards is dancing a jig as the ice age he predicted will grip the world, appears to finally be here.

While global equities are sharply lower today following the end of the US-China trade ceasefire, it’s nothing compared to what is going on in the bond market, where one day after the 10Y US Treasury plunged a whopping 6% to 1.832% – the biggest one day drop since Brexit – to the lowest since the Trump election…

… the real show is in Germany, where not only did German 10Y Bunds tumble to the lowest on record, sliding to -0.503%, far below the ECB’s -0.40% deposit rate, the highlight was the plunge in 30Y yield, which today dropped below 0%…

 (larger image)

… dragging the entire German yield curve in negative territory for the first time ever.

(larger Image)

Enter “Japanification”: as Bloomberg notes, “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”, which is ironic because not even Japan’s 30Ys trade negative. 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. And as of today, anyone investing in German paper is guaranteed to lose money if holding to maturity.

“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.”

In addition to fears about a German recession sparked by the renewed Trump tariff threat, Germany’s bond market is also plagued by a problem of scarcity, with the government mandated by law to effectively maintain a budget surplus. The ECB holds nearly a third of the existing debt, leaving less to trade, which has helped to compress yields even further.

“It is a combination of a very uncertain economic outlook, a central bank that left all doors open in terms of new easing measures, the absence of inflation and vigorous search for yield,” said Nordea Bank chief strategist Jan von Gerich. “It was almost bound to happen.”

Source: ZeroHedge

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Recession Signs Are Hitting Europe; Is Lagarde Up For The Challenge?

Rhine River At Dangerously Low Water Levels Could Cause Production Hell For German Firms

Prepare To Be Vastly Richer or Poorer After The Fed Introduces Negative Interest Rates

Summary
  • Negative interest rates are little understood in the U.S., and this may lead to very expensive mistakes by many investors.
  • The move to negative interest rates can be extremely profitable – but investors have to be prepared before it happens or the opportunities will be gone.
  • Detailed analysis of how the Fed using trillions in quantitative easing to force negative interest rates can directly create hundreds of billions of dollars in profits for sophisticated insiders.
  • When we “follow the money”, quantitative easing in a new recession would use monetary creation to force artificially high prices and vastly overpay knowledgeable investors.

(Daniel Amerman) “Following the money” can be a good way of unraveling complexity. Sometimes what the technical jargon is covering up can be as simple as Insider A handing money over to Insider B in massive quantities – and when we understand that, our whole perspective can change.

In this analysis, we will explore how a potential future of negative interest rates in combination with quantitative easing could become one of the largest re-distributions of wealth in U.S. history, with hundreds of billions of dollars in profits going disproportionately to insiders – at the expense of the general public. As illustrated with a step by step example when we follow the money – $279 billion out of every $1 trillion in newly created money could end up going straight into the hands of organizations and individuals who make up a relatively small percentage of the nation.

If there is another recession, then the Federal Reserve intends to engage in what could become the largest round of monetary creation in U.S. history. Those dollars will be quite real, and the reason for their creation is to spend them. A big chunk of that spending will become profits going straight into the pockets of investors. This won’t actually be a closed game – anyone can try for a share of those new Federal Reserve dollars, but first, they have to understand that the game exists, and then they need to learn how it is played.

Continue reading

Hedge Fund Closures Exceed Launches For The Third Straight Quarter

Global hedge fund liquidations exceeded launches for the third straight quarter as a result of a tougher capital raising environment, according to Bloomberg.

During the first quarter of this year, about 213 funds closed compared to 136 that opened. Liquidations remained steady from the quarter prior and launches were up about 23%. 

But hedge fund startups remain under pressure due to poor performance and investors grappling with high fees. $17.8 billion was pulled from hedge funds during the first 3 months of the year, marking the fourth consecutive quarterly outflow. Additionally, the industry has seen a number of funds shut down or return capital, including Highbridge Capital Management and Duane Park Capital.

The average management fee for funds that launched in the first quarter was down 10 bps to 1.19%, while the average incentive fee increased to 18.79% from 17.9% in 2018.

Hedge funds on average were up 3% in the first quarter on an asset weighted basis, which lagged the S&P index by a stunning 10.7% with dividends reinvested over the same period. 

In May we had noted that the broader S&P 500 had trounced the average hedge fund, returning 18% YTD, and charging precisely nothing for this out performance. 

Also in late May, we documented shocking losses from Horseman Global. The fund’s losses more than doubled in April, when the fund was down a was a staggering 12%, which brought its total loss YTD to more than 25%. 

In early June, we wrote about Neil Woodford, the UK’s equivalent of David Tepper, blocking redemptions from his £3.7bn equity income fund after serial under performance led to an investor exodus, “inflicting a serious blow to the reputation of the UK’s highest-profile fund manager.”

Source: ZeroHedge

As China’s Banking System Freezes, SHIBOR Tumbles To Lowest In A Decade

One trading day after we reported that China was “Hit By “Significant Banking Stress” as SHIBOR (Shanghi Interbank Offered Rate) tumbled to recession levels, and less than a week after we warned that China’s interbank market was freezing up in the aftermath of the Baoshang Bank collapse and subsequent seizure, which led to a surge in interbank repo rates and a spike in Negotiable Certificates of Deposit (NCD) rates…

https://www.zerohedge.com/s3/files/inline-images/china%20repo%20rates.jpg?itok=IUQDoORO

… China’s banking stress has taken a turn for the worse, and on Monday, China’s overnight repurchase rate dropped to its lowest level in nearly 10 years, after the central bank’s repeated liquidity injections to ease credit concerns in small-to-medium banks: The rate fell as much as 11 basis points to 0.9861% on Monday, before being fixed at exactly 1.000%.

https://www.zerohedge.com/s3/files/inline-images/shibor%20on%206.24.jpg?itok=i2icegOc

Seeking to ease funding strains after the Baoshang collapse and to unfreeze the financial channels in the banking sector, the PBOC has been injecting cash into the financial system to soothe credit risk concerns in smaller banks following the seizure of Baoshang Bank, which sent shockwaves through China’s markets.

Also helping drive the rate lower is China’s move to allow brokerages to issue more debt, said ANZ Bank’s Zhaopeng Xing, quoted by Bloomberg. As a result, at least five brokerages had their short-term debt quotas increased by the People’s Bank of China in recent days, according to filings.

The improved access to shorter-term debt will cut costs for brokerages compared with alternative funding sources such as bond issuance. The flipside, of course, is that the lower overnight funding rates drop, the greater the investor skepticism that China’s massive, $40 trillion financial system is doing ok, especially since the last time overnight funding rates were this low, the near-collapse of the global financial system was still fresh and the S&P was trading in the triple-digits.

Commenting on the ongoing collapse in SHIBOR, Commodore Research wrote overnight that “low SHIBOR lending rates are supposed to be supportive and accommodative in nature — but rates are now at the lowest level seen this decade and  are very likely an indication that China is facing significant banking stress at the moment. It is extremely rare for the overnight SHIBOR lending rate to be set as low as 1.00%. This previously had not all been seen this decade, and the last time it occurred was during the financial crisis in 2008 – 2009.”

Meanwhile, as the world’s biggest financial time bomb ticks ever louder, traders and analysts are blissfully oblivious, focusing instead on central banks admitting that the recession is imminent and trying to spin how a world war with Iran would be bullish for stocks.

Source: ZeroHedge

“On The Precipice”

Authored by Kevin Ludolph via Crescat Capital,

Dear Investors:

The US stock market is retesting its all-time highs at record valuations yet again. We strongly believe it is poised to fail. The problem for bullish late-cycle momentum investors trying to play a breakout to new highs here is the oncoming freight train of deteriorating macro-economic conditions.

US corporate profit growth, year-over-year, for the S&P 500 already fully evaporated in the first quarter of 2019 and is heading toward outright decline for the full year based on earnings estimate revision trends. Note the alligator jaws divergence in the chart below between the S&P 500 and its underlying expected earnings for 2019. Expected earnings for 2019 already trended down sharply in the first quarter and have started trending down again after the May trade war escalation.

Continue reading

Global Negative Yielding Debt Soars By $700 Billion In One Day To Record $13 Trillion

The “deflationary ice age” predicted by SocGen’s Albert Edwards some 25 years ago is upon us.

The one-two punch of a dovish Draghi and Powell unleashing the “deflationary spirits” has resulted not only in the S&P hitting a new all time high, but in an unprecedneted flight to safety as investors freak out that a recession may be imminent (judging by the forceful jawboning by central bankers hinting of imminent easing), pushing gold above $1,400 – its highest price since 2013 – and global yields to new all time lows.

As a result, the total notional amount of global debt trading with negative yields soared by $700 billion in just one day, and a whopping $1.2 trillion this week, the biggest weekly increase in at least three years.

https://www.zerohedge.com/s3/files/inline-images/weekly%20change%20in%20neg%20debt.jpg?itok=jz-AGpp9

This has pushed the amount of negative yielding debt to a new all time high of $13 trillion.

https://www.zerohedge.com/s3/files/inline-images/global%20neg%20yielding%20debt_0.jpg?itok=IY5FU-OA

Europe in particular is, for lack of a better word, a disaster.

https://www.zerohedge.com/s3/files/inline-images/european%20bonds.png?itok=NjhgsEAs

We won’t paraphrase everything else we said in the context of this very troubling observation (see our latest post from yesterday discussing the surge in (-) yielding debt), we’ll just repeat the big picture summary: such a collapse in yields is not bullish, or indicative of a new golden age for the global economy. Quite the contrary – it signifies that debt investors are more confident than ever that the global growth rate is collapsing and only central bank intervention may possibly delay (not prevent) the world sliding into recession. Worse, rates are set to only drop, because as Rabobank’s Michael Every wrote yesterday “if the Fed do cut ahead then yields fall, more so at the shorter end; but if they don’t cut then yields still fall, but more so at the longer end (now around 2.02%).”

His conclusion: “Either way US (and global) yields are going to fall – which tells its own sad story.

Source: ZeroHedge

The Fed, QE, And Why Rates Are Going To Zero

Summary

  • On Tuesday, Federal Reserve Chairman Jerome Powell, in his opening remarks at a monetary policy conference in Chicago, raised concerns about the rising trade tensions in the U.S.
  • The extremely negative environment that existed, particularly in the asset markets, provided a fertile starting point for monetary interventions.
  • Given rates are already negative in many parts of the world, which will likely be even more negative during a global recessionary environment, zero yields will still remain more attractive to foreign investors.
  • This idea was discussed in more depth with members of my private investing community, Real Investment Advice PRO.

(Lance Roberts) On Tuesday, Federal Reserve Chairman Jerome Powell, in his opening remarks at a monetary policy conference in Chicago, raised concerns about the rising trade tensions in the U.S.,

“We do not know how or when these issues will be resolved. As always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2 percent objective.”

However, while there was nothing “new” in that comment, it was his following statement that sent “shorts” scrambling to cover.

“In short, the proximity of interest rates to the ELB has become the preeminent monetary policy challenge of our time, tainting all manner of issues with ELB risk and imbuing many old challenges with greater significance.

“Perhaps it is time to retire the term ‘unconventional’ when referring to tools that were used in the crisis. We know that tools like these are likely to be needed in some form in future ELB spells, which we hope will be rare.”

As Zerohedge noted:

“To translate that statement, not only is the Fed ready to cut rates, but it may take ‘unconventional’ tools during the next recession, i.e., NIRP and even more QE.”

This is a very interesting statement considering that these tools, which were indeed unconventional“emergency” measures at the time, have now become standard operating procedure for the Fed.

Yet, these “policy tools” are still untested.

Clearly, QE worked well in lifting asset prices, but not so much for the economy. In other words, QE was ultimately a massive “wealth transfer” from the middle class to the rich which has created one of the greatest wealth gaps in the history of the U.S., not to mention an asset bubble of historic proportions.

https://static.seekingalpha.com/uploads/2019/3/8/saupload_Household-NetWorth-GDP-030519.png

However, they have yet to operate within the confines of an economic recession or a mean-reverting event in the financial markets. In simpler terms, no one knows for certain whether the bubbles created by monetary policies are infinitely sustainable? Or, what the consequences will be if they aren’t.

The other concern with restarting monetary policy at this stage of the financial cycle is the backdrop is not conducive for “emergency measures” to be effective. As we wrote in “QE, Then, Now, & Why It May Not Work:”

“If the market fell into a recession tomorrow, the Fed would be starting with roughly a $4 Trillion balance sheet with interest rates 2% lower than they were in 2009. In other words, the ability of the Fed to ‘bail out’ the markets today, is much more limited than it was in 2008.

But there is more to the story than just the Fed’s balance sheet and funds rate. The entire backdrop is completely reversed. The table below compares a variety of financial and economic factors from 2009 to present.

https://static.seekingalpha.com/uploads/2019/3/8/saupload_Economy-Then-Vs-Now-030519.png

“The critical point here is that QE and rate reductions have the MOST effect when the economy, markets, and investors have been ‘blown out,’ deviations from the ‘norm’ are negatively extended, confidence is hugely negative.

In other words, there is nowhere to go but up.”

The extremely negative environment that existed, particularly in the asset markets, provided a fertile starting point for monetary interventions. Today, as shown in the table above, the economic and fundamental backdrop could not be more diametrically opposed.

This suggests that the Fed’s ability to stem the decline of the next recession, or offset a financial shock to the economy from falling asset prices, may be much more limited than the Fed, and most investors, currently believe.

While Powell is hinting at QE4, it likely will only be employed when rate reductions aren’t enough. Such was noted in 2016 by David Reifschneider, deputy director of the division of research and statistics for the Federal Reserve Board in Washington, D.C., released a staff working paper entitled “Gauging The Ability Of The FOMC To Respond To Future Recessions.”

The conclusion was simply this:

“Simulations of the FRB/US model of a severe recession suggest that large-scale asset purchases and forward guidance about the future path of the federal funds rate should be able to provide enough additional accommodation to fully compensate for a more limited [ability] to cut short-term interest rates in most, but probably not all, circumstances.”

In effect, Powell has become aware he has become caught in a liquidity trap. Without continued “emergency measures” the markets, and subsequently economic growth, cannot be sustained. This is where David compared three policy approaches to offset the next recession:

  1. Fed funds goes into negative territory, but there is no breakdown in the structure of economic relationships.
  2. Fed funds returns to zero and keeps it there long enough for unemployment to return to baseline.
  3. Fed funds returns to zero and the FOMC augments it with additional $2-4 Trillion of QE and forward guidance.

This is exactly the prescription that Jerome Powell laid out on Tuesday, suggesting the Fed is already factoring in a scenario in which a shock to the economy leads to additional QE of either $2 trillion, or in a worst-case scenario, $4 trillion, effectively doubling the current size of the Fed’s balance sheet.

This is also why 10-year Treasury rates are going to ZERO.

Why Rates Are Going To Zero

I have been discussing over the last couple of years why the death of the bond bull market has been greatly exaggerated. To wit:

“There is an assumption that because interest rates are low, that the bond bull market has come to its inevitable conclusion. The problem with this assumption is three-fold:

  1. All interest rates are relative. With more than $10-Trillion in debt globally sporting negative interest rates, the assumption that rates in the U.S. are about to spike higher is likely wrong. Higher yields in U.S. debt attracts flows of capital from countries with negative yields which push rates lower in the U.S. Given the current push by Central Banks globally to suppress interest rates to keep nascent economic growth going, an eventual zero-yield on U.S. debt is not unrealistic.
  2. The coming budget deficit balloon. Given the lack of fiscal policy controls in Washington, and promises of continued largesse in the future, the budget deficit is set to swell back to $1 Trillion or more in the coming years. This will require more government bond issuance to fund future expenditures which will be magnified during the next recessionary spat as tax revenue falls.
  3. Central Banks will continue to be a buyer of bonds to maintain the current status quo, but will become more aggressive buyers during the next recession. The next QE program by the Fed to offset the next economic recession will likely be $2-4 Trillion which will push the 10-year yield towards zero.”

It’s item #3 that is most important.

In “Debt & Deficits: A Slow Motion Train Wreck”, I laid out the data constructs behind the points above.

However, it was in April 2016, when I stated that with more government spending, a budget deficit heading towards $1 Trillion, and real economic growth running well below expectations, the demand for bonds would continue to grow. Even from a purely technical perspective, the trend of interest rates suggested at that time a rate below one percent was likely during the next economic recession.

https://static.seekingalpha.com/uploads/2019/6/7/saupload_10-yr-interest-rates-bollingerbands-060419.png

Outside of other events such as the S&L Crisis, Asian Contagion, Long-Term Capital Management, etc. which all drove money out of stocks and into bonds pushing rates lower, recessionary environments are especially prone at suppressing rates further. But, given the inflation of multiple asset bubbles, a credit-driven event that impacts the corporate bond market will drive rates to zero.

Furthermore, given rates are already negative in many parts of the world, which will likely be even more negative during a global recessionary environment, zero yields will still remain more attractive to foreign investors. This will be from both a potential capital appreciation perspective (expectations of negative rates in the U.S.) and the perceived safety and liquidity of the U.S. Treasury market.

Rates are ultimately directly impacted by the strength of economic growth and the demand for credit. While short-term dynamics may move rates, ultimately, the fundamentals, combined with the demand for safety and liquidity, will be the ultimate arbiter.

With the majority of yield curves that we track now inverted, many economic indicators flashing red, and financial markets dependent on “Fed action” rather than strong fundamentals, it is likely the bond market already knows a problem in brewing.

https://static.seekingalpha.com/uploads/2019/6/7/saupload_Inverted-Yield-Curve-060419.png

However, while I am fairly certain the “facts” will play out as they have historically, rest assured that if the “facts” do indeed change, I will gladly change my view.

Currently, there is NO evidence that a change of facts has occurred.

Of course, we aren’t the only ones expecting rates to go to zero. As Bloomberg noted:

“Billionaire Stan Druckenmiller said he could see the Fed funds rate going to zero in the next 18 months if the economy softens and that he recently piled into Treasuries as the U.S. trade war with China escalated.

‘When the Trump tweet went out, I went from 93% invested to net flat, and bought a bunch of Treasuries,’ Druckenmiller said Monday evening, referring to the May 5 tweet from President Donald Trump threatening an increase in tariffs on China. ‘Not because I’m trying to make money, I just don’t want to play in this environment.'”

It has taken a massive amount of interventions by Central Banks to keep economies afloat globally over the last decade, and there is rising evidence that growth is beginning to decelerate.

While another $2-4 Trillion in QE might indeed be successful in further inflating the third bubble in asset prices since the turn of the century, there is a finite ability to continue to pull forward future consumption to stimulate economic activity. In other words, there are only so many autos, houses, etc., which can be purchased within a given cycle.

There is evidence the cycle peak has been reached.

If I am correct, and the effectiveness of rate reductions and QE are diminished due to the reasons detailed herein, the subsequent destruction to the “wealth effect” will be far larger than currently imagined. There is a limit to just how many bonds the Federal Reserve can buy and a deep recession will likely find the Fed powerless to offset much of the negative effects.

If more “QE” works, great.

But, as investors, with our retirement savings at risk, what if it doesn’t?

Source: by Lance Roberts | Seeking Alpha

Good Thing? US Treasury Curve Flattens To Zero As Unemployment Falls To Lowest Level Since 1969

Good thing! US unemployment has fallen to its lowest level since the 1960s.

The US Treasury 10-year – 3-month yield curve has flattened to zero as unemployment hits its 50 year low.

https://confoundedinterestnet.files.wordpress.com/2019/05/yc10u3.png

Is this signaling the end of a business cycle? Or is it signaling the excesses of central banking?

We are seeing turbulence in the US yield curve given the many economic uncertainties around the globe, like Brexit, China trade, etc.

https://confoundedinterestnet.files.wordpress.com/2019/05/usyc.png

At least devaluation of the US dollar Purchasing Power has slowed.

https://confoundedinterestnet.files.wordpress.com/2019/05/fed1913.png

Source: Confounded Interest

Hedge Fund CIO: “America’s Yield Curve Inversion Can Mean One Of Three Things”

Three Worlds

America’s yield curve inversion can mean one of three things,” said (Eric Peters, CIO of One River Asset Management). “We’re either living in a world of secular stagnation and investors worry that central banks no longer have sufficient policy tools to spur growth and inflation,” he continued. “Or the economy is simply sliding toward recession and the inversion will persist until the Fed panics and spurs a recovery,” he said. “Or we’re living in a world, where the market is moving in ways that defy historical norms because of global QE. And if that’s the case, the curve is sending a false signal.”

https://www.zerohedge.com/s3/files/inline-images/TSY%20yield%20curve%203.31.jpg?itok=B16pb_qT

“If we’re sliding toward recession, then it seems odd that credit markets are holding up so well,” continued the same CIO. “So keep an eye on those,” he said. “And if the curve is sending a false signal due to German and Japanese government bonds yielding less than zero out to 10yrs, then the recent Fed pivot and these low bond rates in America may very well spur a blow-off rally in stocks like in 1999.” A dovish Fed in 1998 (post-LTCM) and 1999 (pre-Y2K) provided the liquidity without which that parabolic rally could have never happened.

https://www.zerohedge.com/s3/files/inline-images/aligator%20jaws%20march%202019_1.jpg?itok=KGvQ1sIB

“But if investors believe America is succumbing to the secular stagnation that has gripped Japan and Europe, and if they’re growing scared that global central banks are no longer capable of rescuing markets, then we have a real problem,” said the CIO. “Because a recession is bad for markets, but not catastrophic provided that central banks can step in to spur recovery. But with global rates already so low, if investors lose faith in the ability of central banks to do what they have always done, then we’re vulnerable to a stock market crash.”

Sovereignty:

Turkish overnight interest rates squeezed to 300% on Monday. Then 600% on Tuesday. By Wednesday, they hit 1,200%. Downward pressure on the Turkish lira, and the government’s efforts to punish speculators fueled the historic rise. Erdogan allegedly wants to limit lira loses ahead of today’s elections. The pressures that drove the currency lower were mainly of Turkish origin. Of course, the Turks have every right to their own economic policies, but they must bear the consequences. That’s what comes with being a sovereign state.

The Greeks and Turks are neighbors. The Turks began negotiations to join the EU in 2005, with plans to adopt the Euro after their acceptance. Those negotiations stalled in 2016. As they look across the border at their Greek neighbors now, and see their interest rates stuck at -0.40%, are they envious? Perhaps. But having witnessed the 2011 Greek humiliation, would the Turks be willing to forfeit sovereignty for the Euro’s stability and stagnation? And how do the Greeks (and Italians) feel about having forfeited their sovereignty?

Anecdote:

“Only optimists start companies,” I answered. The Australian superannuation CEO had asked if I’m an optimist or pessimist. “I see the potential for technological advances to produce abundance in ways difficult to fathom. But I also see the chance of something profoundly dark,” I continued. He observed that people seemed consumed by the latter but spend so little time on the former. “That’s good. Humans are wonderful at solving problems of our own creation. The more we worry, the less goes wrong,” I said. So he asked what worries me most?

“Not the displacement of human labor by machines, we can solve the resulting social challenges. I worry that the only thing Americans seem to agree on now is that China is our adversary.” And pressing, he asked me to list the things I admire about China. “Okay. I admire China’s work ethic, drive, ambition, economic accomplishments. They’ve overtaken us in many advanced scientific fields. I admire that very much.” He smiled and asked me to carry on. “I’m grateful for their competition. It makes us better. And I admire that they’ve evolved communism to make it work while all others failed. The world is better with diversity of thought, philosophy – diversity increases resiliency, robustness. And democratic free-market capitalism will grow stronger with a formidable competitor.” He smiled.

“But China’s system values the collective over the individual. We value the opposite. And I’m concerned the two systems cannot peacefully coexist now that we’re the world’s two largest economies. I don’t want to live under their system, I don’t want their vision of the future for my children. They probably feel the same way. Both views are valid but incompatible, and increasingly in conflict,” I explained. He nodded and said, “I don’t want that for our children either.”

Source: ZeroHedge

“Recap & Release” – Trump Unveils Plan To End Govt Control Of Fannie, Freddie

After months (or years) of on-again, off-again headlines, President Trump is expected to sign a memo on an overhaul of Fannie Mae and Freddie Mac this afternoon, kick-starting a lengthy process that could lead to the mortgage giants being freed from federal control.

https://www.zerohedge.com/s3/files/inline-images/plante.jpg?itok=ivrIc_7m

The White House has been promising to release a plan for weeks, and its proposal would be the culmination of months of meetings between administration officials on what to do about Fannie and Freddie.

Bloomberg reports that while Treasury Secretary Steven Mnuchin has said it’s a priority to return the companies to the private market, such a dramatic shift probably won’t happen anytime soon.

