August 26, 2019
But by Monday afternoon, things are looking relatively calm.
What happened?
The news of the day, attributed to the calmer tone, was some ambiguous commentary on China trade negotiations. But it probably had as much to do with the call out to the banks that the President and Treasury Secretary made about 10 days ago (to “assure normal market operations”). And with a meeting that Trump had with Abe over the weekend, the leader of Japan and the commander of biggest and boldest QE program left in existence (within which, is a mandate to outright buy stocks).
With that, both the U.S. banks and the Bank of Japan were likely the stewards of global financial market stability overnight (i.e. the plunge protection team).
Of course, U.S. stocks remain an important barometer of global economic sentiment. And, on that note, we start the week with what seems to be a healthier head-space than we ended last week (with stocks about 5% off of all-time highs, despite some very ugly risks).
But two spots will be key to watch, for signals on whether the mood might be calming: 1) The Chinese yuan traded to another 11-year low overnight. The weaker the PBOC sets the yuan, the more aggressive retaliation signal they send to Trump. And 2) The U.S. yield curve (10-year/2-year) inverted just briefly a couple of weeks ago (fueling recession talk). Today, it was inverted much of the trading day.
August 23, 2019
It didn't seem to alter the message. It was a very carefully crafted speech, but not exactly what the market was hoping to force.
In his 12-page speech, the Fed did NOT give the market (nor the President) the signal that they were planning the type of easing assault we are seeing at other central banks in the world.
But he did make the comparison to the 1994-1995 period.
Importantly, Powell described the mid-90s Fed cuts as a “response to threats to growth,” but not a change in the rate cycle. This almost looks like a double-down on his “mid-cycle” cut comment in July. That didn’t go over well.
Bottom line: They will keep tactically cutting rates until the geopolitical risks pass (namely the trade war).
Now, with China's retaliatory threats this morning, and a Fed that didn't brandish a monetary policy bazooka, Trump wasn't happy.
He responded with this …
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The question everyone should be asking: Is this tweet, threatening to deal with "a very strong dollar," a signal that a dollar devaluation is coming?
Remember, we talked about the prospects of a Plaza Accord 2.0 earlier this summer. Here's an excerpt from my June note … "There are a lot of similarities between the U.S/China standoff and that of U.S. and Japan in the 1980s. That was ended with the "Plaza Accord" — an agreement between the U.S., Japan, Germany, England and France. The Plaza Accord was a plan to balance global trade, through a 50% depreciation of the dollar (vs. the yen and d-mark).
… we may wake up one day and find a similar agreement has been made between the U.S. and major global trading partners (which may include China, or not). It might be a deal between the U.S. and China to “revalue” the yuan (i.e. strengthen it). Or it may exclude China (just G3 economies). With the behavior in markets the past few days, it smells like something is cooking."
So, what happened to stocks, following the '85 currency agreement? Stocks rallied about 15% into the end of the year in 1985, following the deal. Stocks were up 16% in 1986, and rose as much as 40% year-to-date in 1087, prior to the October crash. Gold rose close to 60% of the next two years.
August 23, 2019 Throughout the post-financial crisis era, there have been some major policy signals given from the Fed at the Kansas City Fed's annual economic symposium in Jackson Hole.
Tomorrow will be another big one. Jay Powell will need to deliver a message that shows a clear willingness to ease more aggressively, even if it appears to be a pre-emptive strike on an economy that is currently doing fine. Inflation is soft. And we have growing prospects (in the past month) of an indefinite U.S./China trade war. The Fed has room (the interest rate market thinks a lot of room) to be positioned more aggressively. If we get these signals from Powell tomorrow, stocks should be on their way to a very big year (similar to 1995). And with the aggressive positioning from global central banks in the past month, including signals from the ECB that they will restart QE next month, gold should (continue to) be among the biggest winners by year end. As we head into tomorrow's big event the S&P 500 is up 16.5% year-to-date. Gold is up almost 18% (ytd).
