Back Stories for the Week
TOPICS: ·National Security Threats·The Fed·Traditional Technical Market Research·U S Dollar
RELEVANCE: ·bad·good·not sure
Last night, when we previewed Germany’s sale this morning of what would be the world’s first ultra-long (30 Year) auction with a negative yield, we said that "traders will closely following the oversubscription rate on the sale, which neared a record low in the July after falling for the last three auctions." And sure enough that turned out to be a rather thorny issue as the bond sale was […]
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Last night, when we previewed Germany's sale this morning of what would be the world's first ultra-long (30 Year) auction with a negative yield, we said that "traders will closely following the oversubscription rate on the sale, which neared a record low in the July after falling for the last three auctions." And sure enough that turned out to be a rather thorny issue as the bond sale was technically a failure.
Here's what happened: on Wednesday morning, with its entire yield curve below zero and the yield on the 30Y auction assured to be below zero, a reflection of dwindling expectations for inflation and growth over the coming years and ahead of the ECB's relaunch of QE next month - Germany was hoping to sell some €2 billion in bonds maturing 2050. However, with bond yields rising sharply into the auction, with the yield on the German 30Y rising from -0.18% to as high as -0.10%, demand suddenly slumped.
And so, when the dust settled, it turned out that Germany had managed to sell just €824 million of the total €2 billion target at a record low yield of -0.11%, with the Bundesbank forced to retain almost two-thirds of the entire issue as demand plunged. In other words, this was basically a failed auction.
Thanks to the central bank's intervention, the bid-to-cover ratio was just barely above one, or 1.05 times, versus 1.07 times for the previous sale of similar maturity bonds on July 17, while the real subscription rate - which accounts for retentions by the Bundesbank - fell to 0.43 times against 0.86 times at the previous auction. Anything below 1 indicates that there is no real market demand for the entire issuje.
“It is technically a failed auction,” said Jens Peter Sorensen, chief analyst at Danske Bank AS. “I am not all worried about this -- as investors can always just buy in the future and do not need to participate in auctions.”
He may not be worried, but the optics are certainly not pleasant. Worse, it means that a disconnect may be forming between the primary (auction) and secondary market, where foreign investors are willing to send yields to record lows in the open market but stay quiet at auction, resulting in a potential air pocket between market and auction prices.
As Bloomberg adds, Commerzbank AG had expected demand to come from life insurers and macro investors before the sale. It failed to materialize.
Which begs the question: will this mini buyers strike for the historic auction be the catalyst that sends yields sharply higher? So far, it has not - despite the poor demand, the yield on the bonds dropped as low as -.13% after the auction, and was trading at -.117% last, suggesting that buyers are less worried about the failure and more worried about what happens to the European economy in the future.
The White House/Flickr Despite all of the evidence to the contrary, Donald Trump claims that he doesn’t have a racist bone in his body. Meanwhile, his enablers blame the rise in white supremacist terrorism on liberals. When charges that the president is racist reach a crescendo, it is almost always over something he has said (or tweeted), like telling four congresswomen of color that they should “go back” to […]
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When charges that the president is racist reach a crescendo, it is almost always over something he has said (or tweeted), like telling four congresswomen of color that they should “go back” to the countries they “originally came from.” (Three of the four American legislators were born in the U.S.) But Trump doesn’t just say racist things, he regularly demonstrates it with his actions. For example, last Thursday, he nominated Steven Menashi to serve on the United States Court of Appeals for the Second Circuit.
According to Menashi’s biography, he graduated from Stanford Law School, clerked for Supreme Court Justice Samuel Alito, served as acting general counsel in Betsy DeVos’s Department of Education, and then became a senior associate counsel in Trump’s White House.
The day after Menashi’s nomination was announced, Rachel Maddow did a segment about him, revealing something that didn’t tend to show up in the summaries about his background. She focused most of her attention on a paper written by Menashi titled, “Ethnonationalism and Liberal Democracy.” Here is one of the quotes she highlighted.
Democratic self-government depends on national fellow-feeling: the capacity of citizens to identify with each other, to respect their competing political claims, and to trust that others will do the same.
Ethnic ties provide the groundwork for social trust and political solidarity and, universalist aspirations notwithstanding, continue to do so. At the same time, social scientists have found that greater ethnic heterogeneity is associated with lower social trust. Ethnically heterogeneous societies exhibit less political and civic engagement, less effective governing institutions, and fewer public goods. The sociologist Robert Putnam has concluded that greater ethnic diversity weakens social solidarity, fosters social isolation, and inhibits social capital…
These findings confirm that the solidarity underlying democratic polities rests in large part on ethnic identification.