In its memo, the White House sets out a broad set of recommendations for Treasury and HUD, such as increasing competition for Fannie and Freddie and protecting taxpayers from losses.

The memo itself has a worryingly familiar title (anyone else thinking 2007 housing bubble?):

President Donald J. Trump Is Reforming the Housing Finance System to Help Americans Who Want to Buy a Home

“We’re lifting up forgotten communities, creating exciting new opportunities, and helping every American find their path to the American Dream – the dream of a great job, a safe home, and a better life for their children.”

President Donald J. Trump

REFORMING THE HOUSING FINANCE SYSTEM: The United States housing finance system is in need of reform to help Americans who want to buy a home.

  • Today, the President Donald J. Trump is signing a Presidential memorandum initiating overdue reform of the housing finance system.
  • During the financial crisis, Fannie Mae and Freddie Mac suffered significant losses and were bailed out by the Federal Government with billions of taxpayer dollars.
    • Fannie Mae and Freddie Mac have been in conservatorship since September 2008.
  • In the decade since the financial crisis, there has been no comprehensive reform of the housing finance system despite the need for it, leaving taxpayers exposed to future bailouts.
    • Fannie Mae and Freddie Mac have grown in size and scope and face no competition from the private sector.
    • The Department of Housing and Urban Development’s (HUD) housing programs are exposed to high levels of risk and rely on outdated business processes and systems.

PROMOTING COMPETITION AND PROTECTING TAXPAYERS: The Trump Administration will work to promote competition in the housing finance market and protect taxpayer dollars.

  • The President is directing relevant agencies to develop a reform plan for the housing finance system. These reforms will aim to:
    • End the conservatorship of Fannie Mae and Freddie Mac and improve regulatory oversight over them.
    • Promote competition in the housing finance market and create a system that encourages sustainable homeownership and protects taxpayers against bailouts.
  • The President is directing the Secretary of the Treasury and the Secretary of Housing and Urban Development to craft administrative and legislative options for housing finance reform.
    • Treasury will prepare a reform plan for Fannie Mae and Freddie Mac.
    • HUD will prepare a reform plan for the housing finance agencies it oversees.
  • The Presidential memorandum calls for reform plans to be submitted to the President for approval as soon as practicable.
  • Critically, the Administration wants to work with Congress to achieve comprehensive reform that improves our housing finance system.

HELPING PEOPLE ACHIEVE THE AMERICAN DREAM: These reforms will help more Americans fulfill their goal of buying a home.

  • President Trump is working to improve Americans’ access to sustainable home mortgages.
  • The Presidential memorandum aims to preserve the 30-year fixed-rate mortgage.
  • The Administration is committed to enabling Americans to access Federal housing programs that help finance the purchase of their first home.
  • Sustainable homeownership is the benchmark of success for comprehensive reforms to Government housing programs.

*  *  *

Because what Americans need is more debt and more leverage at a time when home prices are at record highs and rolling over.

https://www.zerohedge.com/s3/files/inline-images/bfm7374_0.jpg?itok=3W8iDDOR

Hedge funds that own Fannie and Freddie shares have long called on policy makers to let the companies build up their capital buffers and then be released from government control.

It’s unclear whether the White House would be willing to take such a significant step without first letting lawmakers take another stab at overhauling the companies.

But not everyone is excited about the recapitalizing Fannie Mae and Freddie Mac. Edward DeMarco, president of the Housing Policy Council, warned that releasing them from conservatorship would do nothing to fix the mortgage giants’ charters or alter their implied government guarantee:

“I’m not sure what is good about recap and release,” DeMarco, a former acting director of the Federal Housing Finance Agency, said in a phone interview.

DeMarco also noted that the government stepped in to save the companies in 2008, and they continue to operate with virtually no capital. On Tuesday, DeMarco told the Senate, during the first of two hearings on the housing finance system that “recap and release should not even be on the table.”

But shareholders in the firms were excitedly buying… once again.

https://www.zerohedge.com/s3/files/inline-images/2019-03-27_11-24-00.jpg?itok=xZk_Y8LJ

Deciding the fate of Fannie and Freddie, which stand behind about $5 trillion of home loans, remains the biggest outstanding issue from the 2008 financial crisis.

Source: ZeroHedge

It’s Not Too Soon For A Fed Rate Cut, According To This Chart

  • The time between the Fed’s final interest rate hike and its first rate cut in the past five cycles has averaged just 6.6 months, according to Natixis economist Joseph LaVorgna. 
  • The bond market  has quickly pivoted, and fed funds futures are pricing in a quarter point of easing for this year, just days after the Fed forecast no more hikes for this year. 
  • LaVorgna said there are three conditions required for a Fed reversal, and that of a soft economy could soon be met.

(by Patti Domm) The bond market has quickly priced in a Federal Reserve interest rate cut this year, just days after the Fed said it would stop raising rates.

That has been a surprise to many investors, but it shouldn’t be — if history is a guide.

Joseph LaVorgna, Natixis’ economist for the Americas, studied the last five tightening cycles and found there was an average of just 6.6 months from the Federal Reserve’s last interest rate hike in a hiking cycle to its first rate cut.

The economist points out, however, that the amount of time between hike and cut has been lengthening.

“For example, there was only one month from the last tightening in August 1984 to the first easing in September 1984. This was followed by a four-month window succeeding the July 1989 increase in rates, a five-month gap after the February 1995 hike, an eight-month interlude from May 2000 to January 2001, and then a record 15- month span between June 2006 and September 2007,” he wrote.

The Fed last hiked interest rates by a quarter point in December. Last week, it confirmed a new dovish policy stance by eliminating two rate hikes from its forecast for this year. That would leave interest rates unchanged for the balance of the year, with the Fed expecting one more increase next year.

But the fed funds futures market has quickly moved to price in a full fledged 25 basis point easing, or cut, for this year.

“The market’s saying it’s going to happen in December,” said LaVorgna.

There are three conditions that need to be met for the Fed to reverse course and cut interest rates, LaVorgna said. First, the economy’s bounce back after the first quarter slump would have to be weaker than expected, with growth just around potential. Secondly, there would have to be signs that inflation is either undershooting the Fed’s 2 percent target or even decelerating. Finally, the Fed would have to see a tightening of financial conditions, with stock prices under pressure and credit spreads widening.

LaVorgna said the condition of a sluggish economy could be met.

“I don’t think the economy did very well in the first quarter just based on the fact the momentum downshifted hard from Q4, sentiment was awful, production was soft,” he said. ’I’m worried growth is close to zero in the first quarter.”

LaVorgna said he does not see much of a snap back in the second quarter.

In the current cycle, the Federal Reserve began raising interest rates in December 2015 after taking the fed funds target rate to zero during the financial crisis.

Source: by Patti Domm | CNBC

***

Americans Are Only Now Starting To Seek Higher Deposit Rates… Just As The Fed Prepares To Cut

 

Yield Curve Inverts For The First Time Since 2007: Recession Countdown Begins

The most prescient recession indicator in the market just inverted for the first time since 2007.

https://www.zerohedge.com/s3/files/inline-images/bfm960.jpg?itok=c0gP8hQC

https://i0.wp.com/northmantrader.com/wp-content/uploads/2019/03/yield.png?ssl=1

Don’t believe us? Here is Larry Kudlow last summer explaining that everyone freaking out about the 2s10s spread is silly, they focus on the 3-month to 10-year spread that has preceded every recession in the last 50 years (with few if any false positives)… (fwd to 4:20)

As we noted below, on six occasions over the past 50 years when the three-month yield exceeded that of the 10-year, economic recession invariably followed, commencing an average of 311 days after the initial signal. 

And here is Bloomberg showing how the yield curve inverted in 1989, in 2000 and in 2006, with recessions prompting starting in 1990, 2001 and 2008. This time won’t be different.

https://www.zerohedge.com/s3/files/inline-images/prior%20inversions.jpg?itok=BgnEMjCQ

On the heels of a dismal German PMI print, world bond yields have tumbled, extending US Treasuries’ rate collapse since The Fed flip-flopped full dovetard.

https://www.zerohedge.com/s3/files/inline-images/bfm14B0.jpg?itok=Ez0lIVd_

The yield curve is now inverted through 7Y…

https://www.zerohedge.com/s3/files/inline-images/bfm1EA4.jpg?itok=xPH6zVO8

With the 7Y-Fed-Funds spread negative…

https://www.zerohedge.com/s3/files/inline-images/bfm2864.jpg?itok=HqnSx1RR

Bonds and stocks bid after Powell threw in the towell last week…

https://www.zerohedge.com/s3/files/inline-images/bfmA98E.jpg?itok=D4zUXHf3

But the message from the collapse in bond yields is too loud to ignore. 10Y yields have crashed below 2.50% for the first time since Jan 2018…

https://www.zerohedge.com/s3/files/inline-images/bfm5670.jpg?itok=rocy5sKV

Crushing the spread between 3-month and 10-year Treasury rates to just 2.4bps – a smidge away from flashing a big red recession warning…

https://www.zerohedge.com/s3/files/inline-images/bfm36A8.jpg?itok=3cfUyMJ1

Critically, as Jim Grant noted recently, the spread between the 10-year and three-month yields is an important indicator, James Bianco, president and eponym of Bianco Research LLC notes today. On six occasions over the past 50 years when the three-month yield exceeded that of the 10-year, economic recession invariably followed, commencing an average of 311 days after the initial signal. 

Bianco concludes that the market, like Trump, believes that the current Funds rate isn’t low enough:

While Powell stressed over and over that the Fed is at “neutral,” . . . the market is saying the rate hike cycle ended last December and the economy will weaken enough for the Fed to see a reason to cut in less than a year.

https://www.zerohedge.com/s3/files/inline-images/bfm1B73_0.jpg?itok=iZGfa7C7

Equity markets remain ignorant of this risk, seemingly banking it all on The Powell Put. We give the last word to DoubleLine’s Jeff Gundlach as a word of caution on the massive decoupling between bonds and stocks…

“Just because things seem invincible doesn’t mean they are invincible. There is kryptonite everywhere. Yesterday’s move created more uncertainty.”

Source: ZeroHedge

10Y Treasury Yield Tumbles Below 2.50% As 7Y Inverts

The bond bull market is alive and well with yesterday’s bond-bear-battering by The Fed extending this morning.

10Y Yields are back below 2.50% for the first time since Jan 2018…

https://www.zerohedge.com/s3/files/inline-images/bfmCA1F.jpg?itok=_jgnif7R

…completely decoupled from equity markets….

https://www.zerohedge.com/s3/files/inline-images/bfm51AD.jpg?itok=s4YZh3r-

The yield is now massively inverted to Fed Funds…

https://www.zerohedge.com/s3/files/inline-images/bfm8BAA.jpg?itok=hEx0M8LV

With 7Y yields now below effective fed funds rate…

https://www.zerohedge.com/s3/files/inline-images/bfm5F7C.jpg?itok=yYvetY6-

Source: ZeroHedge

US Department Store Sales Lowest Since 1992 (Retail REIT and CMBS Alert!)

The US Commerce Department reported that Department stores are a “wipeout.”

E-commerce continue to wipeout brick and mortar store sales.

https://confoundedinterestnet.files.wordpress.com/2019/03/screen-shot-2019-03-15-at-11.59.42-am.png

At the same time, e-commerce sales continue to rise.

https://confoundedinterestnet.files.wordpress.com/2019/03/screen-shot-2019-03-15-at-12.00.35-pm.png

It’s not the end of the world for bricks and mortar shopping. Consumers still eat out at restaurants, use fitness clubs, bars, etc. But, it does cause a rethinking of retail REIT and CMBS valuation and growth projections.

https://confoundedinterestnet.files.wordpress.com/2019/03/wipo.jpg

Source: Confounded Interest

Alarm! Europe’s And US Bond Volatility Grinding To A Halt (Precursor To Recession)

European bond volatility (according to the Merrill Lynch 3-month EUR option volatility estimate) has plunged to the lowest level on record.

https://confoundedinterestnet.files.wordpress.com/2019/03/dyingvol.png

A similar chart for the US bond market is the Merrill Lynch Option Volatility Estimate for 3-months shows exactly the same thing. The US bond market is grinding to a halt.

https://confoundedinterestnet.files.wordpress.com/2019/03/move3.png

Note that the US MOVE 3-month estimate hit a low in May 2007, just ahead of The Great Recession of 2007-2009.

Alarm!

Source: Confounded Interest

***

Stocks End Week With Five Days Of Declines

  • U.S. stocks almost clawed their way to break-even, shaking off concerns over slowing global growth, a weak hiring report in the U.S., and disappointing China trade data.
  • S&P fell 0.2% as did the  Nasdaq, and the Dow nudged down 0.1%.
  • For the week, the Nasdaq declined 2.5%, while the S&P 500 and the Dow each slipped 2.2%.
  • Among industry sectors, utilities (+0.4%) and materials (+0.2%) gained the most on Friday, while energy (-2.0%) and consumer discretionary (-0.7%) were the biggest underperformers.
  • 10-year Treasury yield fell is down about 1 basis point to 2.63%.

Bond Illiquidity, LIBOR and You

Summary
  • A letter to the Alternative Reference Rates Committee (ARRC) from the Secured Finance Industry Group (SFIG) put an end to the fiction that major financial institutions support SOFR.
  • Financial institutions are justly concerned that SOFR could fatally squeeze bank margins in a crisis.
  • Nevertheless, other proposed alternatives, such as the changes to LIBOR proposed by Intercontinental Exchange (ICE), do not fit the regulators’ requirement that the replacement be determined by liquid market transactions prices.
  • Regulators cannot introduce a new financial instrument. LIBOR’s replacement must be the result of private sector innovation.

(Kurt Dew) A recent Secured Finance Industry Group (SFIG) comment letter is SFIG’s response to a request for comment by the Alternative Reference Rates Committee (ARRC) – a Fed-appointed committee of bankers tasked to solve the LIBOR problem. The Fed’s ARRC creation was an embarrassingly transparent attempt by the regulators to co-opt industry objections to their LIBOR replacement. ARRC proposes to replace LIBOR by the Secured Overnight Financing Rate (SOFR) – a Fed-created version of the overnight repurchase agreement rate. The SFIG comment details the objections of financial institutions to SOFR. Importantly, SFIG serves as chair of ARRC. The critical comment letter is thus the final blow to the regulators’ failed effort to gain the appearance of financial institution support for SOFR.

However, more importantly, neither financial institutions nor their regulators have a clear plan to resolve the need to replace LIBOR. If replacing LIBOR were not such a critical matter, the Byzantine machinations of the bank regulators and financial institutions around SOFR would be amusing. However, the pricing of tens of trillions in debt instruments and hundreds of trillions in derivative instruments depends on a smooth transition to some reference rate other than LIBOR. I contend that this enormous magnitude is a low estimate of the financial market assets at risk due to poorly governed debt markets.

Financial markets’ failure to solve the LIBOR replacement problem is the result of a misunderstanding of the reasons for the LIBOR problem. Understanding of LIBOR suffers from journalistic misdirection, on one hand, and a misunderstanding of the root problem that the LIBOR brouhaha exemplifies, on the other.

The failure of LIBOR is a market structure failure. However, the financial press bills LIBOR’s failure mistakenly as a failure of ethics among bankers. Recorded transcripts of telephone, email, and chat room conversations of small groups of traders provided the evidence of ethical weaknesses leading to attempted market manipulation that drove the post-Financial Crisis LIBOR embarrassment.

However, markets themselves typically are the best antidote to attempted market manipulation. The market solution to trader cabals formed to alter prices has always been a simple one. In a liquid market, larger market forces inevitably swamp organized efforts to manipulate prices. Cabals don’t work in a liquid market because the manipulators lose money.

The split over a LIBOR is an enormous opportunity.

Financial institutions have quite reasonably insisted on two key properties that SOFR lacks.

  • The LIBOR replacement should be forward-looking. That is, the rate should reflect the market’s opinion of overnight interest costs on average in the coming three months.
  • The LIBOR replacement should reflect the interest cost of private unsecured borrowers, instead of the lower interest costs of the Treasury.

Thus, coupled with the TBTF banks’ endorsement of the Intercontinental Exchange Inc. (ICE) candidate for a LIBOR replacement, the SFIG letter shows that ARRC’s SOFR proposal does not represent the banks and other financial institutions that are ARRC members. Worse, it raises a serious threat. If regulators seize on an index that might potentially bankrupt one or more major financial institutions during a financial crisis, those institutions do not plan to allow the Fed to pass the blame for this disastrous decision to them.

However, the banks (or a third party) will, I believe, have to do more than provide another bank-calculated index. The self-acknowledged problem with the ICE (TBTF endorsed) LIBOR replacement is that any index the procedure produces is the result of a transaction selection process by banks themselves. Thus, the ICE fix remains vulnerable to the same ethical vulnerabilities that LIBOR itself faced.

In short, any satisfactory LIBOR replacement must be a form of debt that doesn’t exist now. We could throw up our hands and use the hazardous SOFR, but this seems to be a negative way of looking at the situation.

This is an obvious opportunity to seize an enormous chunk of the financial markets in one fell swoop by addressing bond market illiquidity more generally. Moreover, it is an opportunity that anybody with the courage and the capital could pursue. The problem is one of creating a new debt market with a different structure. Such a new market would have no incumbent oligopolies and no reactionary regulators. Capital, a few hotshot IT professionals, and some people with skills of persuasion would be enough ammunition to get the job done. Island overwhelmed the incumbent stock exchanges with less.

Interestingly, in all likelihood, TBTF banks, incumbent exchanges, and regulators are at a disadvantage in the pursuit of a debt market innovation since they are married to old ways of generating revenues. An incumbent TBTF bank pursuing a new market structure, for example, would not find management friendly to ideas such as putting an end to collateral hypothecation in the repo market.

Why are we getting LIBOR wrong?

SFIG and the TBTF banks also concede that there is no existing instrument that meets the minimal standards required of a LIBOR replacement – the replacement should be a term (probably three-month, or six-month) unsecured debt instrument, traded in a liquid marketplace where recorded transaction prices are the result of the combined forces of supply and demand. SFIG’s comment letter to ARRC’s request to comment on SOFR points to a central quandary that neither SOFR nor its detractors have addressed. No financial instrument meets these criteria today.

Don’t blame the Fed. The Fed did everything imaginable to get industry support for repurchase agreements, the only existing liquid instrument where an honest broker (the Fed) records market transactions. Blame the markets themselves. Organized market participants are adopting the time-honored “See no evil; hear no evil; speak no evil.” approach. Once ARRC had endorsed SOFR, CME Group (CME) helpfully created a futures contract based on SOFR.

All that remained was for the markets to begin trading the SOFR-based instruments. However, that didn’t happen. CME volume in SOFR futures remains a small fraction of Eurodollar (LIBOR) futures volume. In itself, this is not a failing of the marketplace. It’s simply the market’s recognition that SOFR futures don’t provide adequate protection for their existing risks.

How big is the LIBOR problem?

No matter how dire you believe the LIBOR problem to be, the underlying problem of debt market illiquidity that the LIBOR problem reveals is many times bigger. A LIBOR fix only resolves the issue of illiquidity in the short-term end of the market for unsecured debt.

LIBOR became important to society when it began to appear as a factor in the cost of mortgages, municipal debt, and credit card debt. In other words, LIBOR is different from the interest cost of a corporate bond because of LIBOR’s visibility. However, of course, all bank debt, no matter how obscure, is a factor in the cost of consumer borrowing.

An exchange trading liquid tailor-made debt issues that capture the primary price risks associated with debt issuance at all maturities would have a massive beneficial effect on the cost of financing. This market would generate transactions comparable to the combined volume of the stock exchanges, assuming turnover in the two markets to be comparable.

What flaw in market structure creates the LIBOR/debt market liquidity problem? In the markets for corporate liabilities, the issuer is concerned about the market appeal of the terms upon which debt is sold only once – the issue date. After that, any action the corporation might take that benefits its stockholders at the expense of its debtholders faces a single low hurdle – is it legal? Investors are wise to devote more time and attention to debt acquisition than to share acquisition.

If bondholders could devise an instrument that liberates its holder from the negative effects on debt valuation of the decision-making power of a single issuer, it would be interesting to see what effect that would have on the position within corporate politics of debtholders relative to stockholders. One could imagine the popularity of this buyer-friendly instrument growing relative to the popularity of the current issuer-centric debt issues. As this form of debt grows as a share of the market for debt, the management of this debt would become gatekeepers for bond market liquidity. They might gradually induce issuers to write more buyer-friendly forms of debt.

The legal obligation of corporate management to consider the interest of stockholders when these interests conflict with the interests of debtholders is writ in stone. Nevertheless, there is no legal barrier to investors – the final constituency for all corporate obligations – using their influence to discriminate among debt issues. If debtholders confront stockholders with a positive payoff to pleasing debtholders, there might be multiple systemic improvements. The value of buyer-friendly debt would rise relative to issuer-friendly issues, driving down its interest cost and resulting in capital gains to both debt and shareholders. The result would be an altogether safer financial system as a whole.

Source: by Kurt Dew, Think Twice Finance | Seeking Alpha

Recession Signal Getting Louder: 5-Year Yield Inverts With 3-Month Yield

The yield curve is inverted in 11 different spots. The latest is 5-year to 3-month inversion.

https://www.zerohedge.com/s3/files/inline-images/2019-02-27_5-47-38.jpg?itok=PW46u5cc

The yield curve recession signal is louder and louder. Inversions are persistent and growing.

https://www.zerohedge.com/s3/files/inline-images/https___s3-us-west-2.amazonaws%20%2810%29_1.jpg?itok=a4nvYnOV

Let’s compare the spreads today to that of December 18, the start of the December 2018 FOMC meeting.

Yield Curve 2019-02-26 vs December and October 2018

https://www.zerohedge.com/s3/files/inline-images/https___s3-us-west-2.amazonaws%20%2811%29_1.jpg?itok=fBQyAcf-

Yield Curve Spread Analysis

https://www.zerohedge.com/s3/files/inline-images/https___s3-us-west-2.amazonaws%20%2812%29_1.jpg?itok=rSGh9O9m

Spread Changes

  • Yellow: Spreads Collapsed Since October (1 Month to 5 Years)
  • Pink: Spreads Remained Roughly the Same (7 Year)
  • Blue: Spreads Increased (30-Year and 10-Year)

Something Happening

Something is happening. What is it?

https://www.zerohedge.com/s3/files/inline-images/2019-02-27_5-51-51.jpg?itok=EnviRvls

Possibilities

  1. The bond market is staring to worry about trillion dollar deficits as far as the eye can see
  2. The bond market has stagflation worries
  3. The bond bull market is over or approaching

My take is number one and possibly all three.

An in regards to recession the economy is weakening fast.

Source: by Mike Shedlock via MishTalk| ZeroHedge

***

Core US Factory Orders Suffer Worst Slump In 3 Years

US core factory orders (ex transports) fell for the second month in a row in December. This is the worst sequential drop since Feb 2016.

New orders ex-trans fell 0.6% in Dec. after falling 1.3% the prior month.

https://www.zerohedge.com/s3/files/inline-images/2019-02-27_7-13-00.jpg?itok=bUbibSEj

The headline factory orders rose 0.1% MoM (well below the 0.6% MoM gain expected).

Capital goods non-defense ex aircraft new orders for Dec. fall 1% after falling 1.1% in Nov.

Non-durables shipments for Dec. fall 1% after falling 2% in Nov.

Not a pretty picture, but it was an 8.0% drop in Defense spending that triggered the weakness – so we’re gonna need moar war.

The “Failing Angels” Are Back

Lehman, WorldCom And Now PG&E

https://zh-prod-1cc738ca-7d3b-4a72-b792-20bd8d8fa069.storage.googleapis.com/s3fs-public/styles/teaser_desktop_2x/public/2019-01/failing%20angel.jpg?h=579ef2d9

(ZeroHedge) One week ago when we wrote that with PG&E facing a threat of an imminent bankruptcy (which we now know will soon be realized), the most bizarre development in this latest corporate fiasco was that until the first week of January, both S&P and Moody’s had rated the California utility with over $30 billion in debt as investment grade even as its bonds and stocks were cratering ahead of what investors deemed to be an imminent Chapter 11 filing.

And while we have extensively discussed the multi-trillion threat posed by “falling angel” companies, or those corporations rated BBB – the lowest investment grade equivalent rating – as they slide into junk territory, the recent events surrounding PG&E highlight an even greater blind spot in the corporate bond arsenal: that of the failing angel.