August 21, 2019 That stock market fallout in December, led to a response from the U.S. Treasury. Mnuchin (Treasury Secretary) called out to major banks and the President's Working Group on Financial Markets (which includes the Fed) to "coordinate efforts to assure normal market operations."
That was the turning point. That put a bottom in stocks. Within days of that, the three most powerful central bankers of the past ten years (Bernanke, Yellen and Powell) were backtracking on the Fed's rate path — signaling a pause. The Fed's pivot fueled a V-shaped recovery in stocks, and by July stocks were on new record highs. But then we had another mis-step by the Fed (calling the July rate cut, just a "mid-cycle adjustment"). And, shortly thereafter, Trump escalated the trade war with China, sending the signal that China has turned its back on the prospects of a deal, opting to wait it out until the 2020 elections. Yields plunged. More global government bond yields have gone negative. The yield curve inverted. And the chatter recession and crisis has quickly returned. With that, last Wednesday morning, stocks were having the worst day of 2019, and the set-up across global financial markets was beginning to look very vulnerable to a melt-down. Once again, the major banks were summoned. Mnuchin and the President had what appears to be an emergency call with the heads of the top three banks (Citibank, JP Morgan and Bank of America). By the afternoon, stocks had stabilized. And any selling pressure in the major U.S. stock indices, have since been met with a persistent bid (i.e. large indiscriminate buying). The “Plunge Protection Team” appears to be at work. This sets up for the Fed to do a repeat of the early January repentance. On Friday, Jay Powell will be making a speech at the Kansas City Fed’s annual economic policy symposium at Jackson Hole. If he does indeed telegraph the aggressive easing that the markets are asking for (if not forcing), stocks should take off (i.e. a resumption of what has been a big year for stocks).
August 20, 2019 Within the "deregulation" pillar of Trumponomics, dialing back the Volcker rule has been one. The Volcker Rule, under the Dodd-Frank Act was the post-financial crisis response to proprietary trading at the big Wall Street banks.
They banned it. And that has had major consequences for the liquidity that banks used to provide in global markets. Hence, that is, in part, why the swings in markets have become so violent (post-financial crisis). Of course (related), it has also damaged their, historically, very profitable market making businesses (which is classified as "trading revenue"). The line of managing the risk of market making activities and speculative trading, by the big banks, is a blurry one. And the Volcker Rule put the burden on the banks to prove that their trading activity is against their market making activity. That weakened the market making businesses of the banks and increased compliance costs. And the major Wall Street banks haven't been the same since. If we look at the five largest investment banks, the total revenue from fixed income, commodities and currency trading at banks has been cut in half since 2009. Today, two of the five bank regulators approved revisions to the Volcker Rule that soften that scrutinty on bank market making activity. This is a big step in a process that could unlock tremendous pent-up value in bank stocks.
August 19, 2019 The most important news last week, didn't come from the President's twitter account. It didn't come from China. It came from the mouth of an ECB governing council member.
Olli Rehn, voting ECB member and the central bank head of Finland, was vying for the head job at the ECB earlier this year. He didn't get it. It went to the IMF chief, Cristine Lagarde. Last week, Rehn laid the groundwork for the ECB to roll out another big stimulus round in September.
Remember, as we discussed last week, the catalyst for the melt-down in global bond markets was the one-two punch from the ECB and the Fed back in December. The ECB officially quit QE. Days later, the Fed hiked again, into an ugly decline in the stock markets, and, moreover, Jay Powell said their quantitative tightening program was on “auto-pilot.” This sent a clear message/reality check to markets that (at least a portion of) the $14+ trillion in global liquidity that the big three central banks have pumped into the world — that promoted stability and little to no inflation – was getting sucked out. With that, we now have the ECB, importantly, heading back to the QE business. And it may involve outright buying stocks. Let's take a look at how that might impact German stocks. As you can see in the chart below, the DAX remains 14% from the record highs that were made in early 2018 (German stocks have been in drawdown for 17 months) … |
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The Bank of Japan has been in the business of buying Japanese stocks for a long time. But under the Abe plan, it has become a key tool in the massive QQE program at the Bank of Japan since 2013. With the BOJ involved in stocks, it reduces the risk premium in the stock market. And in a world of zero interest rates, the lower risk in stocks is an incentive for capital to chase the higher potential returns of stocks. The idea is that it ultimately drives demand and inflation in the economy.