As Bank of America’s Hans Mikkelsen wrote in a recent research note, Investment Grade defaults – defined as defaults within one year of being rated IG – are “rare and unpredictable” (even if in the case of PG&E, its downfall was quite obvious to many) as globally in more than half of years historically there were no HG defaults at all.

https://www.zerohedge.com/s3/files/inline-images/PG%26EBOFA1.jpg?itok=76YRhTp2

As such, Monday’s pre-announcement by The Pacific Gas and Electric Company (PCG) that it intends to file Chapter 11 by January 29th…

https://www.zerohedge.com/s3/files/inline-images/PG%26EBOFA2.jpg?itok=LPUASg8i

… is a singular event and if the company follows through, it will become the third largest IG default since 1999, behind Lehman and Worldcom, with $17.5bn of index eligible debt.

The chart below lists all US index defaults since 1999 that occurred within one year of being included in ICE BofAML benchmark US high grade index. The three largest defaults in terms of index notional were Lehman ($34.9bn), WorldCom ($22.9bn) and CIT Group ($12.4bn).

https://www.zerohedge.com/s3/files/inline-images/PG%26E%20BOFA4.jpg?itok=I3W3gy_w

In fact, as BofA adds, if PG&E does file before the end of the month the company will become a member of a much more exclusive group of “Failing Angel”, formerly-IG companies consisting of Enron, Lehman and MF Global that defaulted directly out of IG, before making it into the HY index as Fallen Angels.

https://www.zerohedge.com/s3/files/inline-images/PG%26E%20BOFA3.jpg?itok=L-y4cUJ4

Ironically, as Mikkelsen adds, until recently he had looked at PCG as set to become a large Fallen Angel from BBB accounting for 1.4% of the HY market. Now it appears the company plans to bypass the HY market, and proceed straight to default.

So as the world obsesses over the risk of “falling angels”, just how many other “failing angels” are hiding in the shadows, waiting for their moment to wipe out billions in stakeholder value as the economy continues to slowdown to what is now an inevitable recession, and just what will the knock-on effects of this “historic” default be? We will find out in less than two weeks.

Source: ZeroHedge

Did Russia Just Trigger A Global Reserve Currency Reset Process?

Russia De-Dollarizes Deeper: Shifts $100 Billion To Yuan, Yen, And Euro

(Listen to the report here)

Russia is continuing to ramp up its efforts to move away from the American dollar (Federal Reserve Notes). The country just shifted $100 billion of its reserves to the yuan, the yen, and the euro in their ongoing effort to ditch the US Dollar.

The Central Bank of Russia has moved further away from its reliance on the United States dollar and has axed its share in the country’s foreign reserves to a historic low, transferring about $100 billion into euro, Japanese yen, and Chinese yuan according to a report by RT. The share of the U.S. dollar in Russia’s international reserves portfolio has dramatically decreased in just three months between March and June 2018. The holding decreased from 43.7 percent to a new low of 21.9 percent, according to the Central Bank’s latest quarterly report, which is issued with a six-month lag.

The money pulled from the dollar reserves was redistributed to increase the share of the euro to 32 percent and the share of Chinese yuan to 14.7 percent. Another 14.7 percent of the portfolio was invested in other currencies, including the British pound (6.3 percent), Japanese yen (4.5 percent), as well as Canadian (2.3 percent) and Australian (1 percent) dollars.

The Central Bank’s total assets in foreign currencies and gold increased by $40.4 billion from July 2017 to June 2018, reaching $458.1 billion. –RT

Russian and others have been consistently moving away from the dollar and toward other currencies. Economic sanctions, which are losing their power as more countries move from the dollar, and trade wars seem to be fueling the dollar’s uncertainty.

Peter Schiff warns that as the supply of dollars is going to grow and grow, the demand for the American currency can fall, while the US Fed will be unable to stop the dollar’s demise. Schiff says that what is coming for Americans, is massive inflation.

“Eventually, what’s going to happen is it’s going to be the demand for those dollars is going to collapse, not the supply. And when the demand for dollars collapses, then the price of the dollar collapses. You get massive inflation. That is what is coming.”

Russia began its unprecedented dumping of U.S. Treasury bonds in April and May of last year. Russia appears to be moving on from the rise in tensions with the United States. The massive $81 billion spring sell-off coincided with the U.S.’s sanctioning of Russian businessmen, companies, and government officials. But Russia has long had plans to “beat” the U.S. when it comes to sanctions by stockpiling gold.

The Russian central bank’s First Deputy Governor Dmitry Tulin said that Moscow sees the acquisition of gold as a “100-percent guarantee from legal and political risks.”

As reported by RT, the Kremlin has openly stated that American sanctions and pressure are forcing Russia to find alternative settlement currencies to the U.S. dollar to ensure the security of the country’s economy. Other countries, such as China, India, and Iran, are also pursuing steps to challenge the greenback’s dominance in global trade.

Source: ZeroHedge

***

India Begins Paying For Iranian Oil In Rupees Instead Of US Dollars

Three months ago, in Mid-October, Subhash Chandra Garg, economic affairs secretary at India’s finance ministry, said that India still hasn’t worked out yet a payment system for continued purchases of crude oil from Iran, just before receiving a waiver to continue importing oil from Iran in its capacity as Iran’s second largest oil client after China.

https://www.zerohedge.com/sites/default/files/inline-images/iran%20oil%20clients_0.jpg?itok=DURuMPHn

That took place amid reports that India had discussed ditching the U.S. dollar in its trading of oil with Russia, Venezuela, and Iran, instead settling the trade either in Indian rupees or under a barter agreement. One thing was certain: India wanted to keep importing oil from Iran, because Tehran offers generous discounts and incentives for Indian buyers at a time when the Indian government is struggling with higher oil prices and a weakening local currency that additionally weighs on its oil import bill.

Fast forward to the new year when we learn that India has found a solution to the problem, and has begun paying Iran for oil in rupees, a senior bank official said on Tuesday, the first such payments since the United States imposed new sanctions against Tehran in November. An industry source told Reuters that India’s top refiner Indian Oil Corp and Mangalore Refinery & Petrochemicals have made payments for Iranian oil imports.

To be sure, India, the world’s third biggest oil importer, has wanted to continue buying oil from Iran as it offers free shipping and an extended credit period, while Iran will use the rupee funds to mostly pay for imports from India.

“Today we received a good amount from some oil companies,” Charan Singh, executive director at state-owned UCO Bank told Reuters. He did not disclose the names of refiners or how much had been deposited.

Hinting that it wants to extend oil trade with Tehran, New Delhi recently issued a notification exempting payments to the National Iranian Oil Company (NIOC) for crude oil imports from steep withholding taxes, enabling refiners to clear an estimated $1.5 billion in dues.

Meanwhile, in lieu of transacting in US Dollars, Iran is devising payment mechanisms including barter with trading partners like India, China and Russia following a delay in the setting up of a European Union-led special purpose vehicle to facilitate trade with Tehran, its foreign minister Javad Zarif said earlier on Tuesday.

As Reuters notes, in the previous round of U.S. sanctions, India settled 45% of oil payments in rupees and the remainder in euros but this time it has signed deal with Iran to make all payments in rupees as New Delhi wanted to fix its trade balance with Tehran.  Case in point: Indian imports from Iran totaled about $11 billion between April and November, with oil accounting for about 90 percent.

Singh said Indian refiners had previously made payments to 15 banks, but they will now be making deposits into the accounts of only 9 Iranian lenders as one had since closed and the U.S has imposed secondary sanctions on five others.

It’s all about control… Robert Fripp

Source: ZeroHedge

Are You Prepared For A Credit Freeze?

2, 3 and 5-Year Treasury Yields All Drop Below The Fed Funds Rate

Things are getting increasingly more crazy in bond land, where moments ago the 2Y Treasury dipped below 2.40%, trading at 2.3947% to be exact, and joining its 3Y and 5Y peers, which were already trading with a sub-2.4% handle. Why is that notable? Because 2.40% is where the Effective Fed Funds rate is, by definition the safest of safe yields in the market, that backstopped by the Fed itself. In other words, for the first time since 2008, the 2Y (and 3Y and 5Y) are all trading below the effective Fed Funds rate.

That the curve is now inverted from the Fed Funds rate all the way to the 5Y Treasury position suggests that whatever is coming, will be very ugly as increasingly more traders bet that one or more central banks may have no choice but to backstop risk assets and they will do it – how else – by buying bonds, sending yields to levels last seen during QE… i.e., much, much lower.

https://confoundedinterestnet.files.wordpress.com/2019/01/5eff.png

Explained…

Source: ZeroHedge

***

Gold Soars Above $1,300; Nikkei, JGB Yields Tumble As Rout Goes Global

https://www.zerohedge.com/sites/default/files/inline-images/gold%20futs%201.3.jpg?itok=Wll68K3N

US Federal Reserve Bank’s Net Worth Turns Negative, They’re Insolvent, A Zombie Bank, That’s All Folks

While the Fed has been engaging in quantitative tightening for over a year now in an attempt to shrink its asset holdings, it still has over $4.1 trillion in bonds on its balance sheet, and as a result of the spike in yields since last summer, their massive portfolio has suffered substantial paper losses which according to the Fed’s latest quarterly financial report, hit a record $66.453 billion in the third quarter, raising questions about their strategy at a politically charged moment for the central bank, whose “independence” has been put increasingly into question as a result of relentless badgering by Donald Trump.

https://www.zerohedge.com/sites/default/files/inline-images/Fed%20P%26L%20dec%202018.jpg?itok=DRsSjcAj

What immediately caught the attention of financial analysts is that the gaping Q3 loss of over $66 billion, dwarfed the Fed’s $39.1 billion in capital, leaving the US central bank with a negative net worth…

https://www.zerohedge.com/sites/default/files/inline-images/Fed%20BS%2012.12.jpg?itok=f5WkIqu4

… which would suggest insolvency for any ordinary company, but since the Fed gets to print its own money, it is of course anything but an ordinary company as Bloomberg quips.

It’s not just the fact that the US central bank prints the world’s reserve currency, but that it also does not mark its holdings to market. As a result, Fed officials usually play down the significance of the theoretical losses and say they won’t affect the ability of what they call “a unique non-profit entity’’ to carry out monetary policy or remit profits to the Treasury Department. Indeed, confirming this the Fed handed over $51.6 billion to the Treasury in the first nine months of the year.

The risk, however, is that should the Fed’s finances continue to deteriorate if only on paper, it could impair its standing with Congress and the public when it is already under attack from President Donald Trump as being a bigger problem than trade foe China.

Commenting on the Fed’s paper losses, former Fed Governor Kevin Warsh told Bloomberg that “a central bank with a negative net worth matters not in theory. But in practice, it runs the risk of chipping away at Fed credibility, its most powerful asset.’’

Additionally, the growing unrealized losses provide fuel to critics of the Fed’s QE and the monetary operating framework underpinning them, just as central bankers begin discussing the future of its balance sheet. And, as Bloomberg cautions, the metaphoric red ink also could make it politically more difficult for the Fed to resume QE if the economy turns down.

“We’re seeing the downside risk of unconventional monetary policy,’’ said Andy Barr, the outgoing chairman of the monetary policy and trade subcommittee of the House Financial Services panel. “The burden should be on them to tell us why this does not compromise their credibility and why the public and Congress should not be concerned about their solvency.’’

Of course, the culprit for the record loss is not so much the holdings, as the impact on bond prices as a result of rising rates which spiked in the summer as a result of the Fed’s own overoptimism on the economy, and which closed the third quarter at 3.10% on the 10Y Treasury. Indeed, with rates rising slower in the second quarter, the loss for Q3 was a more modest $19.6 billion.

And with yields tumbling in the fourth quarter as a result of the current growth and markets scare, it is likely that the Fed could book a major “profit” for the fourth quarter as the 10Y yield is now trading just barely above the 2.86% where it was on June 30.

Meanwhile, the Fed continues to shrink its bond holdings by a maximum of $50 billion per month, an amount that was hit on October 1, not by selling them, which could force it to recognize but by opting not to reinvest some of the proceeds of securities as they mature.

The Fed is expected to continue shrinking its balance sheet at rate of $50BN / month until the end of 2020 (as shown below) unless of course market stress forces the Fed to halt QT well in advance of its tentative conclusion.

https://www.zerohedge.com/sites/default/files/inline-images/Fed%20Soma%20Nov%202018_1.jpg?itok=i1IAr1B1

In any case, the Fed will certainly never return to its far leaner balance sheet from before the crisis, which means that it will continue to indefinitely pay banks interest on the excess reserves they park at the Fed, with many of the recipient banks being foreign entities.

Barr, a Kentucky Republican, has accurately criticized that as a subsidy for the banks, one which will amount to tens of billions in annual “earnings” from the Fed, the higher the IOER rate goes up. He is not alone: so too has California Democrat Maxine Waters, who will take over as chair of the House Financial Services Committee in January following her party’s victory in the November congressional elections.

* * *

Going back to the Fed’s unique treatment of losses on its income statement and its under capitalization, in an Aug. 13 note, Fed officials Brian Bonis, Lauren Fiesthumel and Jamie Noonan defended the central bank’s decision not to follow GAAP in valuing its portfolio. Not only is the central bank a unique creation of Congress, it intends to hold its bonds to maturity, they wrote.

Under GAAP, an institution is required to report trading securities and those available for sale at fair or market value, rather than at face value. The Fed reports its balance-sheet holdings at face value.

The Fed is far less cautious with the treatment of its “profits”, which it regularly hands over to the Treasury: the interest income on its bonds was $80.2 billion in 2017. The central bank turns a profit on its portfolio because it doesn’t pay interest on one of its biggest liabilities – $1.7 trillion in currency outstanding.

The Fed’s unique financial treatments also extends to Congress, which while limiting to $6.8 billion the amount of profits that the Fed can retain to boost its capital has also repeatedly “raided” the Fed’s capital to pay for various government programs, including $19 billion in 2015 for spending on highways.

Still, a negative net worth is sure to raise eyebrows especially after Janet Yellen said in December 2015 that “capital is something that I believe enhances the credibility and confidence in the central bank.”

* * *

Furthermore, as Bloomberg adds, if it had to the Fed could easily operate with negative net worth – as it is doing now – like other central banks in Chile, the Czech Republic and elsewhere have done, according to Nathan Sheets, chief economist at PGIM Fixed Income. That said, questionable Fed finances pose communications and mostly political problems for Fed policymakers.

As for long-time Fed critic and former Fed governor, Kevin Warsh, he zeroed in on the potential impact on quantitative easing.

“QE works predominantly through its signaling to financial markets,’’ he said. “If Fed credibility is diminished for any reason — by misunderstanding the state of the economy, under-estimating the power of QE’s unwind or carrying a persistent negative net worth — QE efficacy is diminished.’’

The biggest irony, of course, is that the more “successful” the Fed is in raising rates – and pushing bond prices lower – the greater the un-booked losses on its bond holdings will become; should they become great enough to invite constant Congressional oversight, the casualty may be none other than the equity market, which owes all of its gains since 2009 to the Federal Reserve.

While a central bank can operate with negative net worth, such a condition could have political consequences, Tobias Adrian, financial markets chief at the IMF said. “An institution with negative equity is not confidence-instilling,’’ he told a Washington conference on Nov. 15. “The perception might be quite destabilizing at some point.”

That point will likely come some time during the next two years as the acrimonious relationship between Trump and Fed Chair Jerome Powell devolves further, at which point the culprit by design, for what would be the biggest market crash in history will be not the Fed – which in the past decade blew the biggest asset bubble in history – but President Trump himself.

Source: ZeroHedge

***

Diagnosing What Ails The Market

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Credit “Death Spiral” Begins As Loan ETF Sees Massive Outflows, Liquidates Quality Paper

One week after even the IMF joined the chorus of warnings sounding the alarm over the unconstrained, unregulated growth of leveraged loans, and which as of November included the Fed, BIS, JPMorgan, Guggenheim, Jeff Gundlach, Howard Marks and countless others, it appears that investors have finally also joined the bandwagon and are now fleeing an ETF tracking an index of low-grade debt as credit spreads blow out and cracks appear across virtually all credit products.

Not only has the $6.4 billion BKLN Senior Loan ETF seen seven straight days of outflows, with investors pulling $129 million on Wednesday alone and reducing the fund’s assets by 2% to the lowest level in more than two years, but over 800 million has been pulled in last current month, the biggest monthly outflow ever as investors are packing it in.

https://www.zerohedge.com/sites/default/files/inline-images/bkln%20loan.jpg?itok=lKtR3fpZ

Year to date, the shares of the largest ETF backed by the risky debt are down 1.7% and reached their lowest since April 2016; the ETF’s underlying benchmark, the S&P/LSTA Leveraged Loan Index, has also been hit recently and is down 0.6% YTD.

What is more concerning is that what has been a mere trickle of selling appears to be evolving into a full blown liquidation: some 29 million shares of BKLN, worth $654 million, traded on Tuesday – mostly on the downside – resulting in a record trading day for the fund and more than eight times its average daily turnover for the past five years.

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Speaking to Bloomberg, Yannis Couletsis, principal at Credence Capital Management said that “outflows for BKLN have most probably to do with the most recent deterioration of the credit environment,”; he ascribed the ETF’s drift on the deterioration of low-grade credit and “repricing of investors’ forecast regarding the path of Federal Reserve’s interest rate hikes.”

Couletsis pointed to widening credit spreads and the fact that BKLN has floating-rate underlying instruments, assets that become less attractive than fixed-rate ones should the Fed skip its March rate hike, as some are anticipating.

The loan ETF puke comes at a time when both US investment grade and junk bond spreads have blown out this week the most in nearly two years, while yields spiked to a 30-month high this month. In fact, investment grade bonds are on track for their worst year in terms of total returns since 2008.

“The price action in the ETF hasn’t warranted investors to justify keeping it on to collect the monthly coupon it pays,” said Mohit Bajaj, director of exchange-traded funds at WallachBeth Capital. “The risk/reward hasn’t been there compared to short-term treasury products like JPST,” he added, referring to the $4.2 billion JPMorgan Ultra-Short Income ETF, which hasn’t seen a daily outflow since April 9.

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BLKN isn’t alone: investors have pulled $1.5 billion from loan funds since mid-October. According to a note from Citi strategists Michael Anderson and Philip Dobrinov, leveraged loans in the U.S. may no longer be the “star performer” amid a potential pause in rate hikes by the Fed, while the recent redemption scramble has caused ETFs to offload better quality loans to raise cash, according to the Citi duo. That’s despite leveraged loan issuance being at its highest since 2008 and returns on the S&P/LSTA Leveraged Loan Index at about 3.5 percent so far this year.

If investors are, indeed, unloading to raise cash, Anderson and Dobrinov write “this is a bearish sign, particularly if outflows persist and managers eventually turn to deep discount paper for cash. Furthermore, as we get closer to the end of the Fed’s hiking cycle, we expect further outflows as traditional fixed-rate credit products become more in vogue.”

Incidentally the behavior described by Citi’s strategists, in which ETF administrators first sell high quality paper then shift to deep discount holdings, was one of the catalysts that hedge fund manager Adam Schwartz listed three weeks ago as a necessary condition for credit ETFs to enter a “death spiral.” And with virtually everyone – including the Fed, BIS and IMF – all warning that the next crisis will begin in the leverage loan sector, the question to ask is “has it begun.”?

Source: ZeroHedge

 

Is The Corporate Debt Bubble Bursting? GE’s 5% Perpetual Bond Falls To $79 While Stock Goes Sub-$10

Last decade, there was a residential mortgage credit bubble that burst. While there doesn’t appear to be a residential mortgage credit bubble (well, just a little), there is most definitely a corporate debt credit bubble that appears to be bursting.

Take General Electric. Their stock price has slipped to under $10 per share from over $30 per share back in early 2017 while the 5% perpetual bond has rapidly gone from around par ($100) to $79 in the wink of The Fed’s eye.

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Of course, GE’s earnings-per-share have been tanking as interest rates have been rising.

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And to make matters worse, US investment grade debt is on track for worst year since 2008.

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Like Robot Monster, the Federal Reserve has helped to create bubbles in the corporate bond market.

Source: Confounded Interest


“The Collapse Has Begun” – GE Is Now Trading Like Junk

Two weeks after we reported that GE had found itself locked out of the commercial paper market following downgrades that made it ineligible for most money market investors, the pain has continued, and yesterday General Electric lost just over $5bn in market capitalization. While far less than the $49bn wiped out from AAPL the same day, it was arguably the bigger headline grabber.

The shares slumped -6.88% after dropping as much as -10% at the lows after the company’s CEO, in an interview with CNBC yesterday, failed to reassure market fears about a weakening financial position. The CEO suggested that the company will now urgently sell assets to address leverage and its precarious liquidity situation whereby it will have to rely on revolvers – and the generosity of its banks – now that it is locked out of the commercial paper market.

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Indeed, shares hit levels first seen in 1995 yesterday and have only been lower since, very briefly, during the financial crisis when they hit $6.66 in March 2009. For a bit of perspective, Deutsche Bank notes that the market cap of GE now is $69.5bn and it’s the 80th largest company in the S&P 500. Yet in August 2003, GE was the largest company in the index (and regularly the world between 1993-2005) at a market cap of $296bn, $12bn more than Microsoft in second place. Since then, the tech giant has grown to be a $826bn company well over 10 times the size, while GE’s market cap peaked (ironically) during the dot com bubble in August 2000 at $594BN before tumbling first in the tech crash and then the GFC.

But while most investors have been focusing on GE’s sliding equity, the bigger concern is what happens to the company’s giant debt load, especially if it is downgraded to junk.

First, some background: GE had about $115 billion of debt outstanding as of the end of September, down from $136 billion a year earlier. And while GE is targeting a net EBITDA leverage ratio of 2.5x, this hasn’t been enough to appease credit raters, which have expressed concern recently that GE’s beleaguered power business and deteriorating cash flows will continue to weaken the company’s financial position. As a result, Moody’s downgraded GE two levels last month to Baa1, three steps above speculative grade. S&P Global Ratings and Fitch Ratings assign the company an equivalent BBB+, all with stable outlooks.

The problem is that while the rating agencies still hold GE as an investment grade company, the market disagrees.

GE – a top 15 issuer in both the US and EU indices – was recently downgraded into the BBB bucket, and as recently as September it was trading 20bps inside BBB- bonds. However they crossed over at the end of that month and now trade up to 50bps wide to the average of the weakest notch of IG.

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In other words, GE is already trading like junk, and has become the proverbial canary in the coalmine for what many have said could be the biggest risk facing the bond market: over $1 trillion in potential “fallen angel” debt, or investment grade names that end up being downgraded to high yield, resulting in a junk bond crisis.

As Deutsche Bank’s Jim Reid notes, GE’s recent collapse has come at time when much discussion in recent months has been about BBBs as a percentage of the size of the HY market. Since 2005, BBBs have been steadily rising as a percentage of HY climbing back above the previous peak in 2014 (175%) before extending that growth to a current level of 274%. Meanwhile, the total notional of BBB investment grade debt has grown to $2.5 trillion in par value today, a 227% increase since 2009, and now represents 50% of the entire IG index. 

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Next, to get a sense of just how large the risk of fallen angels in the US is, consider that the BBB part of the IG index is now ~2.5x as large as the entire HY index.

https://www.zerohedge.com/sites/default/files/inline-images/BBB%20par%20vs%20HY%20par.jpg

So large BBB companies – and none are larger than GE – with a deteriorating credit story are prone to additional widening pressure as investors fear the risks of an eventual downgrade to HY and a swamping of paper into that market. This, as Deutsche Bank writes, isn’t helping GE at the moment and may be a dress rehearsal for what happens for weaker and large BBB issuers in the next recession.

Meanwhile, while GE is not trading as a pure play junk bond just yet, it is well on its way as the following chart of GE’s spread in the context of both IG and HY shows.

https://www.zerohedge.com/sites/default/files/inline-images/GE%20spread%20IG%20vs%20HY.jpg?itok=xpv-KlGJ

Which is both sad, and ironic: as Bloomberg’s Sebastian Boyd writes this morning, “the company’s CEOs boasted of its AAA rating as a key strategic asset, but it was more than that. The rating, which it maintained for more than half a century, was symbolic of the company’s status as a champion of American commerce. Now, Microsoft and Johnson & Johnson are the only U.S. corporates with the top rating from S&P.”

And while rating agencies have yet to indicate they are contemplating further cuts to the company’s investment grade rating, the bond market has clearly awoken, and nowhere more so than in the swap space, where GE’s Credit Default Swaps have exploded in recent weeks.

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What kind of an impact would GE’s downgrade have? With $48 billion of bonds in the Bloomberg Barclays US Corporate index, GE would become almost 9% of the BB universe. And one look at Boyd’s chart below shows that the market is increasingly pricing GE’s index-eligible bonds as junk, especially in the context of the move over the past month.

https://www.zerohedge.com/sites/default/files/inline-images/GE%20bonds%20vs%20BB%2B.jpg?itok=opTII-vm

An additional risk to the company’s credit profile: GE has more debt coming due in the next 18 months than any other BBB rated borrower: that fact alone makes it the most exposed to higher rates according to Boyd.

Meanwhile, GE’s ongoing spread blow out, and junk-equivalent price, has not escaped unnoticed, and as we have been warning for a while, could portend a broader repricing in the credit sector. As Guggenheim CIO commented this morning, “the selloff in GE is not an isolated event. More investment grade credits to follow. The slide and collapse in investment grade debt has begun.”

Then again, Minerd’s concern pales in comparison to what some other credit strategists. In an interview with Bloomberg TV on November 8, Bruce Richards, chairman and chief executive officer of the multi-billion Marathon Asset Management warned that over leveraged companies “are going to get crushed” in the next recession.  Richards also warned that when the cycle does turn, “with no liquidity in the high-yield market to speak of, when these tens of billions or potentially hundreds of billions falls into junk land, it’s “Watch out below!” because there’s going to be enormous price adjustments.”

Echoing what we said above, Richards noted that about $1 trillion of bonds are rated as BBB, as investment- grade, when they has leverage ratios worthy of junk, adding that “the magnifying glass is now shifting” toward ratings companies.

For now the “magnifying glass” appears to have focused on GE, and judging by the blow out in spreads for this “investment grade” credit, what it has found has been unexpected. Which brings us to the question we asked at the top: will GE be the canary in the credit crisis coalmine and, when the next crisis finally does strike, the biggest fallen angel of them all?

Source: ZeroHedge

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“There Is No Corner To Hide”: $100 Billion Fund Manager Warns Credit Rout Is Just Starting

Without that central bank support and transitioning off the fiscal stimulus, our long-term outlook for investment grade is definitely on the more bearish side over the last two to three years.”

Interest On US Treasury Debt Hits $523 Billion As China Issues “Ron Swanson” Bonds

US debt continues to climbs along with interest rates. The interest paid to private banks and others on US Treasury debt has hit $523 BILLIION … and rising.

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Meanwhile, in China bondholders are being paid in ham instead of cash. Or perhaps bacon. Ron Swanson would approve!

Source: Confounded Interest

Where The Next Financial Crisis Begins

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(Global Macro Monitor) We are not sure of how the next financial crisis will exactly unfold but reasonably confident it will have its roots in the following analysis. Maybe it has already begun.

The U.S. Treasury market is the center of the financial universe and the 10-year yield is the most important price in the world, of which, all other assets are priced. We suspect the next major financial crisis may not be in the Treasury market but will most likely emanate from it.

U.S. Public Sector Debt Increase Financed By Central Banks 

The U.S. has had a free ride for this entire century, financing its rapid run up in public sector debt,  from 58 percent of GDP at year-end 2002, to the current level of 105 percent, mostly by foreign central banks and the Fed.

Marketable debt, in particular, notes and bonds, which drive market interest rates have increased by over $9 trillion during the same period, rising from 20 percent to 55 percent of GDP.

Central bank purchases, both the Fed and foreign central banks, have, on average, bought 63 percent of the annual increase in U.S. Treasury notes and bonds from 2003 to 2018. Note their purchases can be made in the secondary market, or, in the case of foreign central banks,  in the monthly Treasury auctions.

In the shorter time horizon leading up to the end of QE3,  that is 2003 to 2014, central banks took down, on average, the equivalent of 90 percent of the annual increase in notes and bonds.  All that mattered to the price-insensitive central banks was monetary and exchange rate policy. 

Stunning.

Greenspan’s Bond Market Conundrum

The charts and data also explain what Alan Greenspan labeled the bond market conundrum just before the Great Financial Crisis (GFC).   The former Fed chairman was baffled as long-term rates hardly budged while the Fed raised the funds rate by 425 bps from 2004 to 2006, largely, to cool off the housing market.

The data show foreign central banks absorbed 120 percent of all the newly issued T-notes and bonds during the years of the Fed tightening cycle, freeing up and displacing liquidity for other asset markets, including mortgages. Though the Fed was tight, foreign central bank flows into the U.S., coupled with Wall Street’s financial engineering, made for easy financial conditions.

Greenspan lays the blame on these flows as a significant factor as to why the Fed lost control of the yield curve.  The yield curve inverted because of these foreign capital flows and the reasoning goes that the inversion did not signal a crisis; it was a leading cause of the GFC (great financial crisis) as mortgage lending failed to slow, eventually blowing up into a massive bubble.

Because it had lost control of the yield curve, the Fed was forced to tighten until the glass started shattering.  Boy, did it ever.

Central Bank Financing Is A Much Different Beast

The effective “free financing” of the rapid increase in the portion of the U.S debt that matters most to markets, by creditors who could not give one whit about pricing, displaced liquidity from the Treasury market, while at the same time, keeping rates depressed, thus lifting other asset markets.

More importantly, central bank Treasury purchases are not a zero-sum game. There is no reallocation of assets to the Treasury market in order to make the bond buys.  The purchases are made with printed money.

Reserve Accumulation

It is a bit more complicated for foreign central banks, which accumulate reserves through currency intervention and are often forced to sterilize their purchase of dollars, and/or suffer the inflationary consequences.

Nevertheless, foreign central banks park much of their reserves in U.S. Treasury securities, mainly notes.

Times They Are A Chang ‘en

The charts and data show that since 2015, central banks have on average been net sellers of Treasury notes and bonds to the tune of an annual average of -19 percent of the yearly increase in net new note and bonds issued. The roll-off of the Fed’s SOMA Treasury portfolio, which is usually financed by a further increase in notes and bonds, does not increase the debt stock but, it is real cash flow killer for the U.S. government.

Unlike the years before 2015, the increase in new note and bond issuance is now a zero-sum game and financed by either the reallocation from other asset markets or an increase in financial leverage. The structural change in the financing of the Treasury market is taking place at a unpropitious time as deficits are ramping up.

Because 2017 was unique and an aberration of how the Treasury financed itself due to debt ceiling constraint, the markets are just starting to feel this effect. Consequently, the more vulnerable emerging markets are taking a beating this year and volatility is increasing across the board.

The New Market Meta-Narrative 

We suspect very few have crunched these numbers or understand them and this new meta-narrative supported by the data is the main reason for the increase in market gyrations and volatile capital flows this year.   We are pretty confident in the data, and the construction of our analysis. Feel free to correct us if you suspect data error and where you think we are wrong in our analysis. We look forward to hearing from you.

Moreover, the screws will tighten further as the ECB ends their QE in December.  We don’t think, though we reserve the right to be wrong, as we often are, this is just a short-term bout of volatility, but it is the beginning of a structural change in the markets as reflected in the data.

Interest Rates Will Continue To Rise

It is clear, at least to us, the only possibility for the longer-term U.S. Treasury yields to stay at these low levels is an increase in haven buying, which, ergo other asset markets will have to be sold. If you expect a normal world going forward, that is no recession or sharp economic slowdown, no major geopolitical shock, or no asset market collapse,  by default, you have to expect higher interest rates.  The sheer logic is in the data.

Of course,  Chairman Powell could cave to political pressure and “just print money to lower the debt” but we seriously doubt it and suspect the markets would not respond positively.

Stay tuned.

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Source: Global Macro Monitor

From Russia With Love?

Russia Dumps US Treasuries As Rates Climb

As predicted, Russia has reduced its holdings of US Treasuries as US rates continue to rise.

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But Russia is a relatively small player in the US Treasury market (unless they are using proxies like postage-stamp sized Luxembourg, Ireland or the Cayman Islands).

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As The Federal Reserve SLOWLY unwinds its balance sheet, the Confounded Interest blog is surprised that Japan and China have not unloaded MORE of their Treasury holdings.

Source: Confounded Interest

Mortgage Rates Surge The Most Since Trump’s Election, Hit New Seven Year High

With US consumers suddenly dreading to see the bottom line on their next 401(k) statement, they now have the housing market to worry about.

As interest rates spiked in the past month, one direct consequence is that U.S. mortgage rates, already at a seven-year high, surged by the most since the Trump elections.

According to the latest weekly Freddie Mac statement, the average rate for a 30-year fixed mortgage jumped to 4.9%, up from 4.71% last week and the highest since mid-April 2011. It was the biggest weekly increase since Nov. 17, 2016, when the 30-year average surged 37 basis points.

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With this week’s jump, the monthly payment on a $300,000, 30-year loan has climbed to $1,592, up from $1,424 in the beginning of the year, when the average rate was 3.95%.

Even before this week’s spike, the rise in mortgage rates had cut into affordability for buyers, especially in markets where home prices have been climbing faster than incomes, which as we discussed earlier this week, is virtually all. That’s led to a sharp slowdown in sales of both new and existing homes: last month the NAR reported that contracts to buy previously owned properties declined in August by the most in seven months, as purchasing a new home becomes increasingly unaffordable.

“With the escalation of prices, it could be that borrowers are running out of breath,” said Sam Khater, chief economist at Freddie Mac.

“Rising rates paired with high and escalating home prices is putting downward pressure on purchase demand,” Khater told Bloomberg, adding that while rates are still historically low, “the primary hurdle for many borrowers today is the down payment, and that is the reason home sales have decreased in many high-priced markets.”

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Meanwhile, lenders and real-estate agents say that, even now, all but the most qualified buyers making large down payments face borrowing rates of 5%. And while rates have been edging higher in recent months, “the last week we’ve seen an explosion higher in mortgage rates,” said Rodney Anderson, a mortgage lender in the Dallas area quoted by the WSJ.

Meanwhile, the WSJ reports that once-hot markets are showing signs of cooling down. Bill Nelson, president of Your Home Free, a Dallas-based real-estate brokerage, said that in the neighborhoods where he works, the number of homes experiencing price cuts is more than double the number that are going into contract.

The rise in rates could have far-reaching effects for the mortgage industry. Some lenders—particularly non-banks that don’t have other lines of business —could take on riskier customers to keep up their level of loan volume, or be forced to sell themselves. Many U.S. mortgage lenders, including some of the biggest players, didn’t exist a decade ago and only know a low-rate environment, and many younger buyers can’t remember a time when rates were higher.

Meanwhile, in more bad news for the banks, higher rates will kill off any lingering possibility of a refinancing boom, which bailed out the mortgage industry in the years right after the 2008 financial crisis. If rates hit 5%, the pool of homeowners who would qualify for and benefit from a refinance will shrink to 1.55 million, according to mortgage-data and technology firm Black Knight Inc. That would be down about 64% since the start of the year, and the smallest pool since 2008.

Naturally, hardest hit by the rising rates will be young and first-time buyers who tend to make smaller down payments than older buyers who have built up equity in their previous homes, and middle-income buyers, who can least afford the extra cost. Khater said that about 45% of the loans that Freddie Mac is backing are to first-time buyers, up from about 30% normally, which also means that rising rates could have an even bigger impact on the market than usual.

Younger buyers are also more likely to be shocked by higher rates because they don’t remember when rates were more than 18% in the early 1980s, or more recently, the first decade of the 2000s, when rates hovered around 5% to 7%.

“There’s almost a generation that has been used to seeing 3% or 4% rates that’s now seeing 5% rates,” said Vishal Garg, founder and chief executive of Better Mortgage.

Source: ZeroHedge

When The Fed Comes Marching Home: Mortgage Refinancing Applications Killed, Purchase Applications Stalled by Fed Rate Hikes

It was inevitable. Federal Reserve rate hikes and balance sheet shrinkage is having the predictive effect: killing mortgage refinancing applications.

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And, mortgage purchases applications SA have stalled in terms of growth with Fed rate hikes and balance sheet shrinkage.

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WASHINGTON, D.C. (October 10, 2018) – Mortgage applications decreased 1.7 percent from one week earlier, according to data from the Mortgage Bankers Association’s (MBA) Weekly Mortgage Applications Survey for the week ending October 5, 2018.

The Market Composite Index, a measure of mortgage loan application volume, decreased 1.7 percent on a seasonally adjusted basis from one week earlier. On an un-adjusted basis, the Index decreased 2 percent compared with the previous week. The Refinance Index decreased 3 percent from the previous week. The seasonally adjusted Purchase Index decreased 1 percent from one week earlier. The un-adjusted Purchase Index decreased 1 percent compared with the previous week and was 2 percent higher than the same week one year ago.

The refinance share of mortgage activity decreased to 39.0 percent of total applications from 39.4 percent the previous week. The adjustable-rate mortgage (ARM) share of activity increased to 7.3 percent of total applications.

The FHA share of total applications increased to 10.5 percent from 10.2 percent the week prior. The VA share of total applications remained unchanged at 10.0 percent from the week prior. The USDA share of total applications increased to 0.8 percent from 0.7 percent the week prior.

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Yes, The Fed has begun its bomb run.

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Source: Confounded Interest

Liquidity Crisis Looms As Global Bond Curve Nears “The Rubicon” Level

(Nedbank) The first half of 2018 was dominated by tighter global financial conditions amid the contraction in Global $-Liquidity, which resulted in the stronger US dollar weighing heavily on the performance of risks assets, particularly EM assets.

GLOBAL BOND YIELDS ON THE MOVE AMID TIGHTER GLOBAL FINANCIAL CONDITIONS

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Global bond yields are on the rise again, led by the US Treasury yields, which as we have highlighted in numerous reports, is the world’s risk-free rate.

The JPM Global Bond yield, after being in a tight channel, has now begun to accelerate higher. There is scope for the JPM Global Bond yield to rise another 20-30bps, close to 2.70%, which is the ‘Rubicon level’ for global financial markets, in our view.

If the JPM Global Bond yield rises above 2.70%, the cost of global capital would rise further, unleashing another risk-off phase. Our view is that 2.70% will hold, for the time being.

We believe the global bond yield will eventually break above 2.70%, amid the contraction in Global $-Liquidity.

GLOBAL LIQUIDITY CRUNCH NEARING AS GLOBAL YIELD CURVE FLATTENS/INVERTS

A stronger US dollar and the global cost of capital rising is the perfect cocktail, in our opinion, for a liquidity crunch.

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Major liquidity crunches often occur when yield curves around the world flatten or invert. Currently, the global yield curve is inverted; this is an ominous sign for the global economy and financial markets, especially overvalued stocks markets like the US.

The US economy remains robust, but we believe a global liquidity crunch will weigh on the economy. Hence, we believe a US downturn is closer than most market participants are predicting.

GLOBAL VELOCITY OF MONEY WOULD LOSE MOMENTUM

The traditional velocity of money indicator can be calculated only on a quarterly basis (lagged). Hence, we have developed our own velocity of money indicator that can be calculated on a monthly basis.

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Our Velocity of Money Indicator (VoM)is a proprietary indicator that we monitor closely. It is a modernized version of Irving Fisher’s work on the Quantity Theory of Money, MV=PQ.

We believe it is a useful indicator to understand the ‘animal spirits’ of the global economy and a leading indicator when compared to PMIs, stock prices and business cycle indicators, at times.

The cost of capital and Global $-Liquidity tend to lead the credit cycle (cobweb theory), which in turn filters through to prospects for the real economy.

Prospects for global growth and risk assets are likely to be dented over the next 6-12 months, as the rising cost of capital globally will likely weigh on the global economy’s ability to generate liquidity – this is already being indicated by our Global VoM indicator.

Source: ZeroHedge

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The “VaR Shock” Is Back: Global Bonds Lose $880 Billion In One Week

 

 

Debts & Deficits: A Slow Motion Train Wreck

Europe’s Junk Bond Bubble Has Finally Burst

Home Builder Stocks Decline As Fed Hikes Rates And Unwinds

The bloom is off the rose for home builders. Yes, it had been a great run, fueled by The Fed’s zero-interest rate policy (ZIRP) and asset purchases (QE). But despite a roaring economy, SPDR S&P Home builders ETF have been falling since January as The Federal Reserve Open Market Committee (FOMC) sticks to their guns and keeps normalizing interest rates.

https://confoundedinterestnet.files.wordpress.com/2018/10/spdrhbfed.png

Yes, the Fed Dots Plot project indicates that there is still upside momentum to short-term interest rates.

https://confoundedinterestnet.files.wordpress.com/2018/10/feddotsplots.png

And the Fed’s System Open Market Accounts (SOMA) show a declining inventory of Treasury Notes and Bonds to let mature.

https://confoundedinterestnet.files.wordpress.com/2018/10/somadist.png

Source: Confounded Interest

 

Bonds Experienced Biggest Bloodbath Since Trump’s Election

Yields spiked by the most since Nov 2016 (the day of and following President Trump’s election).

https://www.zerohedge.com/sites/default/files/inline-images/2018-10-03_12-28-06.jpg?itok=9ksI3vBw

NOTE – After 1430ET, bond were suddenly bid (and stocks sold off).

30Y yields spiked to the highest since Sept 2014…

https://www.zerohedge.com/sites/default/files/inline-images/2018-10-03_12-28-57.jpg?itok=EQdN9mnQ

10Y yields spiked to the highest since June 2011…

https://www.zerohedge.com/sites/default/files/inline-images/2018-10-03_12-20-38.jpg?itok=CJftSC_v

5Y yields spiked to the highest since Oct 2008…

https://www.zerohedge.com/sites/default/files/inline-images/2018-10-03_12-21-26.jpg?itok=WPeoecA9

The yield curve steepened dramatically…

https://www.zerohedge.com/sites/default/files/inline-images/2018-10-03_11-06-13.jpg?itok=_YVCE3Zz

All of which is fascinating given that Treasury Futures net speculative positioning is already at record shorts…

https://www.zerohedge.com/sites/default/files/inline-images/2018-10-03_7-51-10_0.jpg?itok=1clcbFN-

The entire global developed sovereign bond market saw yields surge

https://www.zerohedge.com/sites/default/files/inline-images/2018-10-03_11-20-58.jpg?itok=8o6Ynw1W

…observations and serious concerns from a trader.

JGB Market Enters “Uncharted Territory” As Bond Rout Goes Global

“Monster Move” In Treasuries Unleashes Global Market Rout

https://www.zerohedge.com/sites/default/files/inline-images/10y%20tsy%20yield%2010.4.jpg?itok=Y8eDvwh3

Fed Chair Powell Hints He May Soon Crash The Market

Source: ZeroHedge

Janet Yellen Says It’s Time For “Alarm” As Leveraged Loan Bubble Runs Amok

The deluge of leveraged loans is getting increasingly difficult to regulate as it takes over Wall Street. A new report brings up a perfect example of this: Bomgar Corp., who just lined up $439 million in loans. It was the company’s third trip to the debt markets this year and estimates have the company’s leverage potentially spiking as high as 15 times its earnings going forward, raising the obvious question of the risk profile of these loans.

As rates move higher like they are now, the loans – whose interest rates reference such floating instruments as LIBOR or Prime – pay out more. As a result, as the Fed tightens the money supply, defaults tend to increase as the interest expenses rise and as the overall cost of capital increases. And because an increasing amount of the financing for these loans is done outside of the traditional banking sector, regulators and agencies like the Federal Reserve aren’t able to do much to rein it in. The market for leveraged loans and junk bonds is now over $2 trillion. 

https://www.zerohedge.com/sites/default/files/styles/teaser_desktop_2x/public/2018-09/yellen%20teaser%205.jpg?itok=q6f-iemo

Escalating the risk of the unbridled loan explosion, none other than Janet Yellen – who is directly responsible for the current loan bubble – recently told Bloomberg that “regulators should sound the alarm. They should make it clear to the public and the Congress there are things they are concerned about and they don’t have the tools to fix it.”

Thanks Janet.

https://www.zerohedge.com/sites/default/files/inline-images/LL1_1.jpg?itok=isaqY6JU

As we noted recently, the risks of such loans defaulting are obvious, including loss of jobs and risk to companies on both the borrowing and the lending side. 

Tobias Adrian, a former senior vice president at the New York Fed who’s now the IMF’s financial markets chief, told Bloomberg: “…supporting growth is important, but future downside risks also need to be considered.” He also stated that regulators had “limited tools to rein in nonbank credit”.

But you’d never know this by listening to the Federal Reserve. According to Fed chairman Jerome Powell, during his press conference Wednesday, the Fed doesn’t see any risks right now. Powell said that “overall vulnerabilities” were “moderate”. He also stated that banks today “take much less risk than they used to”… We’ll pause for the obligatory golf clap. 


Goldman Warns Of A Default Wave As $1.3 Trillion In Debt Is Set To Mature


The lenders for the Bomgar deal included Jefferies Financial Group Inc. and Golub Capital BDC Inc., names that are outside the reach of the Fed. The company itself used the astounding defense that its pro forma leverage may only be “about seven times earnings”, which for some reason they seem to think is manageable, despite it obviously being an aggressive amount of leverage.

And since lenders may not ultimately wind up being the ones that pay the piper in the case of a default, the standards are lax on all sides. These types of loans are generally either bought by mutual funds or sometimes packaged into other securities that are sold to investors.

Of course, the harder that regulators squeeze to try to prevent these types of loans, the quicker that the market slips past them evolves. Trying to tighten loan standards has instead resulted in the market shifting to less regulated lenders, including companies like KKR & Co., Jefferies and Nomura. Hedge funds are next.

https://www.zerohedge.com/sites/default/files/inline-images/LL2_1.jpg?itok=yUD95ZhZ

The history of regulating leveraged loans goes back to 2013, when the Fed and the Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. issued guidance that told banks what acceptable leverage was. It restricted traditional banks from participating in the riskiest of these deals. Jerome Powell in 2015 said that this type of regulation would stop “a return to pre-crisis conditions”. Yes, the same Jerome Powell who today doesn’t see any risk. 

Of course, Wall Street lobbied against this back then, as did Republican lawmakers, declaring it as an overreach of regulation. And so now that the market has evolved in its wake, the leveraged loan market has started to run amok again.

Joseph Otting, the former banker who leads the Office of the Comptroller of the Currency is quoted as stating in February that: “…institutions should have the right to do the leveraged lending they want as long as they have the capital and personnel to manage that.”

Trying to put a favorable spin on current events, Richard Taft, the OCC’s deputy comptroller for credit risk, stated this month: “There isn’t anything going on in the market right now that would cause us to increase our supervision of that because we are always looking at that type of portfolio.”

Increased demand also means that yields won’t rise much even though loan quality has gotten worse. Investors may not be compensated for the risk that they’re taking, as we pointed out recently. We quoted Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC, who stated: “It’s not a good time to be buying bank loans”.

He also noted something troubling which we have discussed on numerous prior occasions: the collapse in lender protections which are worse than usual as there’s a smaller pool of creditors to absorb losses, and as covenant protection has never been weaker.

https://www.zerohedge.com/sites/default/files/inline-images/cov%20lite%20loans%202_1.jpg?itok=sW9aG8KX

Source: ZeroHedge

Goldman Warns Of A Default Wave As $1.3 Trillion In Debt Is Set To Mature

Ten years after the Lehman bankruptcy, the financial elite is obsessed with what will send the world spiraling into the next financial crisis. And with household debt relatively tame by historical standards (excluding student loans, which however will likely be forgiven at some point in the future), mortgage debt nowhere near the relative levels of 2007, the most likely catalyst to emerge is corporate debt. Indeed, in a NYT op-ed penned by Morgan Stanley’s, Ruchir Sharma, the bank’s chief global strategist made the claim that “when the American markets start feeling it, the results are likely be very different from 2008 —  corporate meltdowns rather than mortgage defaults, and bond and pension funds affected before big investment banks.

But what would be the trigger for said corporate meltdown?

According to a new report from Goldman Sachs, the most likely precipitating factor would be rising interest rates which after the next major round of debt rollovers over the next several years in an environment of rising rates would push corporate cash flows low enough that debt can no longer be serviced effectively.

* * *

While low rates in the past decade have been a boon to capital markets, pushing yield-starved investors into stocks, a dangerous side-effect of this decade of rate repression has been companies eagerly taking advantage of low rates to more than double their debt levels since 2007. And, like many homeowners, companies have also been able to take advantage of lower borrowing rates to drive their average interest costs lower each year this cycle…. until now.

According to Goldman, based on the company’s forecasts, 2018 is likely to be the first year that the average interest expense is expected to tick higher, even if modestly.