How has it worked out for Japanese stock prices? Here's a look at the chart … |
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As you can see in the chart, the Japanese stock market has doubled since the BOJ started in 2013. During the same period, U.S. stocks have about doubled too (not unrelated).
But after six years of outright buying ETFs, the BOJ is now the top shareholder in 55 of the 225 companies in the Nikkei 225. And they own more than 75% of the Japanese ETF market. It has worked for stock market investors. But many would argue it hasn't worked for the economy. Growth in Japan has run about 1% annualized over the period. And inflation, a little less. But Japan's asset purchases (including stocks) have been a big contributor to what has been feeble global economic recovery, rather than a global depression. We will see next month if Europe has been forced to follow Japan’s lead (buying stocks). If you haven't signed up for my Billionaire's Portfolio, join now — get your risk free access here.
August 16, 2019 Yesterday, we talked about the one-two punch from the Fed and ECB last December, that set up for a global liquidity shock.
Let's take a look closer today … As we know, the Fed went on a three year monetary policy "normalization campaign." But the view from the Fed proved premature. After an initial hike in late 2015, the global economy found trouble again. And by early 2016, the Fed was forced to stand-down. They didn't hike again until Trump was elected, and the prospects of aggressive pro-growth policies were coming down the pike. Leaning against those policies, the Fed hiked another 200 basis points over 25 months. And at the beginning of 2018, they began "quantitative tightening" (i.e. shrinking their balance sheet). Since January of last year, the Fed has removed $642 billion from the global economy. Meanwhile, the BOJ was continuing to pump about $25 billion a month into the global economy. And the ECB was good for about $20 billion. The ECB and the BOJ not only served as the offset to QT, but they combined to represented a buffer against shocks to the global economy (still in 'do whatever it takes' mode). But the balance sheet of the three most powerful central banks in the world peaked in August of last year. And then the ECB quit QE in December. |
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With that, as you can see in the chart above, the liquidity provided by QE has been on the decline. But maybe most importantly, is the potential (if not noticeable) shock to the system created by the "rate of change." In combination the three most powerful central banks had been pumping liquidity into the global economy at a double-digit rate throughout the post-crisis period. Now we have a negative rate of change.
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This seems to be what is sending global bond markets haywire. And appears to have forced the ECB to reverse course. Yesterday, an ECB official said they need to announce a significant easing package at their September meeting.
If you haven't signed up for my Billionaire's Portfolio, join now — get your risk free access here.
August 15, 2019 The move in global bond yields (market interest rates) continue to plunge today.
The U.S. 10 year broke 1.50%. German 10-year yields traded to (again) new record lows of negative 70 basis points. You can see in the chart below that this move in yields is triggering global capital flows into gold. |
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Interestingly, while we have geopolitical chaos dominating the news wires everyday, if we look back at the month of December, we may find the real driver of this blood-bath in yields. It's the reality that the major central banks (led by the Fed) were too aggressive in moving away from emergency level policy.
On December 13th, the ECB officially ended QE (its nearly $3 trillion bond buying program). German yields were 30 basis points that day. And we have not seen that level since. Now German yields are 100 basis points lower (and in negative territory). A few days later, with the ECB now out of the QE business, the Fed made yet another rate hike and told us all that their quantitative tightening program was on “automatic pilot.” The U.S. 10-year yield was trading 2.86% that day. We haven't seen that level since. The 10-year yield has now been cut in half. That one-two punch from the Fed and ECB was a toxic cocktail (in the, still, fragile post financial crisis environment) that meant a massive and rapid global liquidity withdrawal was underway (and that a very important shock absorber — the ECB — has exited the game). If you bought gold the day the Fed's December rate hike, you've never been underwater. It's up 24%. This is global capital exchanging paper currency for hard currency, foreseeing more money printing. Gold is being revalued to global paper currencies – which should ultimately translate into higher broader commodities prices (not just gold). If you haven't signed up for my Billionaire's Portfolio, join now — get your risk free access here.