There is one major consequence of this transition: interest expenses will flip from a tailwind for EPS growth to a headwind on a go-forward basis and in some cases will create a risk to guidance. As shown in the chart below, in aggregate, total interest has increased over the course of this cycle, though it has largely lagged the overall increase in debt levels.

https://www.zerohedge.com/sites/default/files/inline-images/gsdebt1.jpg?itok=Yjz992Sy

The silver lining of the debt bubble created by central banks since the global financial crisis, is that along with refinancing at lower rates, companies have been able to generally extend maturities in recent years at attractive rates given investors search for yield as well as a gradual flattening of the yield curve.

According to Goldman’s calculations, the average maturity of new issuance in recent years has averaged between 15-17 years, up from 11-13 years earlier this cycle and <10 years for most of the late 1990’s and early 2000’s.

And while this has pushed back the day when rates catch up to the overall increase in debt, as is typically the case, there is nonetheless a substantial amount of debt coming due over the next few years: according to the bank’s estimates there is over $1.3 trillion of debt for our non-financials coverage maturing through 2020, roughly 20% of the total debt outstanding.

https://www.zerohedge.com/sites/default/files/inline-images/gsdebt2.jpg?itok=0CGcITP5

What is different now – as rates are finally rising – is that as this debt comes due, it is unlikely that companies will be able to roll to lower rates than they are currently paying. A second source of upward pressure on average interest expense is the recent surge in leverage loan issuance, i.e., those companies with floating rate debt (just 9% in aggregate for large caps, but a much larger percent for small-caps). The Fed Funds Futures curve currently implies four more rate hikes (~100 bp) through year-end 2019 (our economists are looking for 2 more than that, for a total of six through year-end 2019). While it is possible that some companies have hedges in place, there is still a substantial amount of outstanding bank loans directly tied to LIBOR which will result in a far faster “flow through” of interest expense catching up to the income statement.

While rising rates has already become a theme in several sectors such as Utilities and Real Estate, Goldman warns that this has the potential to be more widespread:

We saw evidence of this during the 2Q earnings season, where a number of companies cited higher interest expense as a headwind to reported earnings and/or guidance. Some examples:

  • “… we’re anticipating an increase in interest. It’s going to be n probably up in the $3.5mm, $4mm range, depending on interest rate increases… Obviously, we are anticipating floating rate increases if you think through the rate curve, so we embed that thinking into our forecast.” – Brinker International, FY4Q2018
  • “We expect net interest expense will be approximately $144 million [vs. $128 mn for the year ending February 3, 2018], reflecting an expectation for two additional rate increases as implied by the current LIBOR curve.” – Michaels Cos., 2Q2018
  • “Due largely to the effects of rising interest rates on our variable rate conduit facility, vehicle interest expense increased $9 million in the quarter… We continue to expect around $20 million higher vehicle interest expense due to rising U.S. benchmark interest rates.” – Avis Budget Group, 2Q2018

What does that mean for the bigger picture?

While many cash-rich companies have a remedy to rising rates, namely paying down debt as it matures, this is unlikely to be a recourse for the majority of corporations. The good news is that today, corporate America looks extremely healthy against a solid US economic backdrop. Revenue growth is running above trend, and EPS and cash flow growth are even stronger, boosted by Tax Reform.

And while Goldman economists assign a low likelihood that this will change anytime soon, there has been a sharp pickup in the “Recession 2020” narrative as of late. Specifically, along with the growth of the fiscal deficit which will see US debt increase by over $1 trillion next year, the fact that debt growth has outpaced EBITDA growth this cycle has implications for investors if and when the cycle turns.

Which brings us round circle to the potential catalyst of the next crisis: record debt levels.

According to Goldman’s calculations, Net Debt/EBITDA for its coverage universe as a whole remains near the highest levels this cycle, if not all time high. And while the bank cannot pinpoint exactly when the cycle will turn, it is easy to claim that US companies are “over-earning” relative to their cycle average today, a key points as the Fed continues “normalizing” its balance sheet. Indeed, this leverage picture looks even more stretched when viewed through a “normalized EBITDA” lens (which Goldman defines as the median LTM 2007 Q1-2018 Q2).

https://www.zerohedge.com/sites/default/files/inline-images/gsdebt3.jpg?itok=DDHa8fGv

There are two main factors that have driven this increase: net debt has increased while cash levels have declined:

  • the % of highly levered companies (i.e. >2x Net Debt/EBITDA) have nearly doubled vs. 2007 levels (even after EBITDA has improved for a large part of the Energy sector.)
  • The number of companies in a net cash position has declined precipitously to just 15% today down from 25% from 2006-2014.

Meanwhile, and touching on another prominent topic in recent months in which many on Wall Street have highlighted the deterioration in the investment grade space, i.e., the universe of “near fallen angels”, or companies that could be downgraded from BBB to junk, Goldman writes that credit metrics for low-grade IG and HY have been moving lower. If the cycle turns, the cost of debt could increase, with convexity suggesting that this turn could happen fast.

Picking up on several pieces we have written on the topic (most recently “Fallen Angel” Alert: Is Ford’s Downgrade The “Spark” That Crashes The Bond Market“), Goldman specifically highlights the potential high yield supply risk that could unfold.

Here are the numbers: currently there are $2tn of non-financial bonds rated BBB, the lowest rating across the investment grade scale. The amount has increased to 58% of the non-financial IG market over the last several years and is currently at its highest level in the last 10 years.

And for those wondering what could prompt the junk bond market to finally break – and Ford’s recently downgrade is precisely such a harbinger – Goldman’s credit strategists warn that this is important “because a turn in the cycle could result in these bonds being downgraded to high yield.”

From a market standpoint, too many bonds falling to the high yield market would create excess supply and potentially pressure prices. Looking back to prior cycles, approximately 5% to 15% of the BBB rated bonds were downgraded to high yield. If we assume the same percentages are applied to a theoretical down-cycle today, a staggering $100-300bn of debt could be at risk of falling to the high yield market in a cycle correction, an outcome that would choke the bond market and shock market participants. It is also the reason why Bank of America recently warned that the ECB can not afford a recession, as the resulting avalanche of “fallen angels” would crush the high yield bond market, sending shockwaves across the entire fixed income space.

And while such a reversal is not a near-term risk given solid sales/earnings growth and low recession risk, “it is potentially problematic given the current size of the high yield market is only $1.2tn.”

Should the market indeed turn, prices would need to adjust – i.e. drop sharply – in order to  generate the level of demand that would require a potential 25% increase in the size of the high yield market – especially at a time when risk appetite could be low.

https://www.zerohedge.com/sites/default/files/inline-images/gsdebt4.jpg?itok=cQT-grsj

Careful not to scare its clients too much, Goldman concedes that an imminent risk of a wave of credit rating downgrades is low, but warns that “the market could potentially be overlooking the underlying cost of capital/financial risks (high leverage, low coverage) for certain issuers based on their current access to market.

* * *

As for the worst case scenario, it should be self-explanatory: a sharp slowdown in the economy, coupled with a major repricing of bond market risk could result in a crash in the bond market, which together with the stock market has been the biggest beneficiary of the Fed’s unorthodox monetary policies. Furthermore, should companies suddenly find themselves unable to refinance debt, or – worse – rollover debt maturities, would lead to a wave of corporate defaults that starts at the lowest level of the capital structure and moves its way up, impacting such supposedly “safe” instrument as leveraged loans which in recent months have seen an explosion in issuance due to investor demand for higher yields.

To be sure, this transition will not happen overnight, but it will happen eventually and it will start with the riskiest companies.

To that end, Goldman has created a watch list for those companies that are most at risk: the ones with a credit rating of BBB or lower that are paying low average interest rates (less than 5%), have limited interest coverage (EBIT/Interest of <5x) and high leverage (Net Debt/EBITDA>2.5x) based on 2019 estimates; the screen is also limited to companies where Net Debt is a substantial portion of Enterprise value (30% or higher). The screen is hardly exhaustive and Goldman admits that “there are much more highly levered companies out there that could be more  exposed to a turn in the cycle.” However, the bank focuses on this subset given the low current interest cost relative to the risk-free rate, “suggesting investors could be complacent around their financing costs.”

In other words, investors who are exposed to debt in the following names may want to reasses if holding such risk is prudent in a time when, for the first time in a decade, the average interest expense is expected to tick higher.

https://www.zerohedge.com/sites/default/files/inline-images/gsdebt5.jpg?itok=KpIU11pk

….. and than there’s political pressure.

Source: ZeroHedge

Imagine Mortgage Rates Headed to 6%, 10-Year Yield to 4%, Yield Curve Fails to “Invert,” and Fed Keeps Hiking

Nightmare scenario for the markets? They just shrugged. But home buyers haven’t done the math yet.

There’s an interesting thing that just happened, which shows that the US Treasury 10-year yield is ready for the next leg up, and that the yield curve might not invert just yet: the 10-year yield climbed over the 3% hurdle again, and there was none of the financial-media excitement about it as there was when that happened last time. It just dabbled with 3% on Monday, climbed over 3% yesterday, and closed at 3.08% today, and it was met with shrugs. In other words, this move is now accepted.

Note how the 10-year yield rose in two big surges since the historic low in June 2016, interspersed by some backtracking. This market might be setting up for the next surge:

https://wolfstreet.com/wp-content/uploads/2018/09/US-treasury-yields-10-year-2018-09-19.png

And it’s impacting mortgage rates – which move roughly in parallel with the 10-year Treasury yield. The Mortgage Bankers Association (MBA) reported this morning that the average interest rate for 30-year fixed-rate mortgages with conforming loan balances ($453,100 or less) and a 20% down-payment rose to 4.88% for the week ending September 14, 2018, the highest since April 2011.

And this doesn’t even include the 9-basis-point uptick of the 10-year Treasury yield since the end of the reporting week on September 14, from 2.99% to 3.08% (chart via Investing.com; red marks added):

https://wolfstreet.com/wp-content/uploads/2018/09/US-mortgage-rates-MBA-2011_2018-09-19.png

While 5% may sound high for the average 30-year fixed rate mortgage, given the inflated home prices that must be financed at this rate, and while 6% seems impossibly high under current home price conditions, these rates are low when looking back at rates during the Great Recession and before (chart via Investing.com):

https://wolfstreet.com/wp-content/uploads/2018/09/US-mortgage-rates-MBA-2000_2018-09-19.png

And more rate hikes will continue to drive short-term yields higher, even as long-term yields for now are having trouble keeping up. And these higher rates are getting baked in. Since the end of August, the market has been seeing a 100% chance that the Fed, at its September 25-26 meeting, will raise its target for the federal funds rate by a quarter point to a range between 2.0% and 2.25%, according to CME 30-day fed fund futures prices. It will be the 3rd rate hike in 2018.

And the market now sees an 81% chance that the Fed will announced a 4th rate hike for 2018 after the FOMC meeting in December (chart via Investing.com, red marks added):

https://wolfstreet.com/wp-content/uploads/2018/09/US-Fed-rate-hike-probability-Dec-meeting-2018-09-19.png

The Fed’s go-super-slow approach – everything is “gradual,” as it never ceases to point out – is giving markets plenty of time to prepare and adjust, and gradually start taking for granted what had been considered impossible just two years ago: That in 2019, short-term yields will be heading for 3% or higher – the 3-month yield is already at 2.16% — that the 10-year yield will be going past 4%, and that the average 30-year fixed rate mortgage will be flirting with a 6% rate.

Potential home buyers next year haven’t quite done the math yet what those higher rates, applied to home prices that have been inflated by 10 years of interest rate repression, will do to their willingness and ability to buy anything at those prices, but they’ll get around to it.

As for holding my breath that an inverted yield curve – a phenomenon when the 2-year yield is higher than the 10-year yield – will ominously appear and make the Fed stop in its tracks? Well, this rate-hike cycle is so slow, even if it is speeding up a tiny bit, that long-term yields may have enough time to go through their surge-and-backtracking cycles without being overtaken by slowly but consistently rising short-term yields.

There has never been a rate-hike cycle this slow and this drawn-out: We’re now almost three years into it, and rates have come up, but it hasn’t produced the results the Fed is trying to achieve: A tightening of financial conditions, an end to yield-chasing in the credit markets and more prudence, and finally an uptick in the unemployment rate above 4%. And the Fed will keep going until it thinks it has this under control.

Source: by Wolf Richter | Wolf Street

Even Mortgage Lenders Are Repeating Their 2006 Mistakes

You’d think the previous decade’s housing bust would still be fresh in the minds of mortgage lenders, if no one else. But apparently not.

https://www.zerohedge.com/sites/default/files/inline-images/HousingCrash_c.gif?itok=g2TS43IF

One of the drivers of that bubble was the emergence of private label mortgage “originators” who, as the name implies, simply created mortgages and then sold them off to securitizers, who bundled them into the toxic bonds that nearly brought down the global financial system.

The originators weren’t banks in the commonly understood sense. That is, they didn’t build long-term relationships with customers and so didn’t need to care whether a borrower could actually pay back a loan. With zero skin in the game, they were willing to write mortgages for anyone with a paycheck and a heartbeat. And frequently the paycheck was optional.

In retrospect, that was both stupid and reckless. But here we are a scant decade later, and the industry is headed back towards those same practices. Today’s Wall Street Journal, for instance, profiles a formerly-miniscule private label mortgage originator that now has a bigger market share than Bank of America or Citigroup:

https://www.zerohedge.com/sites/default/files/inline-images/Mortgages-non-bank-Sept-18.jpg?itok=GSikgG3e

Its rise points to a bigger shift in the home-lending business to specialized mortgage lenders that fall outside the banking sector. Such non-banks, critically wounded in the housing crisis, have re-emerged to become the market’s dominant players, with 52% of U.S. mortgage originations, up from 9% in 2009. Six of the 10 biggest U.S. mortgage lenders today are non-banks, according to the research group.

They symbolize both the healthy reinvention of a mortgage market brought to its knees a decade ago—and how the growth in that market almost exclusively has been in its less-regulated corner.

Post crisis regulations curb bank and non-bank lenders alike from making the “liar loans” that wiped out many lenders and forced a wave of foreclosures during the crisis. What worries some industry participants is that little has changed about non-bank lenders’ structure.

Their capital levels aren’t as heavily regulated as banks, and they don’t have deposits or other substantive business lines. Instead they usually take short-term loans from banks to fund their lending. If the housing market sours, banks could cut off their funding—which doomed some non-banks in the last crisis. In that scenario, first-time buyers or borrowers with little savings would be the first to get locked out of the mortgage market.

“As long as the good times roll on, it’s fine,” said Ed Pinto, co-director of the Center on Housing Markets and Finance at the American Enterprise Institute. “But all I can say is, we’re in a boom, and you cannot keep going up like this forever.”

Freedom was just a small lender in the last crisis. When it became hard to borrow money, Freedom Chief Executive Stan Middleman embraced government-backed loans on the theory they would offer more stability.

As Quicken Loans Inc., the biggest and best-known non-bank, grew with the help of flashy technology and advertising campaigns, Freedom stayed under the radar, buying smaller lenders and scooping up other companies’ huge portfolios of loans, often made to relatively risky borrowers.

Mr. Middleman is fond of saying that one man’s trash is another man’s treasure. “I always believed that, if somebody is applying for a loan, we should try to make it for them,” says Mr. Middleman.

The New Mortgage Kings: They’re Not Banks

One afternoon this spring, a dozen or so employees lined up in front of Freedom Mortgage’s office in Mount Laurel, N.J., to get their picture taken. Clutching helium balloons shaped like dollar signs, they were being honored for the number of mortgages they had sold.

Freedom is nowhere near the size of behemoths like Citigroup or Bank of America; yet last year it originated more mortgages than either of them, some $51.1 billion, according to industry research group Inside Mortgage Finance. It is now the 11th-largest mortgage lender in the U.S., up from No. 78 in 2012.

What does this mean? Several things, depending on the resolution of the lens you’re using.

In the mortgage market it means that emerging private sector lenders are taking market share – presumably by being more aggressive – which puts pressure on the relatively stodgy brand-name banks to lower their own standards to keep up. To grasp the truth of this, just re-read the last sentence in the above article: “I always believed that, if somebody is applying for a loan, we should try to make it for them.” That is fundamentally not how banks work. Their job is to write profitable loans by weeding out the applicants who probably won’t make their payments.

Now, faced with competitors from the “No Credit, No Problem!” part of the business spectrum, the big guys will once again have to choose between adopting that attitude or leaving the business. See Bad Bankers Drive Out Good Bankers: Wells Fargo, Wall Street, And Gresham’s Law. Since the biggest mortgage lender is currently Wells Fargo, for which cutting corners is standard practice, it presumably won’t be long before variants of liar loans and interest only mortgages will be back on the menu.

From a broader societal perspective, this is par for the late-cycle course. After a long expansion, most banks have already lent money to their high-quality customers. But Wall Street continues to demand that those banks maintain double-digit earnings growth, and will punish their market caps if they fall short.

This leaves formerly-good banks with no choice but to loosen standards to keep the fee income flowing. So they start working their way towards the bottom of the customer barrel, while instructing their prop trading desks and/or investment bankers to explore riskier bets. Miss allocation of capital becomes ever-more-common until the system blows up.

The signs that we’re back there (2007 in some cases, 2008 in others) are spreading, which means the reckoning is moving from “inevitable” to “imminent”.

Source: by John Rubino via DollarCollapse.com | ZeroHedge

Disaster Is Inevitable When America’s Stock Market Bubble Bursts – Smart Money Is Focused On Trade

(Forbes) Despite the volatility and brief correction earlier this year, the U.S. stock market is back to making record highs in the past couple weeks. To many observers, this market now seems downright bulletproof as it keeps going higher and higher as it has for nearly a decade in direct defiance of the naysayers’ warnings. Unfortunately, this unusual market strength is not evidence of a strong, organic economy, but of an extremely unhealthy, artificial bubble economy that will end in a crisis that will be even worse than we experienced in 2008. In this report, I will show a wide variety of charts that prove how unsustainable the current bull market is.

Since the Great Recession low in March 2009, the S&P 500 stock index has gained over 300%, taking it nearly 80% higher than its 2007 peak:

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2Fsp500-2-3.jpg

The small cap Russell 2000 index and the tech-heavy Nasdaq Composite Index are up even more than the S&P 500 since 2009 – nearly 400% and 500% respectively:

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2Fpercentincrease-1.jpg

The reason for America’s stock market and economic bubbles is quite simple: ultra-cheap credit/ultra-low interest rates. As I explained in a Forbes piece last week, ultra-low interest rates help to create bubbles in the following ways:

  • Investors can borrow cheaply to speculate in assets (ex: cheap mortgages for property speculation and low margin costs for trading stocks)
  • By making it cheaper to borrow to conduct share buybacks, dividend increases, and mergers & acquisitions
  • By discouraging the holding of cash in the bank versus speculating in riskier asset markets
  • By encouraging higher rates of inflation, which helps to support assets like stocks and real estate
  • By encouraging more borrowing by consumers, businesses, and governments

The chart below shows how U.S. interest rates (the Fed Funds Rate, 10-Year Treasury yields, and Aaa corporate bond yields) have remained at record low levels for a record period of time since the Great Recession:

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2FUSRates-2.jpg

U.S. monetary policy has been incredibly loose since the Great Recession, which can be seen in the chart of real interest rates (the Fed Funds Rate minus the inflation rate). The mid-2000s housing bubble and the current “Everything Bubble” both formed during periods of negative real interest rates. (Note: “Everything Bubble” is a term that I’ve coined to describe a dangerous bubble that has been inflating in a wide variety of countries, industries, and assets – please visit my website to learn more.)

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2FRealFedFundsRate.jpg

The Taylor Rule is a model created by economist John Taylor to help estimate the best level for central bank-set interest rates such as the Fed Funds Rate. If the Fed Funds Rate is much lower than the Taylor Rule model (this signifies loose monetary conditions), there is a high risk of inflation and the formation of bubbles. If the Fed Funds Rate is much higher than the Taylor Rule model, however, there is a risk that tight monetary policy will stifle the economy.

Comparing the Fed Funds Rate to the Taylor Rule model is helpful for visually gauging how loose or tight U.S. monetary conditions are:

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2FTaylorRule1-1.jpg

Subtracting the Taylor Rule model from the Fed Funds Rate quantifies how loose (when the difference is negative), tight (when the difference is positive), or neutral U.S. monetary policy is:

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2FTaylorRule2-1-1.jpg

Low interest rates/low bond yields have enabled a corporate borrowing spree in which total outstanding non-financial U.S. corporate debt surged by over $2.5 trillion, or 40% from its peak in 2008. The recent borrowing boom caused total outstanding U.S. corporate debt to rise to over 45% of GDP, which is even worse than the level reached during the past several credit cycles. (Read my recent U.S. corporate debt bubble report to learn more).

U.S. corporations have been using much of their borrowed capital to buy back their own stock, increase dividends, and fund mergers and acquisitions – activities that are known for boosting stock prices and executive bonuses. Unfortunately, U.S. corporations have been focusing on these activities that reward shareholders in the short-term, while neglecting longer-term business investments – hubristic behavior that is typical during a bubble. The chart below shows how share buybacks and dividends paid increased dramatically since 2009:

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2Fbuybacks-1.jpg

Another Federal Reserve policy (aside from the ultra-low Fed Funds Rate) has helped to inflate the U.S. stock market bubble since 2009: quantitative easing or QE. When executing QE policy, the Federal Reserve creates new money “out of thin air” (in digital form) and uses it to buy Treasury bonds or other assets, which pumps liquidity into the financial system. QE helps to push bond prices higher and bond yields/interest rates lower throughout the economy. QE has another indirect effect: it causes stock prices to surge (because low rates boost stocks), as the chart below shows:

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2FFedBalanceSheetvsSP500-2.jpg

As touched upon earlier, low interest rates encourage stock speculators to borrow money from their brokers in the form of margin loans. These speculators then ride the bull market higher while letting the leverage from the margin loans boost their returns. This strategy can be highly profitable – until the market turns and amplifies their losses, that is.

There is a general tendency for speculators to use margin most aggressively just before the market’s peak, and the current bull market/bubble appears to be no exception. During the dot-com bubble and housing bubble stock market cycles, margin debt peaked at roughly 2.75% of GDP. In the current stock market bubble, however, margin debt is nearly at 3% of GDP, which is quite concerning. The heavy use of margin at the end of a long bull market exacerbates the eventual downturn because traders are forced to sell their shares to avoid or satisfy margin calls.

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2FSP500vsMarginGDP.jpg

In the latter days of a bull market or bubble, retail investors are typically the most aggressively positioned in stocks. Sadly, these small investors tend to be wrong at the most important market turning points. Retail investors currently have the highest allocation to stocks (blue line) and the lowest cash holdings (orange line) since the Dot-com bubble, which is a worrisome sign. These same investors were the most cautious in 2002/2003 and 2009, which was the start of two powerful bull markets.

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2Fallocation.jpg

The chart below shows the CBOE Volatility Index (VIX), which is considered to be a “fear gauge” of U.S. stock investors. The VIX stayed very low during the housing bubble era and it has been acting similarly for the past eight years as the “Everything Bubble” inflated. During both bubbles, the VIX stayed low because the Fed backstopped the financial markets and economy with its aggressive monetary policies (this is known as the “Fed Put“).

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2FVIX-1.jpg

The next chart shows the St. Louis Fed Financial Stress Index, which is a barometer for the level of stress in the U.S. financial system. It goes without saying that less stress is better, but only to a point – when the index remains at extremely low levels due to the backstopping of the financial markets by the Fed, it can be indicative of the formation of a dangerous bubble. Ironically, when that bubble bursts, financial stress spikes. Periods of very low financial stress foreshadow periods of very high financial stress – the calm before the financial storm, basically. The Financial Stress Index remained at extremely low levels during the housing bubble era and is following the same pattern during the “Everything Bubble.”

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2Ffinancialstress-1.jpg

High-yield (or “junk”) bond spreads are another barometer of investor fear or complacency. When high-yield bond spreads stay at very low levels in a central bank-manipulated environment like ours, it often indicates that a dangerous bubble is forming (it indicates complacency). The high-yield spread was unusually low during the dot-com bubble and housing bubble, and is following the same pattern during the current “Everything Bubble.”

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2FJunkSpread.jpg

In a bubble, the stock market becomes overpriced relative to its underlying fundamentals such as earnings, revenues, assets, book value, etc. The current bubble cycle is no different: the U.S. stock market is as overvalued as it was at major generational peaks. According to the cyclically-adjusted price-to-earnings ratio (a smoothed price-to-earnings ratio), the U.S. stock market is more overvalued than it was in 1929, right before the stock market crash and Great Depression:

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2FCAPE-3-2.jpg

Tobin’s Q ratio (the total U.S. stock market value divided by the total replacement cost of assets) is another broad market valuation measure that confirms that the stock market is overvalued like it was at prior generational peaks:

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2FTobinsQRatio-1.jpg

The fact that the S&P 500’s dividend yield is at such low levels is more evidence that the market is overvalued (high market valuations lead to low dividend yields and vice versa). Though dividend payout ratios have been declining over time in addition, that is certainly not the only reason why dividend yields are so low, contrary to popular belief. Extremely high market valuations are the other rarely discussed reason why yields are so low.