August 14, 2019 Yesterday we looked the chart of the 10-year yield, which was disconnected from the brief risk-reprieve that came from the hope that was re-introduced into the trade dispute picture.
As I said, the 10-year yield will be key to watch, for a guide on how far stocks can recovery without more progress made on the trade deal front. Now we know. It wasn't far. After some soft date in China overnight, and a GDP reading in Germany that confirmed a contraction last quarter, global bond yields took a dive. German yields trade to new record lows (deeper into negative yield territory). And the 2-year to 10-year U.S. yield curve inverted. This was news of the day, but there have been few things better telegraphed than a U.S. yield curve inversion. The 3-month to 10-year yield curve has been inverted, for the most part, since May. The chart below shows the 10-year yield minus the yield on the 3-month treasury bill … |
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When the 10-year is paying you less than you could earn holding a short term T-bill, the yield curve is said to be inverted. And this dynamic has predicted the past seven recessions. Why? Because it typically will be driven by a tighter credit environment, namely banks become less enthused about borrowing in the form of short term loans, to lend that money out in longer term loans. Money dries up. Unemployment goes up. Demand dries up. Economy dips.
So, are we seeing a tighter credit environment? No. Below is the Fed's measure of financial conditions. |
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Positive values (above the black line) indicate financial conditions that are tighter than average. Negative values indicate financial conditions are looser than average. Financial conditions are not a threat.
But we may see financial conditions tighten, if the stalemate on a trade deal continues for much longer. We're seeing market sentiment beginning to crack. An erosion in confidence can ultimately spill over into economic activity. And that can and will tighten financial conditions. So, this uncertainty is all about trade. Where do we stand on trade? As of yesterday, Trump walked back on the magnitude of the September tariff escalation. But today, Peter Navarro said they can't meet China half way. As we've discussed, the longer this plays out the more leverage Trump loses to get any deal done (i.e. the more likely it is that China holds out through the election). Given the fragility in global markets, the timeline isn't working in the favor of Trump at the moment. That puts the Fed in focus, as a potential Fed rate cut could provide some stability for markets. With the next meeting scheduled for September 18th, I would say, if we have another day or two like today, an intermeeting cut is not out of the question. If you haven't signed up for my Billionaire's Portfolio, join now — get your risk free access here.
August 13, 2019 Yesterday we talked about the converging of geopolitical storms.
But as we discussed, the linchpin remains U.S./China trade (i.e. this standoff is what matters). Why? If we get a deal, we have the ingredients for an economic boom-period. And economic prosperity can solve a lot of problems (i.e. to reduce or even resolve risks elsewhere in the world). On the other hand, the longer it drags out, the more damaging it becomes to the global economy, and the less likely we see a deal. That path leads to very ugly outcomes (puts economic depression and global war in play). Given the significance of this binary outcome, we talked yesterday about the prospects of seeing movement on the U.S./China trade front in the next week or so. The prospects were slim. Chinese political leaders are convening at their annual seaside policy strategy summit. But what did we get today? We got movement. The movement was modest. But with a phone call, and some U.S. walk-back, the market view on a U.S./China trade deal went from a “maybe no deal happens,” to “maybe a deal happens.” The break of this stalemate is reported to have been pursued by Trump. That seems obvious, given how fragile markets looked coming into the morning. So, with a positive China headline, we had a sharp bounce in stocks, and a sharp decline in gold, which fell from new-six year highs made overnight. What didn’t race back so aggressively? Yields. German 10-year yields traded to new record lows, and closed near the lows. U.S. yields traded up 10 basis points, but remain 37 basis points off of the highs of August 1, when Trump ramped up the threats with this tweet … |
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This chart will be key to watch, for a guide on how far stocks can recover without more progress made on the trade deal front.
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