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2FDividend-1.jpg

The chart below shows U.S. after tax corporate profits as a percentage of the gross national product (GNP), which is a measure of how profitable American corporations are. Thanks to ultra-cheap credit, asset bubbles, and financial engineering, U.S. corporations have been much more profitable since the early-2000s than they have been for most of the 20th century (9% vs. the 6.6% average since 1947).

Unfortunately, U.S. corporate profitability is likely to revert to the mean because unusually high corporate profit margins are typically unsustainable, as economist Milton Friedman explained. The eventual mean reversion of U.S. corporate profitability will hurt the earnings of public corporations, which is very worrisome considering how overpriced stocks are relative to earnings.

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2FProfitMargins.jpg

During stock market bubbles, the overall market tends to be led by a smaller group of high-performing “story stocks” that capture the investing public’s attention, make early investors rich, and light the fires of greed and envy in practically everyone else. During the late-1990s dot-com bubble, the “story stocks” were tech stocks like Amazon.com, Intel, Cisco, eBay, etc. During the housing bubble era, it was home builder stocks like Hovanian, D.R. Horton, Lennar, mortgage lenders, and alternative energy companies like First Solar, to name a few examples.

In the current stock market bubble, the market is being led by a group of stocks nicknamed FAANG, which is an acronym for Facebook, Apple, Amazon, Netflix, and Google (now known as Alphabet Inc.). The chart below compares the performance of the FAANG stocks to the S&P 500 during the bull market that began in March 2009. Though the S&P 500 has risen over 300%, the FAANGs put the broad market index to shame: Apple is up over 1,000%, Amazon has surged more than 2,000%, and Netflix has rocketed over 6,000%.

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2FFAANGS.jpg

After so many years of strong and consistent performance, many investors now view the FAANGs as “can’t lose” stocks that will keep going “up, up, up!” as a function of time. Unfortunately, this is a dangerous line of thinking that has ruined countless investors in prior bubbles. Today’s FAANG phenomenon is very similar to the Nifty Fifty group of high-performing blue-chip stocks during the 1960s and early-1970s bull market. The Nifty Fifty were seen as “one decision” stocks (the only decision necessary was to buy) because investors thought they would keep rising virtually forever.

Investors tend to become most bullish and heavily invested in leading stocks such as the FAANGs or Nifty Fifty right before the market cycle turns. When the leading stocks finally fall during a bear market, they usually fall very hard, as Nifty Fifty investors experienced in the 1973-1974 bear market. The eventual unwinding of the FAANG stock boom/bubble is going to burn many investors, including institutional investors who have gorged on these stocks in recent years. 

How The Stock Market Bubble Will Pop

To keep it simple, the current U.S. stock market bubble will pop due to the ending of the conditions that created it in the first place: cheap credit/loose monetary conditions. The Federal Reserve inflated the stock market bubble via its record low Fed Funds Rate and quantitative easing programs, and the central bank is now raising interest rates and reversing its QE programs by shrinking its balance sheet. What the Fed giveth, the Fed taketh away.

The Fed claims to be able to engineer a “soft landing,” but that virtually never happens in reality. It’s even less likely to happen in this current bubble cycle because of how long it has gone on and how distorted the financial markets and economy have become due to ultra-cheap credit conditions.

I’m from the same school of thought as billionaire fund manager Jeff Gundlach, who believes that the Fed will keep hiking interest rates until “something breaks.” In the last economic cycle from roughly 2002 to 2007, it was the subprime mortgage industry that broke first, and in the current cycle, I believe that corporate bonds are likely to break first, which would then spill over into the U.S. stock market (please read my corporate debt bubble report in Forbes to learn more).

The Fed Funds Rate chart below shows how the last two recessions and bubble bursts occurred after rate hike cycles; a repeat performance is likely once rates are hiked high enough. Because of the record debt burden in the U.S., interest rates do not have to rise nearly as high as in prior cycles to cause a recession or financial crisis this time around. In addition to raising interest rates, the Fed is now conducting its quantitative tightening (QT) policy that shrinks its balance sheet by $40 billion per month, which will eventually contribute to the popping of the stock market bubble.

https://thumbor.forbes.com/thumbor/960x0/https%3A%2F%2Fblogs-images.forbes.com%2Fjessecolombo%2Ffiles%2F2018%2F08%2FFedFundsRate2-2.jpg

The 10-Year/2-Year U.S. Treasury bond spread is a helpful tool for determining how close a recession likely is. This spread is an extremely accurate indicator, having warned about every U.S. recession in the past half-century, including the Great Recession. When the spread is between 0% and 1%, it is in the “recession warning zone” because it signifies that the economic cycle is maturing and that a recession is likely just a few years away. When the spread drops below 0% (this is known as an inverted yield curve), a recession is likely to occur within the next year or so. 

As the chart below shows, the 10-Year/2-Year U.S. Treasury bond spread is already deep into the “Warning Zone” and heading toward the “Recession Zone” at an alarming rate – not exactly a comforting thought considering how overvalued and inflated the U.S. stock market is, not to mention how indebted the U.S. economy is.

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Although I err conservative/libertarian politically, I do not believe that President Trump can prevent the ultimate popping of the U.S. stock market bubble and “Everything Bubble.” One of the reasons why is that this bubble is truly global and the U.S. President has no control over the economies of China, Australia, Canada, etc. The popping of a massive global bubble outside of the U.S. is enough to create a bear market and recession within the U.S.

Also, as the charts in this report show, our stock market bubble was inflating years before Trump became president. I believe that this bubble was slated to crash to regardless of who became president – it could have been Hillary Clinton, Bernie Sanders, or Marco Rubio. Even Donald Trump called the stock market a “big, fat, ugly bubble” right before the election. Concerningly, even though the stock market bubble is approximately 30% larger than when Trump warned about it, Trump is no longer calling it a “bubble,” and is actually praising it each time it hits another record.

Many optimists expect President Trump’s tax reform plan to result in a powerful boom that creates millions of new jobs and supercharges economic growth, which would help the stock market grow into its lofty valuations. Unfortunately, this thinking is not grounded in reality or math. As my boss Lance Roberts explained, “there will be no economic boom” (Part 1Part 2) because our economy is too debt-laden to grow the way it did back in the 1980s during the Reagan Boom or at other times during the 20th century.

As shown in this report, the U.S. stock market is currently trading at extremely precarious levels and it won’t take much to topple the whole house of cards. Once again, the Federal Reserve, which was responsible for creating the disastrous Dot-com bubble and housing bubble, has inflated yet another extremely dangerous bubble in its attempt to force the economy to grow after the Great Recession. History has proven time and time again that market meddling by central banks leads to massive market distortions and eventual crises. As a society, we have not learned the lessons that we were supposed to learn from 1999 and 2008, therefore we are doomed to repeat them.

The purpose of this report is to warn society of the path that we are on and the risks that we are facing. I am not necessarily calling the market’s top right here and right now. I am fully aware that this stock market bubble can continue inflating to even more extreme heights before it pops. I warn about bubbles as an activist, but I approach tactical investing in a slightly different manner (because shorting or selling too early leads to under performance, etc.). As a professional investor, I believe in following the market’s trend instead of fighting it – even if I’m skeptical of the underlying forces that are driving it. Of course, when that trend fundamentally changes, that’s when I believe in shifting to an even more cautious and conservative stance for our clients and myself.

Source: by Jesse Colombo | Forbes

Learn about Trumps latest moves on trade negotiations with Canada and Mexico…

Gold And Silver Are Acting Like It’s 2008. They May Be Right

2008 has special significance for gold bugs, both because of the money they lost in August of year and the the money they made in the half-decade that followed. Today’s world is beginning to feel eerily similar.

Let’s start with a little background. The mid-2000s economy boomed in part because artificially low interest rates had ignited a housing mania which featured a huge increase in “subprime” mortgage lending. This – as all subprime lending binges eventually do – began to unravel in 2007. The consensus view was that subprime was “peripheral” and therefore unimportant. Here’s Fed Chair Ben Bernanke giving ever-credulous CNBC the benefit of his vast bubble experience.

The experts were catastrophically wrong, and in 2008 the periphery crisis spread to the core, threatening to kill the brand-name banks that had grown to dominate the US and Europe. The markets panicked, with even gold and silver (normally hedges against exactly this kind of financial crisis) plunging along with everything else. Gold lost about 20% of its market value in a single month:

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Gold mining stocks – always more volatile than the underlying metal – lost about half their value.

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Silver also fell harder than gold, taking the gold/silver ratio from around 50 to above 80 — meaning that it took 80 ounces of silver to buy an ounce of gold.

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The world’s governments reacted to the crisis by cutting interest rates to record lows and flooding the financial system with credit. And precious metals and related mining stocks took off on an epic bull market. So it’s easy to see why the investors thus enriched look back on 2008 with nostalgia.

https://d3fy651gv2fhd3.cloudfront.net/charts/embed.png?s=XAUUSD&v=20180904154000&d1=20080801&d2=20110601&h=300&w=600source: tradingeconomics.com

Is History Repeating?

Now fast forward to Autumn 2018. The global economy is booming because of artificially low interest rates and massive lending to all kinds of subprime borrowers. One group of them – the emerging market countries – made the mistake of borrowing trillions of US dollars in the hope that the greenback would keep falling versus their national currencies, thus giving them a profitable carry trade.

Instead the dollar is rising, threatening to bankrupt a growing list of these countries – which, crucially, owe their now unmanageable debts to US and European banks. The peripheral crisis, once again, is moving to the core.

And once again, gold and especially silver are getting whacked. This morning the gold/silver ratio popped back above the 2008 level.

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So are we back there again? Maybe. Some of the big western banks would probably fail if several major emerging markets default on their debts. And historically – at least since the 1990s – the major central banks have responded to this kind of threat with lower rates, loan guarantees and, more recently, massive and coordinated financial asset purchases.

So watch the Fed. If the EM crisis leads to talk of suspending the rate increase program and possibly restarting QE, then we’re off to the races. Just like 2008.

Source: Dollar Collapse

Emerging-Market Selloff Deepens Amid Fresh Alarms Over Contagion

  • Rand sinks as South Africa enters recession in second quarter
  • Developing-nation currencies set for lowest since May 2017

Emerging markets sold off anew Tuesday as South Africa entered a recession and Indonesia’s rupiah joined currencies from Turkey to Argentina in tumbling toward record lows, reinforcing concern that contagion risks are too big to ignore.

MSCI Inc.’s index of currencies dropped for a fifth time in six days, set for the lowest close in more than a year. The rand led global declines as data showed the economy fell into a recession last quarter. Turkey’s lira slid on worry the central bank will disappoint investors at its rate meeting next week, while the Argentine peso slumped to a record and Indonesian rupiah sank to the lowest in two decades even after the central bank intensified its fight to protect it.

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The dollar extended its advance to a fourth day as Donald Trump threatened to ramp up a trade dispute with China with an announcement of tariffs on as much as $200 billion in additional Chinese products as soon as Thursday. As U.S. rates rise, investor fears over idiosyncratic risks in emerging markets have climbed, including Argentina’s fiscal woes, Turkey’s twin deficits, Brazil’s contentious elections and South Africa’s land-reform bill.

Meantime, the dollar is winning by default, according to Kit Juckes, a global strategist at Societe Generale SA.

“There’s not much to make me think the dollar should be going up, but there’s plenty to make me nervous about other currencies,” Juckes said. “The dollar is very strong and lacking rate support, but other currencies are worse.”

HIGHLIGHTS:
  • The rand plunged as much as 3.4 percent after a report showed South Africa’s economy unexpectedly entered into a recession for the first time since 2009. GDP shrank an annualized 0.7 percent last quarter from the prior three months.
  • The lira sank as much as 1.3 percent and Mexico’s peso weakened as much as 1.6 percent.
  • Argentina’s peso slid to a fresh record low. 
  • Indonesia’s rupiah fell for a sixth day, sinking to a fresh two-decade low.
  • CBOE’s emerging-market volatility gauge rose to the highest in almost three weeks.
  • MSCI’s index of EM stocks dropped for a fifth day; MSCI’s currency measure slipped 0.6 percent, the most in almost a month.
  • Russia’s ruble pared losses after the central bank edged closer to raising interest rates for the first time since 2014.

READ: JPMorgan Survey Shows How Quickly Emerging Markets Can Unravel

Here’s what other analysts are saying about the latest in emerging markets:

It’s Not Enough

Tsutomu Soma, general manager for fixed-income trading at SBI Securities Co. in Tokyo:

  • “The measures announced by Argentina and Turkey are probably not enough to lead to a significant improvement in their fundamentals”
  • “Contagion risks to other emerging markets are growing especially as the Fed tightens”

‘Set to Suffer’

Michael Every, head of Asia financial markets research at Rabobank in Hong Kong:

  • “Emerging-market FX are set to suffer almost regardless of what they do, the only issue is how much”
  • The dollar will remain on the front foot against emerging markets as long as the U.S. continues to raise rates and boost fiscal spending while keeping the trade war fears on the radar

‘Further Pain’

Lukman Otunuga, research analyst at FXTM:

  • “Emerging market currencies could be destined for further pain if the turmoil in Turkey and Argentina intensifies”
  • “The combination of global trade tensions, a stabilizing U.S. dollar and prospects of higher U.S. interest rates may ensure EM currencies remain depressed in the short to medium term”

‘A Penny Short’

Stephen Innes, head of Asia Pacific trading at Oanda Corp. in Singapore:

  • Argentina’s measures are “likely a day late and a penny short”
  • “These moves are a step in the right direction, but they’re unlikely to be convincing enough to remove currency speculators from the driver’s seat. I guess it’s all down the IMF’s ‘White Knight’ to the rescue. However, we are getting into the realm of unquantifiability which makes the market utterly untradable”

Most Vulnerable

Masakatsu Fukaya, an emerging-market currency trader at Mizuho Bank Ltd.:

  • Contagion risks from Argentina and Turkey are growing for other emerging markets and economies with weak fundamentals such as those with current-account deficits and high inflation rates
  • Currencies of countries such as Indonesia, India, Brazil and South Africa have been among most vulnerable
  • The Fed’s rate increases and trade frictions means the underlying pressure on emerging currencies is for a further downward move

— With assistance by Tomoko Yamazaki, Yumi Teso, Lilian Karunungan, and Ben Bartenstein

Source: Bloomberg

***

More Emerging Market Chaos – How Long Before It Spreads To The Developed World?

Emerging market chaos is now front page news.

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Commercial Real Estate Paying Lowest Return In Over A Decade

Investors taking on more risk in US commercial real estate are now receiving the lowest return since the housing crisis. The premium spread for buying BBB- tranches of commercial mortgage backed securities versus AAA is the lowest its been since May 2007, according to a new report from analytics company Trepp, the FT reports.

The euphoria associated with the US economy even as the overall global economy is rolling over means that those bearing the brunt of risk for commercial mortgage backed securities are getting paid the least. This also comes as a result of investors chasing yield, which could be another obvious canary in the coal mine that the now record bull market could be reaching an apex.

https://www.zerohedge.com/sites/default/files/inline-images/cmbc%20chart.jpg?itok=BlfaGPxo

“As you get toward the latter innings of the credit cycle, people have money they need to put to work and they take on more risk for less return,” said Alan Todd, a CMBS analyst at Bank of America Merrill Lynch.

Commercial mortgage backed securities are made up of a combination of types of mortgages which are then divided up by risk. Traditionally, as with any financial instrument, the more risk that investors bear, the more they get paid. But now, investors are looking more and more like they’re “picking up pennies in front of bulldozers” as demand for AAA tranches of CMBS’ has fallen. Meanwhile BBB- slices of CMBS continue to see an influx of demand. The conclusion?

“You are probably not getting paid for the risk you are taking and that definitely concerns us,” Dushyant Mehra, co-chief investment officer at Hildene, told the Financial Times.

The Federal Reserve’s tightening could be another potential cause for the shift: higher quality fixed rate investments like AAA tranches of CMBS, have fallen in price as a result of Fed policy. This, in turn, has caused investors to seek out riskier products, like floating rate company loans, to juice returns.

https://www.zerohedge.com/sites/default/files/inline-images/cmbs%201_0_0.jpg?itok=mXWONet8

Meanwhile, the boom in commercial housing has resulted in a significant amount of CMBS supply. $49 billion in new issuance between January and July of this year eclipses the $45 billion that was sold throughout the same period of time last year.

The credit premium between AAA and BBB-, which is as low as you can go without hitting a junk rating, has fallen to 2.1% in August from 2.2% in July, according to the report. While this is below the 2014 low of 2.3%, it still is nowhere near the pre-financial crisis lows of just 0.67%, which printed in May 2007 when everyone was long, and just before RMBS and CMBS blew up, catalyzing the financial crisis.

“It is something everyone frets over,” Gunter Seeger, a portfolio manager at fund manager PineBridge, said of the evaporating premium investors are demanding. “You are always concerned that the pendulum swings too far but the reach for yield is still there.”

Everyone may be “fretting” but it has yet to stop them from buying.

As is the case during any euphoric period, few are paying attention and taking the data as a warning. Perhaps once the numbers start to move closer to May 2007 levels, it will catch people’s attention, although considering that even the Fed has repeatedly warned about “froth” in commercial real estate with no change in behavior, it is safe to say that no lessons from the financial crisis have been learned.

Source: ZeroHedge

Emerging Markets Continue to Slide as Dollar Pressures $3.7 Trillion Debt Wall

Emerging Markets Continue to Slide as Dollar Pressures $3.7 Trillion Debt Wall

Emerging market stocks extended their declines Friday as investors continue to pull cash from some of the world’s biggest developing economies amid concerns that the greenback’s recent rally will pressure the cost of servicing some of the $3.7 trillion in debt taken on in the ten years since the global financial crisis.

Argentina has been at the forefront of the recent emerging market pullback this week, with the peso suffering its biggest single-day slump in three years — including a fifth of its value yesterday — before the central bank stepped in with a move to lift interest rates to an eye-watering 60% amid concerns that President Mauricio Macri’s efforts to cut spending and stave off a looming recession in South America’s third largest economy will ignite social unrest that could toppled his government.

“We have agreed with the International Monetary Fund to advance all the necessary funds to guarantee compliance with the financial program next year,” Macri said Wednesday in reference to a $50 billion support plan in the works. “This decision aims to eliminate any uncertainty. Over the last week we have seen new expressions of lack of confidence in the markets, specifically over our financing capacity in 2019.”

Those moves shadow a similar concern for the Turkish Lira, which resumed its slide against the dollar Thursday following a warning from Moody’s Investors Service earlier this week as the ratings agency downgraded its outlook on 20 domestic banks owning to the country’s slowing growth and their exposure to dollar-denominated debts.

The Turkish lira recovered from yesterday’s decline, but was still marked at 6.57 against the dollar, near to the weakest since the peak of its currency crisis in early August. Larger emerging market economy currencies were on the ropes Thursday, with the Indian rupee hitting a lifetime low of 70.68 against the dollar this week and falling 3.6% this month, the biggest decline since August 2015, while the Russian ruble bounced back from a two-year low to trade at 68.06.

The sell-off has also affected emerging market stocks, which continue to lag their advanced counterparts, with most major EM benchmarks either in or near so-called ‘bear market’ territory, which defines a market that has fallen 20% from its recent peak.

The benchmark MSCI International Emerging Markets index, for example, is down 0.4% today and more than 3% this month alone, extending its decline from the high it reached on January 29 to nearly 17%, while Reuters data notes that 20 out of 23 emerging market benchmarks are trading below their 200-day moving average, a technical condition that investors use as a signal for further selling.

Each of the three major emerging market ETFs, which collectively hold around $143 billion in assets — Vanguard’s FTSE EM (VWOGet Report) , and iShares’ Core MSCI EM (IEMGGet Report) and MSCI EM (EEMGet Report)  — have seen net asset values fall by an average of 15.3% since their January 26 peak.

The Bank for International Settlements, often described as the ‘central bank for central bank’s, estimates that emerging market countries are sitting on $3.7 trillion in dollar-denominated debt, all of which must be serviced in increasingly expensive greenbacks.

And while the dollar index is sitting at a four-week low of 94.60, it has risen more than 5% since the start of the second quarter and is expected to add further gains as the Federal Reserve signals future rate hikes amid a surging domestic economy, which grew 4.2% last quarter and is on pace for a similar advance in the three months ending in September, according to the Atlanta Fed’s GDPNow estimate.

“We look for the dollar to stay bid particularly against the emerging market FX segment where a meaningful decline in risky currencies is spilling over into the wider risk sentiment,” said ING’s Petr Krpata. “

Debt service costs aren’t the only concern, however, as many emerging market economies rely on the export of basic resources, such as oil and gas and other commodities, to fuel their growth.

With China’s economy showing persistent signs of a second half slowdown amid its ongoing trade dispute with the United States, many of those countries are seeing slowing demand, which is pressuring dollar-denominated revenues at exactly the time their needed to both support the value of their currencies in foreign exchange markets and make timely payments on the estimated $700 billion worth of debt that is set to mature over the next two years.

Source: by Martin Baddarcax | TheStreet.com

Which Emerging Markets Will Run Out Of Money First?

For years, in fact for the duration of the US dollar’s use as a global carry currency, Emerging Markets – especially those with a currency peg – were a welcome destination for yield starved US investors who found an easy source of yield differential pick up. All that came to a crashing halt first after the Chinese devaluation in 2015 which sent the dollar surging and slammed the EM sector, and then again in recent months when renewed strong dollar-inspired turmoil gripped the emerging markets, first due to idiosyncratic factors – such as those in Turkey and Argentina…

https://www.zerohedge.com/sites/default/files/inline-images/turkey%20argentina.jpg

… and gradually across the entire world, as contagion spread.

And while many pundits have stated that there is no reason to be concerned, and that the EM spillover will not reach developed markets, Morgan Stanley points out that the real pain may lie ahead.

As the following chart from the bank’s global head of EM Fixed Income strategy, James Lord, shows, whereas returns have slumped across EM rates, outflows from the EM space have a ways to go before they catch down to the disappointing recent returns.

https://www.zerohedge.com/sites/default/files/inline-images/EM%20returns.jpg?itok=9AdbY0_8

One can make two observations here: the first is that despite the equity rout, EM stocks (as captured by the EEM ETF) have a long way to go to catch down to EM bonds as shown by the Templeton EM Bond Fund (TEMEMFI on BBG).

https://www.zerohedge.com/sites/default/files/inline-images/EM%20equity%20vs%20bonds.jpg?itok=6ljNGxw5

The second, more salient point is that a key reason for the solid growth across emerging markets in recent years, has been the constant inflow of foreign capital, resulting in a significant external funding requirement for continued growth, especially for Turkey as discussed previously.

But what happens if this outside capital inflow stops, or worse, reverses? This is where things get dicey. To answer that question, Morgan Stanley has created its own calculation of Emerging Market external funding needs, and defined it as an “external coverage ratio.” It is calculated be dividing a country’s reserves by its 12 month external funding needs, which in turn are the sum of the i) current account, ii) short-term external debt and iii) the next 12 months amortizations from long-term external debt.

More importantly, what this ratio shows is how long a given emerging market has before it runs out of cash. And, as the chart below shows, if we were investors in Turkey, Ukraine, Argentina, or any of the other nations on the left side of the chart – and certainly those with less than a year of reserves to fund its external funding needs – we would be worried.

So to answer the question posed by the title, which Emerging Markets will run out of funding first, start on the left and proceed to the right.

https://www.zerohedge.com/sites/default/files/inline-images/EM%20external%20funding%20need.jpg?itok=HxscRuEo

Source: ZeroHedge

Are Bonds Sending A Signal?

Michael Lebowitz previously penned an article entitled “Face Off” discussing the message from the bond market as it relates to the stock market and the economy. To wit:

“There is a healthy debate between those who work in fixed-income markets and those in the equity markets about who is better at assessing markets. The skepticism of bond guys and gals seems to help them identify turning points. The optimism of equity pros lends to catching the full run of a rally. As an ex-bond trader, I have a hunch but refuse to risk offending our equity-oriented clients by disclosing it. In all seriousness, both professions require similar skill sets to determine an asset’s fair value with the appropriate acknowledgment of inherent risks. More often than not, bond traders and stock traders are on the same page with regard to the economic outlook. However, when they disagree, it is important to take notice.”

This is an interesting point given that despite the ending parade of calls for substantially higher interest rates, due to rising inflationary pressures and stronger economic growth, yields have stubbornly remained below 3% on the 10-year Treasury.

In this past weekend’s newsletter, we discussed the current “bullish optimism” prevailing in the market and that “all-time” highs are now within reach for investors.

“Currently, the “bulls” remain clearly in charge of the market…for now. While it seems as if much of the “tariff talk” has been priced into stocks, what likely hasn’t as of yet is rising evidence of weakening economic data (ISM, employment, etc.), weakening consumer demand, and the impact of higher rates.

While on an intermediate-term basis these macro issues will matter, it is primarily just sentiment that matters in the short-term. From that perspective, the market retested the previous breakout above the March highs last week (the Maginot line)which keeps Pathway #1 intact. It also suggests that next weekwill likely see a test of the January highs.

https://www.zerohedge.com/sites/default/files/inline-images/SP500-Chart3-080318%20%281%29.png?itok=aOPYMJ1K

“With moving averages rising, this shifts Pathway #2a and #2b further out into the August and September time frames. The potential for a correction back to support before a second attempt at all-time highs would align with normal seasonal weakness heading into the Fall. “

One would suspect with the amount of optimism toward the equity side of the ledger, and with the Federal Reserve on firm footing for further rate increases at a time where the U.S. Government is about to issue a record amount of new debt, interest rates, in theory, should be rising.

But they aren’t.

As Mike noted previously:

“Given our opinions on the severe economic headwinds facing economic growth and steep equity valuations, we believe this divergence poses a potential warning for equity holders. Accordingly, we thought it appropriate to provide a few graphs to demonstrate the ‘smarter’ guys are not on board the growth and reflation train.”

In today’s missive, we will focus on the “price” and “yield” of the 10-year Treasury from a strictly “technical”perspective with respect to the signal the bond market may be sending with respect to the stock market. Given that “credit” is the “lifeblood” of the Government, corporate and consumer markets, it should not be surprising the bond market tends to tell the economic story over time.

We can prove this in the following chart of interest rates versus the economic composite of GDP, inflation, and wages.

https://www.zerohedge.com/sites/default/files/inline-images/Rates-GDP-Composite-080618.png?itok=lcRcPHyd

Despite hopes of surging economic growth, the economic composite has remained in an elongated nominal range between 40 and 60 since 2011. This stagnation has never occurred in history and is a function of the massive interventions by the Government and the Federal Reserve to support economic growth. However, now those supports are being removed as the Federal Reserve lifts short-term borrowing costs and reduces liquidity support through their balance sheet reinvestments.

As I said, credit is the “lifeblood” of the economy. Think about all the ways that higher rates impact economic activity in the economy:

1) Rising interest rates raise the debt servicing requirements which reduces future productive investment.

2) Rising interest rates will immediately slow the housing market taking that small contribution to the economy away. People buy payments, not houses, and rising rates mean higher payments.

3) An increase in interest rates means higher borrowing costs which leads to lower profit margins for corporations. 

4) The “stocks are cheap based on low interest rates” argument is being removed.

5) The massive derivatives and credit markets are at risk. Much of the recovery to date has been based on suppressing interest rates to spur growth.

6) As rates increase so does the variable rate interest payments on credit cards. 

7) Rising defaults on debt service will negatively impact banks.

8) Many corporate share buyback plans and dividend issuances have been done through the use of cheap debt, which has led to increases corporate balance sheet leverage.

9) Corporate capital expenditures are dependent on borrowing costs. Higher borrowing costs lead to lower CapEx.

10) The deficit/GDP ratio will begin to soar as borrowing costs rise sharply. The many forecasts for lower future deficits will crumble as new forecasts begin to propel higher.

I could go on, but you get the idea.

So, with the Fed hiking rates, surging bankruptcies for older Americans who are under-saved and over-indebted, stumbling home sales, inflationary prices rising from surging energy costs, what is the 10-year Treasury telling us now.

Short-Term

On a very short-term basis, the 10-year Treasury yield has started a potential-topping process. Given that “yield” is the inverse of the “price” of bonds, the “buy” and “sell” signals are also reversed. As shown below, the 10-year yield appears to be forming the “right shoulder” of a “head and shoulder” topping formation and is currently on a short-term “buy” signal. Such would suggest lower yields over the next couple of months.

https://www.zerohedge.com/sites/default/files/inline-images/Rates-Weekly-080618.png?itok=astGcYCm

The two signals above aren’t a rarity. The chart below expands this view back to 1970. There have only been a few times historically that yields have been this overbought and trading at 3 to 4 standard deviations above their one-year average.

https://www.zerohedge.com/sites/default/files/inline-images/Rates-Weekly-Crisis-080618.png?itok=8OuknfhB

The outcome for investors was never ideal.

Longer-Term

Even using monthly closing data, which smooths out volatility to a greater degree, the same message appears. The chart below goes back to 1994. Each time yields have been this overbought (remember since yield is the inverse of price, this means bonds are very oversold) it is has signaled an issue with both the economy and the markets.

https://www.zerohedge.com/sites/default/files/inline-images/Rates-Monthly-SP500-080618-Crashes.png?itok=8bs9_JzH

Again, we see the same issue going back historically. Also, notice that yields are currently not only extremely overbought, they are also at the top of the long-term downtrend that started back in 1980.

https://www.zerohedge.com/sites/default/files/inline-images/Rates-Monthly-SP500-080618.png?itok=gJpuxCHG

Even Longer Term

Okay, let’s smooth this even more by using quarterly data closes. again, the picture doesn’t change.

https://www.zerohedge.com/sites/default/files/inline-images/Rates-Quarterly-SP500-080618-Crashes.png?itok=32JtcmDe

As I noted yesterday, the economic cycle is extremely advanced and both stocks and bonds are slaves to the full market cycle.

https://www.zerohedge.com/sites/default/files/inline-images/Historical-Recoveries-Declines-080518.png?itok=qWOsFTAd

“The “full market cycle” will complete itself in due time to the detriment of those who fail to heed history, valuations, and psychology.”

Of course, during the late stage of any market advance, there is always the argument which suggests “this time is different.” Mike made an excellent point in this regard previously:

“Given the divergences shown between bond and equity markets, logic says somebody’s wrong. Another possibility is that neither market is sending completely accurate signals about the future state of the economy and inflation. It is clear that bond traders do not buy into this latest growth narrative. Conversely, equity investors are buying the growth and reflation narrative lock, stock and barrel. To be blunt, with global central banks buying both bonds and stocks, the integrity of the playing field as well as normally reliable barometers of market conditions, are compromised.

This divergence between bond and equity traders could prove meaningless, or it may be a prescient warning for one or both of these markets. Either way, investors should be aware of the divergence as such a wide gap in economic opinions is unusual and may portend increased volatility in one or both markets.”

While anything is certainly possible, historical probabilities suggest that not only is “this time NOT different,” it will likely end the same way it always has for investors who fail to heed to bond markets warnings.

Source: ZeroHedge

The Fed Accelerates its QE Unwind

Mopping up liquidity.

The Fed’s QE Unwind – “balance sheet normalization,” as it calls this – is accelerating toward cruising speed. The first 12 months of the QE unwind, which started in October 2017, are the ramp-up period – just like there was the “Taper” during the final 12 months of QE. The plan calls for shedding up to $420 billion in securities in 2018 and up to $600 billion a year in each of the following years until the balance sheet is sufficiently “normalized” – or until something big breaks.

Treasuries

In July, the QE Unwind accelerated sharply. According to the plan, the Fed was supposed to shed up to $24 billion in Treasury Securities in July, up from $18 billion a month in the prior three months. And? The Fed released its weekly balance sheet Thursday afternoon. Over the four weeks ending August 1, the balance of Treasury securities fell by $23.5 billion to $2,337 billion, the lowest since April 16, 2014. Since the beginning of the QE-Unwind, the Fed has shed $129 billion in Treasuries.

https://wolfstreet.com/wp-content/uploads/2018/08/US-Fed-Balance-sheet-2018-08-02-Treasuries.png

The step-pattern in the chart above is a result of how the Fed sheds Treasury securities. It doesn’t sell them outright but allows them to “roll off” when they mature. Treasuries only mature mid-month or at the end of the month. Hence the stair-steps.

In mid-July, no Treasuries matured. But on July 31, $28.4 billion matured. The Fed replaced about $4 billion of them with new Treasury securities directly via its arrangement with the Treasury Department that cuts out Walls Street (its “primary dealers”) with which the Fed normally does business. Those $4 billion in securities, to use the jargon, were “rolled over.” But it did not replace about $24 billion of maturing Treasuries. They “rolled off.”

Mortgage-Backed Securities

Under QE, the Fed also bought mortgage-backed securities, which were issued and guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae. Holders of residential MBS receive principal payments as the underlying mortgages are paid down or are paid off. At maturity, the remaining principal is paid off.  So, to keep the MBS balance from declining on the Fed’s balance sheet after QE ended, the New York Fed’s Open Market Operations (OMO) kept buying MBS.

Settlement of those trades occurs two to three months later. Since the Fed books the trades at settlement, there’s a lag of two to three months between the date of the trade and when the trade appears on the Fed’s balance sheet [here’s my detailed explanation]. This is why it took a few months before the QE unwind in MBS showed up distinctively on the balance sheet.

The current changes of MBS on the balance sheet reflect trades from about two months ago. At the time, the cap for shedding MBS was $12 billion a month. And? Over the past four weeks, the balance of MBS fell by $11.8 billion, to $1,710 billion as of August 1, the lowest since October 8, 2014. In total, $61 billion in MBS have been shed since the beginning of the QE unwind:

https://wolfstreet.com/wp-content/uploads/2018/08/US-Fed-Balance-sheet-2018-08-02-MBS.png

Total Assets on the Balance Sheet

QE only involved Treasuries and MBS. And so the QE unwind only involves Treasuries and MBS. Since the beginning of the QE Unwind, Treasuries dropped by $129 billion and MBS by $61 billion, for a combined decline of $190 billion.

But the balance sheet of the Fed also reflects the Fed’s other functions and activities. And the decline in the overall balance sheet is not going to reflect exactly the amounts shed in Treasuries and MBS.

Total assets on the Fed’s balance sheet for the four weeks ending August 1 dropped by $34.1 billion. This brought the drop since October, when the QE unwind began, to $205 billion. At $4,256 billion, total assets are now at the lowest level since April 9, 2014, during the middle of the “taper.” It took the Fed about six years to pile on these securities, and now it’s going to take years to shed them:

https://wolfstreet.com/wp-content/uploads/2018/08/US-Fed-Balance-sheet-2018-08-02-overall.png

So the pace of the QE Unwind has accelerated in July, as planned. The Fed has not blinked during the sell-offs in the market, and it’s not going to. It is targeting “elevated” asset prices and financial conditions. Asset prices remain elevated and financial conditions remain ultra-loose. Markets have essentially brushed off the Fed so far. And that only acts as an encouragement for the Fed to proceed.

The FOMC, in its August 1 statement, mentioned “strong” five times in describing various aspects of the economy and the labor market – the most hawkish statement in a long time. Rate hikes will continue, and the pace might pick up. And the QE unwind will accelerate to final cruising speed and proceed as planned. The Fed stopped flip-flopping in the fall of 2016 and hasn’t looked back since.

When the economy eventually slows down enough to where the Fed feels like it needs to act, it will cut rates, but it will let the QE unwind proceed on automatic pilot toward “normalization,” whatever that will mean. That’s the stated plan. And the Fed will stick to it – unless something big breaks, such as credit freezing up again in the credit-dependent US economy, at which point all bets are off.

Source: by Wolf Richter | Wolf Street

Why You Should Care About The Narrowest Yield Curve Since 2007

Money manager Michael Pento is sounding the alarm because we are getting very close to something called a “yield curve inversion.” Pento explains, “Why do I care if the yield curve inverts? Because 9 out of the last 10 times the yield curve inverted, we had a recession… The spread with the yield curve is the narrowest it has been since outside of the start of the Great Recession that commenced in December of 2007… The last two times the yield curve inverted, we had a stock market drop of 50%. The market dropped, and the S&P 500 lost 50% of its value.”

For those who don’t have enough money to require professional management, consider storing water and food because that will never go out of style.

Source: by Greg Hunter | USAWatchdog.com

A Hard Rain’s A-Gonna Fall

https://whiskeytangotexas.files.wordpress.com/2017/09/abyss.jpg?w=625&zoom=2

Après moi, le déluge

~ King Louis XV of France

A hard rain’s a-gonna fall

~ Bob Dylan (the first)

As the Federal Reserve kicked off its second round of quantitative easing in the aftermath of the Great Financial Crisis, hedge fund manager David Tepper predicted that nearly all assets would rise tremendously in response. “The Fed just announced: We want economic growth, and we don’t care if there’s inflation… have they ever said that before?” He then famously uttered the line “You gotta love a put”, referring to the Fed’s declared willingness to print $trillions to backstop the economy and financial markets. Nine years later we see that Tepper was right, likely even more so than he realized at the time.

The other world central banks followed the Fed’s lead. Mario Draghi of the ECB declared a similar “whatever it takes” policy and has printed nearly $3.5 trillion in just the past three years alone. The Bank of Japan has intervened so much that it now owns over 40% of its country’s entire bond market. And no central bank has printed more than the People’s Bank of China.

It has been an unprecedented force feeding of stimulus into the global system. And, contrary to what most people realize, it hasn’t diminished over the years since the Great Recession. In fact, the most recent wave from 2015-2018 has seen the highest amount of injected ‘thin-air’ money ever:

https://static.seekingalpha.com/uploads/2018/6/17/saupload_Central_bank_global_QE_flows_-_6.14.18.png

In response, equities have long since rocketed past their pre-crisis highs, bonds continued rising as interest rates stayed at historic lows, and many real estate markets are now back in bubble territory. As Tepper predicted, financial and other risk assets have shot the moon. And everyone learned to love the ‘Fed put’ and stop worrying.

But as King Louis XV and Bob Dylan both warned us, what’s coming next will change everything.

The Deluge Approaches

This halcyon era of ever-higher prices and consequence-free backstopping by the central banks is ending. The central banks, desperate to give themselves some slack (any slack!) to maneuver when the next recession arrives, have publicly committed to ‘tightening monetary policy’ and ‘unwinding their balance sheets’, which is wonk-speak for ‘reversing what they’ve done’ over the past decade.

Most general investors today just don’t appreciate how gargantuanly significant this is. For the past 9 years, we’ve become accustomed to a volatility-free one-way trip higher in asset prices. It’s been all-glory with no risk while the ‘Fed put’ has had our backs (along with the ‘EBC put’, the ‘BOJ’ put, the ‘PBoC put’, etc). Anybody going long, buying the (few, minor) dips along the way, has felt like a genius. That’s all over.

Based on current guidance from the central banks, “global QE” is expected to drop precipitously from here:

https://static.seekingalpha.com/uploads/2018/6/17/saupload_liquidity_20supernova_201.jpg

With just the relatively tiny amount of QE tapering so far, 2018 has already seen more market price volatility than any year since 2009. But we’ve seen nothing so far compared to the volatility that’s coming later this year when QE starts declining in earnest. In parallel with this tightening, global interest rates are rising after years of flat lining at all-time lows. And it’s important to note that our recent 0% (or negative) yields came at the end of a 35-year secular cycle of declining interest rates that began in the early 1980s.

Are we seeing a secular cycle turn now that rates are creeping back up? Will rising interest rates be the norm for the foreseeable future? If so, the world is woefully unprepared for it. Countries and companies are carrying unprecedented levels of debt, as are many households. Rising interest rates increases the cost of servicing that debt, leaving less behind to invest or to meet basic operating needs.

Simon Black reminds us that, mathematically, rising interest rates result in lower valuations for stocks, bonds and housing. But so far, Wall Street hasn’t gotten the message (chart courtesy of Charles Hugh Smith):

https://static.seekingalpha.com/uploads/2018/1/15/saupload_DJIA1-18a.jpg(Source)

So we’re presented with a simple question: What happens when the QE that’s grossly-inflating markets stops at the same time that interest rates rise? The answer is simple, too: Prices fall.

They fall commensurate with the distortion within the system. Which is unprecendented at this stage.

But Wait, There’s More!

So the situation is dire. But it gets worse. Our debt that’s getting more expensive to service? Well, not only are we (in the US) adding to it at a faster rate with our newly-declared horizon of $1+ trillion annual deficits, but we’re increasingly antagonizing the largest buyers of our debt.

This is most notable with China (the #1 Treasury buyer), whom we’ve dragged into a trade war and just announced $50 billion in tariffs against. But Japan (the #2 buyer) is also materially reducing its Treasury purchases. And not to be outdone, Russia recently dumped half of its Treasury holdings, $47 billion worth, in a single fell swoop. Should this trend lead, understandably, to lower demand for US Treasures in the future, that only will put further pressure on interest rates to move higher.

And this is all happening at a time when the stability of the rest of the world is fast deteriorating. Developing (EM) countries are getting destroyed as central bank liquidity flows slow and reverse — as higher interest rates strengthen the USD against their home currencies, their debts (mostly denominated in USD) become more costly while their revenues (denominated in local currency) lose purchasing power. Fault lines are fracturing across Europe as protectionist, populist candidates are threatening the long-standing EU power structure. Italy’s economy is struggling to remain afloat and could take the entire European banking system down with it. The new tit-for-tat tariffs with the US aren’t helping matters. And China, trade war aside, is seeing its fabled economic momentum slow to multi-decade lows.

All players on the chessboard are weakening.

The Timing Is Becoming Clear

Yes, the financial markets are currently still near all-time highs (or at the high, in the case of the NASDAQ). And yes, expected Q2 US GDP has jumped to a blistering 4.8%. But the writing is increasingly on the wall that these rosy heights won’t last for much longer.

These next three charts from Palisade Research, combined with the above forecast of the drop-off in global QE, paint a stark picture for the rest of 2018 and beyond. The first shows that as the G-3 central banks have started their initial (and still small) efforts to withdraw QE, the Global Financial Stress Indicator is spiking worrisomely:

https://static.seekingalpha.com/uploads/2018/6/17/saupload_GlobalStressIndicator.png

Next, one of the best predictors of global corporate earnings now forecasts an imminent collapse. As go earnings, so go stock prices:

https://static.seekingalpha.com/uploads/2018/6/17/saupload_SKEG.png

And looking at trade flows — which track the movement of ‘real stuff’ like air and shipping freights — we see clear signs that the global economy is slowing down (a trend that will be exacerbated if oil prices rise as geologist Art Berman predicts):

https://static.seekingalpha.com/uploads/2018/6/17/saupload_Alt_MeasuresofWorldTrade.png

The end of QE, higher interest rates, trade wars at a time of slowing global trade, China/Europe weakening, EM carnage — it’s like both legs of the ladder you’re standing on being sawed off, as well all of the rungs underneath you.

Conclusion: a major decline in the financial markets is due for the second half of 2018/first half of 2019.

Actions To Take

Gathering clouds deliver a valuable message: Seek shelter before the storm.

Specifically, it’s time to:

  • Get liquid. When the rug gets pulled out from under today’s asset prices, ‘flat’ will be the new ‘up’. Simply not losing money will make you wealthier on a relative basis — it’s the easiest, least-risky strategy for most investors to prepare for what’s coming. “Cash is king” in the aftermath of a deflationary downdraft, when your dry power can be then used to purchase high-quality income-producing assets at excellent value — fractions of their current prices. And in the interim, the returns on cash are getting better for investors who know where to look. We’ve recently explained how you can now get 2%+ interest on cash stored in short-term T-bills (that’s 30x more than most banks will pay on cash savings). If you’re sitting on cash and haven’t looked seriously yet at that program, you really should review our report. With more Fed tightening expected in the future, T-bill rates are likely headed even higher.
  • Get your plan for the correction into place now. In addition to your cash, how is the rest of your portfolio positioned? Do you have suitable hedges in place to mitigate your risk? Does your financial advisor even acknowledge the risks detailed in the above article? The last thing you want to do in a market downdraft is make panicked decisions.
  • Nibble into commodities. The commodities/equities price ratio is the lowest it has been in 47 years. That ratio has to correct some point soon. Much of that correction will be due to stocks dropping; but the rest will be by commodities holding their own or appreciating. While it’s true that commodities could indeed fall as well during a general deflationary rout, that’s not a guarantee — especially given that many commodities are now selling at prices close to — or in some cases, below — their marginal cost of production. The easiest commodities to own yourself, the precious metals, are ‘dirt cheap’ right now (especially silver), as explained in our recent podcast with Ronald Stoeferle. And with Friday’s bloodbath, they just got even cheaper.
  • Assess and address your biggest vulnerabilities before the next crisis hits. Are you worried about the security of your current job when the next recession hits? Are rising interest rates causing you to struggle in deciding whether to buy or sell a home? Are you trying to come up with a plan for a resilient retirement? Are you assessing the pros and cons of relocating? Do you have homesteading questions? Are you trying to create new streams of income?

We’re lurching through the final steps of familiar territory as the status quo we’ve known for the past near-decade is ending. The mind-mindbogglingly massive central bank stimulus supporting asset prices are disappearing. Interest rates are rising. It’s hard to overemphasize how seismic these changes will be to world markets and the global economy. The coming years are going to be completely different than what society is conditioned for. Time is running short to get prepared. Because when today’s Everything Bubble bursts, the effect will be nothing short of catastrophic as 50 years of excessive debt accumulation suddenly deflates.

A hard rain indeed is gonna fall.

Source: by Chris Martenson | Seeking Alpha

US Budget Deficit Hits $530 Billion In 8 Months, As Spending On Interest Explodes

The US is starting to admit that it has a spending problem.

According to the latest Monthly Treasury Statement, in May, the US collected $217BN in receipts – consisting of $93BN in individual income tax, $103BN in social security and payroll tax, $3BN in corporate tax and $18BN in other taxes and duties- a drop of 9.7% from the $240.4BN collected last March and a clear reversal from the recent increasing trend…

https://www.zerohedge.com/sites/default/files/inline-images/receipts%20may%202018.jpg?itok=rEuJVtdq

… even as Federal spending surged, rising 10.7% from $328.8BN last March to $363.9BN last month.

https://www.zerohedge.com/sites/default/files/inline-images/outlays%20may%202018.jpg?itok=HWulNcBr

… where the money was spent on social security ($83BN), defense ($56BN), Medicare ($53BN), Interest on Debt ($32BN), and Other ($141BN).

https://www.zerohedge.com/sites/default/files/inline-images/MTS%20may%202018.jpg?itok=hsSikeNj(click here for larger image)

The surge in spending led to a May budget deficit of $146.8 billion, above the consensus estimate of $144BN, a swing from a surplus of $214.3 billion in April and far larger than the deficit of $88.4 billion recorded in May of 2017. This was the biggest March budget deficit since the financial crisis.

https://www.zerohedge.com/sites/default/files/inline-images/us%20budget%20deficit%20may%202018.jpg?itok=8rJNKZPj

The May deficit brought the cumulative 2018F budget deficit to over $531bn during the first eight month of the fiscal year; as a reminder the deficit is expect to increase further amid the tax and spending measures, and rise above $1 trillion.

https://www.zerohedge.com/sites/default/files/inline-images/budget%20deficit%206.12.jpg?itok=cziKJhqI

The red ink for May deficit brought the deficit for the year to-date to $532.2 billion. Most Wall Street firms forecast a deficit for fiscal 2018 of about $850 billion, at which point things get… worse. As we showed In a recent report, CBO has also significantly raised its deficit projection over the 2018-2028 period.

https://www.zerohedge.com/sites/default/files/inline-images/2018-04-09_11-13-25.jpg

But while out of control government spending is clearly a concern, an even bigger problem is what happens to not only the US debt, which recently surpassed $21 trillion, but to the interest on that debt, in a time of rising interest rates.

As the following chart shows, US government Interest Payments are already rising rapidly, and just hit an all time high in Q1 2018. 

https://www.zerohedge.com/sites/default/files/inline-images/interest%20expenditures.jpg?itok=BuGbNIs6

Interest costs are increasing due to three factors: an increase in the amount of outstanding debt, higher interest rates and higher inflation. A rise in the inflation rate boosts the upward adjustment to the principal of TIPS, increasing the amount of debt on which the Treasury pays interest. For fiscal 2018 to-date, TIPS’ principal has been increased by boosted by $25.8 billion, an increase of 54.9% over the comparable period in 2017.

The bigger question is with short-term rates still in the mid-1% range, what happens when they reach 3% as the Fed’s dot plot suggests it will?

* * *

In a note released by Goldman after the blowout in the deficit was revealed, the bank once again revised its 2018 deficit forecast higher, and now expect the federal deficit to reach $825bn (4.1% of GDP) in FY2018 and to continue to rise, reaching $1050bn (5.0%) in FY2019, $1125bn (5.4%) in FY2020, and $1250bn (5.5%) in FY2021.

https://www.zerohedge.com/sites/default/files/inline-images/exhibit_1.img%20%284%29.png

Goldman also notes that it expects that on its current financing schedule the Treasury still faces a financing gap of around $300bn in FY2019, rising to around $750bn by FY2021, and will thus need to raise auction sizes substantially over the next couple of years to accommodate higher deficits.

https://www.zerohedge.com/sites/default/files/inline-images/exhibit_3.img%20%283%29.png

What does this mean for interest rates? The bank’s economic team explains:

The increase in Treasury issuance and the ongoing unwind of QE should put upward pressure on long-term interest rates. On issuance, the economic research literature suggests as a rule-of-thumb that a 1pp increase in the deficit/GDP ratio raises 10-year Treasury yields by 10-25bp. Multiplying the midpoint of this range by the roughly 1.5pp increase in the deficit due to the recent tax and spending bills implies a 25bp increase in the 10-year yield. On the Fed’s balance sheet reduction, our estimates suggest that about 40-45bp of upward pressure on the 10-year term premium remains.

And here a problem emerges, because while Goldman claims that “the deficit path is known to markets, but academic research suggests these effects might not be fully priced immediately… the balance sheet normalization plan is known too, but portfolio balance effect models imply that its impact should be gradual” the bank also admits that “the precise timing of these effects is uncertain.”

What this means is that it is quite likely that Treasurys fail to slide until well after they should only to plunge orders of magnitude more than they are expected to, in the process launching the biggest VaR shock in world history, because as a reminder, as of mid-2016, a 1% increase in rates would result in a $2.1 trillion loss to government bond P&L.

https://www.zerohedge.com/sites/default/files/images/user5/imageroot/2016/06/04/bond%20market%20exposure_0.png

Meanwhile, as rates blow out, US debt is expected to keep rising, and somehow hit $30 trillion by 2028

https://www.zerohedge.com/sites/default/files/inline-images/debt%20budget%20trump%202019.jpg

… without launching a debt crisis in the process.

Source: ZeroHedge

Bond Yields And Barbarians

I know Kung Foo, Karate, Bond Yields and forty-seven other dangerous words.

– The Wizard

For forty-four years I have trafficked in the bond markets. I have seen massive inflation, Treasury yields in the stratosphere and risk asset spreads that could barely be included on a chart. At four investment banks I ran Capital Markets, and was on the Board of Directors of those companies, and I have witnessed both extreme anger and one fist fight. It is funny, you know, how people behave when money is sitting there on the table.

One of the things rarely discussed in the Press are the mandates of money managers. Almost no one is unconstrained and virtually everyone is bound by regulations, the tax laws and FINRA and SEC stipulations. Life insurance companies and casualty companies and money managers and Trust Departments and everyone is sidled with something. There are no escapes from the dilemmas.

The markets are a random lottery of meaningless tragedies, a couple of wins and a series of near escapes. So, I sit here and I smoke my cigars, staring raptly at it all. Paying very close attention.

There are two issues, in my mind, to be considered carefully when assessing future interest rates. The first is supply, especially the forward borrowing by the U.S. government. “It’s supply,” Michael Schumacher, head of rate strategy at Wells Fargo (NYSE:WFC), told CNBC’s Futures Now. “When you think about the enormous amount of debt that U.S. Treasury’s got to issue over not just this year, frankly, but next year, it’s staggering,” he said.

Using Michael’s calculations, the Treasury will issue more than $500 billion in notes and bonds in the second to the fourth quarter, pushing the total to around $650 billion for the year. Last year, the total came to just $420 billion. That is approximately a 35% increase in issuance. This raises a fundamental question, who are going to be the buyers and at what levels?

The second issue centers on the Fed and what they might do. They keep calling for rate hikes, like it is a new central bank mantra, and they are increasing the borrowing costs of the nation, corporations and individuals, as a result. I often wonder, in their continual clamor for independence, just who they represent.

You might think that the ongoing demand for higher yields does not exactly help the Treasury’s or the President’s desire to grow the economy as the Fed moves in the opposite direction and tries to slow it down by raising rates. I have often speculated that there might be some private tap on the shoulder, at some point, but no such “tap” seems to have taken place or, if it has occurred, it is certainly being ignored, at least in public.

Here are some interesting questions to ponder:

How much of our U.S. and global growth is real?

How much of it, RIGHT NOW, is still being manufactured by the Fed’s, and the other central banks’, “Pixie Dust” money?

Does the world seem honestly ready to economically walk on its own two feet?

If you answered “No,” to the last question, how do you believe the financial markets will react when they realize that the Central Banks are trying to take away the safety net for the global economies?

Are you really worried about inflation running away from us?

Do you believe that a flat/inverted yield curve has been an accurate predictor of events to come, historically?

Have you run the numbers, can the world’s sovereign nations even afford 4% rates, as predicted by many?

If you answered “No,” do you believe that these nations will suppress yields for as long as they can to push back the “end game?”

Across the pond Reuters states,

Italy’s two anti-establishment parties agreed the basis for a governing accord on Thursday that would slash taxes, ramp up welfare spending and pose the biggest challenge to the European Union since Britain voted to leave the bloc two years ago.

That is quite a strong statement, in my opinion. There are plenty of reasons to be worried about Italy and the European Union now, in my view.

A draft of the accord, reviewed by Reuters, lays out a plan to cut taxes, increase welfare payments and rescind the recent pension reforms. To me, this seems incompatible with the EU’s rules and regulations. These new policies would cost billions of euros and would certainly raise Italy’s debt to GDP ratio, which already stands at approximately 132%.
Reuters also states,

The plan promised to introduce a 15 percent flat tax rate for businesses and two tax rates of 15 and 20 percent for individuals – a reform long promoted by the League. Economists say this would cost well over 50 billion euros in lost revenues.

Ratings agency DBRS has already warned that this new proposal could threaten Italy’s sovereign credit rating. If you have been to Rome, you probably visited the Coliseum. I make an observation today:

The Barbarians are at the Gates!
– Mark J. Grant

Source: by Mark J. Grant | Seeking Alpha

Bond Bear Stops Here: Bill Gross Warns Economy Can’t Support Higher Rates

Having thrown in the towel on his bond bear market call two weeks ago, Janus Henderson’s billionaire bond investor Bill Gross now believes that the most recent bearish bond price (rise in yields) will stop here as the economy cannot support higher yields.

As Gross said two weeks ago, yields won’t see a substantial move from here.

“Supply from the Treasury is a factor in addition to what the Fed might do in terms of a mild, bearish tone for U.S. Treasury bonds,” Gross told Bloomberg TV.

“I would expect the 10-year to basically meander around 2.80 to perhaps 3.10 or 3.15 for the balance of the year. It’s a hibernating bear market, which means the bear is awake but not really growling.”

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-03_7-29-30.jpg

Since then, yields have tested the upper-end of his channel and are breaking out today to their highest since 2011 (10Y)…

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-15_5-48-50_1.jpg?itok=fFNyLeBx

and back to their critical resistance levels (30Y)…

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-15_5-50-55_0.jpg?itok=s6Hc1rhv

And now Gross is out with a pair of tweets (here and here) saying that the record bond shorts should not get too excited here…

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-13_9-26-13.jpg?itok=hqAROAA1

Bill Gross thinks they won’t be right. He highlights the long-term downtrend over the past 30-years, which comes in a 3.22%.

“30yr Tsy long-term downward yield trend line for the past 3 decades now at  3.22%, only ~4bps higher than today’s yield.”

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-15_8-39-58.jpg?itok=aNdSRwTH

“Will 3.22% be broken to upside?” he asks.

“I don’t think so. The economy can’t support yields higher than 3.25% for 30s and 10s, nor 3% for 5s.

Continuing hibernating bond bear market is best forecast.”

Asa ForexLive also notes, if he’s right it doesn’t necessarily mean the US dollar will reverse right away but it would be a good sign for stocks and would limit how far the US dollar might run.

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-15_8-44-38.jpg?itok=MS3UBYGJ

So, will Gross be right? Is this latest spike all rate-locks on upcoming IG issuance? And will this leave speculators with a record short position now wondering who will be the one holding the greatest fool bag by the end of the year…

Well worth your time to hear what geo-economic consultant Martin Armstrong has to say.

Source: ZeroHedge

T-Minus… Prepare For Much Higher Long-Term Rates

It is late.  We have been crunching data for three days, and won’t bore you with too much prose.

We will be back to fill in the blanks in the next few days but will leave you with some nice charts and data to contemplate.  They may help explain why the stock market is trading so poorly even with, what appears, to be stellar earnings.

Determination Of The 10-year Yield

There will be many posts to come on this topic as we believe it is the most critical issue investors need to grapple with and get right over the next year.

What is the right price for the U.S. 10-year Treasury yield?

Moreover,  how is the yield determined, and how has it been distorted over the past 20 years by central banks, both foreign and the Federal Reserve?

What does the future hold?

Capital Flows

We agree that inflation, growth expectations, and other fundamental factors weigh heavily on determining bond yields but we always maintain, first, and foremost,

“asset prices are always and everywhere determined by capital flows.” 

New Issuance,  Foreign, and Fed Flows Into The Treasury Market

The following table illustrates the new issuance of marketable Treasury securities held by the public and net purchases by foreign investors, including central banks, and the Federal Reserve over various periods.

https://www.zerohedge.com/sites/default/files/inline-images/may2_flow-tables.png?itok=3SjVchCQ(larger image)

The data show since the beginning of the century, foreign investors, mainly central banks, and the Federal Reserve net purchase of Treasury securities, those which trade in the secondary market, is equivalent to 60 percent of all new marketable debt issued by the Treasury since 2000.

We do not suggest all these purchases were made directly in Treasury auctions, though many of the foreign buys certainly were.

From 2000-2010, foreign central banks were recycling their massive build of foreign exchange reserves back into the Treasury market.  During this period, the foreign central banks bought the equivalent of 50 percent of the new issuance.  Add foreign private investors and the Fed’s primary open market operations, and the total equated to 70 percent of the debt increase over the period.

Alan Greenspan blames the foreign inflows into the Treasury market during this period for Fed losing control of the yield curve, a major factor and cause of the housing bubble, and not excessively loose monetary policy.

Given the decoupling of monetary policy from long-term mortgage rates, accelerating the path of monetary tightening that the Fed pursued in 2004-2005 could not have “prevented” the housing bubble. – Alan Greenspan, March 2009

Greenspan raised the Fed Funds rate 425 bps from June 2004 to June 2006 and the 10-year barely budged, rising only 52 bps.  More on this later.

Fed Plus Total Foreign Purchases

https://www.zerohedge.com/sites/default/files/inline-images/may2_fed_totalforeign_treasuryborrowings.png?itok=9f8p2oHc(larger image)

https://www.zerohedge.com/sites/default/files/inline-images/may2_fed_cenbank_treasuryborrowings.png?itok=-BvhQgmP(larger image)

During the Fed’s QE period,  2010-2015,  foreign investors and the Fed took down the equivalent of 80 percent of  the new debt issuance.

The charts also illustrate that for several of the 3-month rolling periods, net purchases were significantly higher than 100 percent of new supply, distorting not only the 10-year yield, but the valuation of all other asset prices.

Interest rate repression also cause economic distortions, which have political consequences.  Most notably, wealth and income disparities.

Rapid Technical Deterioration

Since 2015, flows into the Treasury market have deteriorated markedly, and the timing could not be worse as new Treasury issuance is ballooning with skyrocketing budget deficits.

During the past twelve months, for example,  net foreign and Fed flows collapsed to just 17.6 percent of new borrowings.  Even worse, the net flows were negative (we estimated March international flows) during the first quarter during a record new issuance of Treasury securities of almost $500 billion.

Can we say, “Gulp”?

Stock Of Outstanding Treasury Securities

Given the rapidly deteriorating technicals and fundamentals — rising inflation –, we believe the 10-year yield should be and will be much higher sometime soon.

That is we are looking for a “super spike” in bond yields, and expect the 10-year to finish the year between 4-5 percent.   The term premium, which has been repressed due to all of the above,  should begin to normalize.

Why is taking so long?

Aside from the record shorts and natural inertia of markets, the stock of Treasury securities remains favorable, as the bulk is still held by the Fed and foreign central banks, who are not price sensitive.

Debt Stock Shortage,  Debt Flow Surplus 

Ironically,  there remains an artificial shortage of the stock of  Treasuries but now a huge glut in the flow.   See here for a must read.

The Bund And JGB Anchor?

Treasuries are at almost at record spreads on some  maturities vis-à-vis the German bund, and foreigners are on a buying strike as the above data show.

How can an anchor be an anchor if there are no buyers?   One asset arbitrage?

It is also not normal for the 10-year to be trading in such a tight range with a record short position in the futures market.  The average daily move in the VIX has increased from 0.20 percent in 2016, to 1.37 percent in 2017, and shorts are now hardly spooked by a 500 point flop in the Dow.

Something must be going on beneath the earth’s crust.  We have our ideas.

Dollar Strength

The recent dollar strength may be a signal foreigners are getting yield-hungry again, however.   We are not so sure the rally has legs.

Market concerns over the political stability of the U.S may trump yield-seeking for the rest of the year.

How Foreign Flows Contributed To The Housing Bubble

We are not going to spend much time here but we are starting coming around to Mr. Greenspan’s reasoning.  The lack of response of long-term yields to a 425 bps increase in the Fed Funds rate from 2004-2006  greatly contributed to the housing bubble.  The 10-year yield only moved up 52 bps from when the Fed started their tightening to when they paused.

Take a look at the chart.

https://www.zerohedge.com/sites/default/files/inline-images/may2_mortgage-debt_gdp.png?itok=yzXhWh6T

The Fed’s interest rate hikes didn’t even put a dent in the momentum of the housing bubble. Household mortgage debt continued to rise from 60 to 72 percent of GDP from the first interest rate hike before the market collapsed on itself.

Bubbles are hard to pop.

https://www.zerohedge.com/sites/default/files/inline-images/may2_phases-of-housing-bubble1.png?itok=a2Dis-7Z

Why Long-Term Yields Didn’t Respond

Simple.

As, always and everywhere, capital flows or the recycling thereof.

The biggest economic event in the past 25 years, in our opinion, is the exchange rate regime shift that took place in the emerging markets in the late 1990’s.  These countries now refuse to allow their currencies to appreciate in any significant magnitude as the result of capital inflows.

They learned some hard lessons in the mid-1990’s with Mexican Peso and Asian Financial Crisis, and the Russian Debt Default.

Balance of payments surpluses are now reconciled with dirty float currency regimes, where central banks intermittently intervene if their currency becomes too strong.

The result was a massive build of global currency reserves, much of which were recycled back into the U.S. Treasury market in the mid-2000’s.

https://www.zerohedge.com/sites/default/files/inline-images/may2_cenbank_treasury_purchases.png?itok=imSym7al(larger image)

The chart illustrates that foreign central bank net purchases of Treasury securities, alone, were equivalent to the over 66 percent of net Treasury issuance during the Fed 2004-2006 tightening cycle.

International  Reserves Drive Gold

The gold price also ramped with international reserves during this period.

We believe the global monetary base, mainly international reserves,  is the main driver of gold.  See here.

Reserves have not been growing witness the punk trading range in gold.  This may change as the U.S. current account blows out again.

https://www.zerohedge.com/sites/default/files/inline-images/gold-and-monetary-base.jpg?itok=USqHmoCM(larger image)

Current Account And Trade Deficits

The Mnuchin crowd are wasting their time in China trying to negotiate lower trade deficits.  Trade deficits are the result of internal imbalances where investment exceeds savings.  See here for another must read.

Introducing trade distortions to artificially lower the external deficit will only accelerate stagflaton, which is already starting to take hold.  Then we will all be worse off.   See here.

Besides, where is Mr. Mnuchin going to obtain the financing for his proliferating budget deficits if his goal is to run trade surplus or balances with our trading partners?

We are all for better terms of trade and protecting are intellectual property rights,  but know and understand thy national income accounting before starting trade wars.

Upshot

We have laid out why we believe, and we could be wrong, long-term yields are unlikely to behave as they did during the last monetary tightening.   That is the a further collapse in Treasury term premia and a yield curve inversion until something breaks.

Unless the U.S. blows up its current account again,  credit expansion accelerates significantly, creating another blast of capital flows into the emerging markets, to be recycled back to the U.S,,  the foreign and Fed financing of the U.S. budget deficit is over.  Punto!

We are preparing for a significant move higher in bond yields.

What Is The Right Real Yield?

Do you really think with the deteriorating flows in the bond market, coupled with rising inflation warrant a 0.5 percent real 10-year yield?

Au contraire!   We believe a 2-3 percent real yield is closer to fair value.

Tack on another 2.5 percent for inflation,  generous as shortages seem to be breaking out everywhere,  and that gets the 10-year to at least 4 1/2 percent.

Timing

A little CYA.   Yields could move a little lower, maybe to 2.80 percent (a stretch),  given the dollar strength as Europe slows, and shorts get spooked.

Our suspicions, however, it is going to be a hot summer.  Higher interest rates and lower stock prices.

Disclaimer

Now let us add our disclaimer.

Even if all our facts are correct,  our conclusions may be completely wrong.

If you have been reading the Global Macro Monitor over the years, you have probably seen it several times.

To illustrate our point, we like to tell the story Abraham Lincoln used to persuade juries when he was an Illinois circuit court lawyer.

The story goes that Lawyer Lincoln was worried he had not convinced the jury during the closing argument of a civil case against a railroad.   The jurors had gone to lunch to deliberate.  Lincoln followed them and interrupted their dessert with a story about a farmer’s son gripped by panic,

“Pa, Pa, the hired man and sis are in the hay mow and she’s lifting up her skirt and he’s letting down his pants and they’re a fixin’ to pee on the hay.” “Son, you got your facts absolutely right, but you’re drawing the wrong conclusion.”

The jury ruled in Lincoln’s favor.

Stay Frosty, Oscar Mike!

Source: ZeroHedge

“How Wrong I Was, My Reputation For Calling Stocks Is In Tatters”

SocGen’s permabear skeptic Albert Edwards is best known for one thing: predicting that the financial world will end in a deflationary singularity, one which will send yields in the US deep in the negative, and which he first dubbed two decades ago as the “Ice Age.” He is also known for casually and periodically forecasting – as he did a few weeks ago in an interview with Barrons – that the S&P will suffer a historic crash, one which will send it back under the March 2009 low of 666.

In this context, a couple of recent events caught Edwards’ attention.

First, speaking of the above mentioned Barron’s interview, Edwards was taken aback by one commentator who took the SocGen strategist to task for his relentless bearishness. Indirectly responding to the reader, in his latest letter to clients Edwards writes that “it’s good to have a little humility in this business because it’s so darn humiliating when forecasts are proved wrong. And the bolder the forecast, the more humiliating it is!” He continues:

That is one reason why most commentators on the sell-side never stray too far from consensus. When I was an avid consumer of sell-side research some 30 years ago, there was one  thing about the macro sell-side that I truly marvelled at – namely the analysts’ ability to totally reverse a view and pretend that had been their view all along! In the days before the internet and email, I had to rifle through our storage cupboards to find the evidence of what were often 180 degree handbrake turns. In the internet age, there is no hiding any more. 

One of the most leveling experiences at the end of an article or interview about my thoughts is to scroll down and read some of the readers’ comments. In my case, they often marvel that I am still in any sort of employment at all! Some are witty and make me smile -– like the one below in response to a recent interview I did with Barron’s.

Edwards refers to the comment titled “‘Prescient as a Broken Clock?” authored by one Gordon Gould from Boulder, Colorado who writes:

“Barron’s notes that Société Générale’s Albert Edwards is a permabear (“S&P 500 Could Still Test 2009 Lows,” Interview, April 7). However, your readers would surely like to know how some of his previous calls have turned out. A quick Google search revealed that nearly five years ago, Edwards called for the Standard & Poor’s 500 index to hit 450 and gold to exceed $10,000. While even a broken clock is correct twice a day, perhaps in Edwards’ case, we’re talking about a broken calendar on Saturn, which takes about 29 years to orbit the sun.”

Albert summarizes his response to this comment eloquently, using just one word: “ouch.” Hit to his pride aside, Albert asks rhetorically “Where did it all go so wrong?” and explains that in the Barron’s interview, “I explain why in my Ice Age thesis I still expect US equity prices to fall to new lows in the next recession.” To be sure, this is familiar to ZH readers, as we highlight every incremental piece from Edwards, because no matter if one agrees or disagrees, he always provides the factual backing to justify his outlook, gloomy as it may be. 

He explains as much:

I always expected the equity market’s day of reckoning to come in a recession with equity valuations falling to lower lows than in the two previous cyclical bear market bottoms in 2001 and 2009. If I am right, the next recession will see a lower level than the forward PE of 10.5x in March 2009. A forward PE of 7x and a 30% decline in forward earnings would take the market to new lows as part of a long-term secular valuation bear market (which began in 2001). Then the stratospheric rise in the market over the past few years will be seen as just a temporary aberration fuelled by QE.

The moment of truth for my strategic Ice Age view will come when we know how far the equity bear market will fall in the next recession, or conversely whether the bond bull market will continue with 10y US yields, for example, falling into negative territory.

And yet, here we are a decade into central planning, and global stocks are just shy of all time highs. How come?

If I were to identify the major error that led me to be too bearish on equities, it would not be the inflationary impact of QE on asset prices. What I got wrong is that after the end of the Great Moderation, which saw an extended period of economic expansion from Dec 2001 to Dec 2007 – as well as low financial volatility, triggering rampant credit growth – I expected economic volatility to return to normal. The lesson from Japan I told clients was that once their Great Moderation died in 1990, the economic cycle returned to normal amplitude as private credit growth could no longer be induced to keep it going. Thus I expected that after the 2008 economic debacle the US economic cycle would return to normality and for recessions to become much more frequent events – as they were in Japan after 1990. And as in Japan, I expected each rapidly arriving recession would take equity valuations down to new lower lows. After 2008, I expected the US economic recovery to quickly fall back into recession and the cyclical bull run in equities to be surprisingly short-lived. How wrong I was!

Indeed, because as Bank of America observed recently, every time the stock market threatened to tumble, central banks would step in: that, if anything, is what Edwards failed to anticipate. The rest is merely noise:

Despite the economy flirting with outright recession on a couple of occasions, this current recovery has endured to the point where we now have enjoyed the second longest economic cycle in US history. We have not returned to ‘normal’ economic cycles as I had expected. QE has helped this, one of the most feeble economic recoveries in history, to also hobble into the record books for its length!

To be sure, Edwards will eventually get the last laugh as the constant, artificial interventions assure that the (final) crash will be unlike anything ever experienced: “a recession delayed is ultimately a recession deepened as more and more credit excesses have built up, Minsky-like, in the system.”

Then again, will it be worth having a final laugh if the S&P is hovering near zero, the fiat system has been crushed, modern economics discredited, and life as we know it overturned? We’ll cross that bridge when we come to it, for now however, Edwards has to bear the cross of his own forecasting indignities:

… having stepped away from the crazed run-up in equity prices, my reputation for calling the equity market correctly has been severely dented, if it is not actually in tatters. I know that.

Still, it’s not just Edwards. As the strategist notes, increasingly wiser heads than I, who did not leave the equity party early, are suggesting a top might be close. He then goes on to quote Mark Mobious who we first referenced earlier this week:

The renowned investor Mark Mobius is also getting nervous. The Financial Express reports that “After Jim Rogers recently warned of the ‘biggest crash in our lifetimes,’ veteran investor and emerging markets champion Mark Mobius warns of a severe stock market correction. “I can see a 30% drop. The market looks to me to be waiting for a trigger to tumble.” He then goes on in the article to cite some possible triggers.

To be fair, there are plenty of others who have recently and not so recently joined Edwards in the increasingly bearish camp (among them not only billionaire traders but economists and pundits like David Rosenberg and John Authers), although one thing missing so far has been the catalyst that will push the world out of its centrally-planned hypnosis and into outright chaos. Now, Edwards believes that this all important trigger has finally emerged:

Perhaps the greatest near-term threat to the stability of the equity markets is seen as the recent surge in bond yields, which are now testing the critical 3% technical level.

https://www.zerohedge.com/sites/default/files/inline-images/edwards%20breach%203.jpg?itok=zXmjbaG5

As this is so important, I want to repeat verbatim what our own Stephanie