Menashi’s defenders, like Ed Whelan, have gone after Maddow, claiming that she mislead her audience by not acknowledging that he was talking specifically about Israel.
Menashi’s specific purpose in the article is to refute claims that “Israel’s particularistic identity—its desire to serve as a homeland for the Jewish people—contradicts principles of universalism and equality upon which liberal democracy supposedly rests.”
But this is how Menashi himself concluded his article.
Identification with a particular national group is a commonplace of liberal democracy. As the experience of Israel illustrates, the achievement of human rights depends on national self- determination…As globalization disrupts the coincidence of ethnic demography and political boundaries, the ethnonational identification of liberal democratic states is becoming more, not less, significant. International law and practice acknowledge national self-determination as a fundament of democracy. Liberal democracy requires a national community if it is to become more than an ineffectual abstraction.
In other words, Menashi was using Israel as an example of how liberal democracies must maintain their “national community.”
Whelan further argues that ethnonationalism doesn’t mean what you think it does.
What matters for national identity, Menashi emphasizes—quoting John Stuart Mill—is that a people are “united among themselves by common sympathies which do not exist between them and any others, which make them cooperate with each other more willingly than with other people, [and] desire to be under the same government.” That—and not race—is clearly what Menashi means by his broader concept of ethnic, or “ethnocultural” or ethnonational, identification.
Frankly, that is a bunch of gobbledygook. If we think about the United States, what are the “common sympathies” that exist among its citizens, but are not shared with any others? If it includes a commitment to democratic self-governance, there are (thankfully) countries all over the world who share that in common with us. Besides, if “common sympathies” is what Menashi was referring to, he wouldn’t have needed to include the prefix “ethno” to the word “national.” One need only look up the word ethnonationalism in the dictionary to be clear about what it means: “A type of nationalism which defines the nation in terms of a shared ethnicity.”
Menashi ends his paper by writing, “Liberal democracy requires a national community if it is to become more than an ineffectual abstraction.” Tucker Carlson, a favorite among white supremacists, seemed to make a similar point when he challenged the notion that diversity is our strength.
How, precisely, is diversity our strength? Since you’ve made this our new national motto, please be specific as you explain it. Can you think, for example, of other institutions such as, I don’t know, marriage or military units in which the less people have in common, the more cohesive they are?
Do you get along better with your neighbors, your co-workers if you can’t understand each other or share no common values? Please be honest as you answer this question.
First of all, let’s be clear that study after study after study after study has endorsed the value of diversity in organizations. Secondly, it is a lie to suggest that people of different ethnicities share no common values. People are complex, and so there are both a host of differences as well as commonalities across ethnic lines. For example, one area that highlights our differences is religion. And yet, no matter how diverse, they all share one thing in common.
It is in going beyond our differences to identify those commonalities that we find our humanity—and our strength. Of course, what really confuses people like Menashi and Carlson is the possibility that we will expand our moral imagination. Here is Barack Obama giving the commencement address at Howard University in 2016.
We must expand our moral imaginations to understand and empathize with all people who are struggling, not just black folks who are struggling — the refugee, the immigrant, the rural poor, the transgender person, and yes, the middle-aged white guy who you may think has all the advantages, but over the last several decades has seen his world upended by economic and cultural and technological change, and feels powerless to stop it. You got to get in his head, too.
Rather than building our efforts on the ethnonationalism of white supremacists, that is how we form a more perfect union.
Yesterday’s market selloff is a distant memory this morning, with US equity futures sharply higher tracking European stocks which rose as much as 1%, and ignoring earlier weakness in Asian markets as hopes for more monetary and fiscal stimulus helped ease fears about global recession, political turmoil in Italy and endless trade wars. Treasury yields ticked higher after retreating Tuesday, while the sharp move higher in German 30Y bonds […]
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Yesterday's market selloff is a distant memory this morning, with US equity futures sharply higher tracking European stocks which rose as much as 1%, and ignoring earlier weakness in Asian markets as hopes for more monetary and fiscal stimulus helped ease fears about global recession, political turmoil in Italy and endless trade wars. Treasury yields ticked higher after retreating Tuesday, while the sharp move higher in German 30Y bonds resulted in the failure of a much anticipated 30Y bond auction with a negative yield, a historic first.
Still, with key Fed announcements looming, in the form of today's FOMC minutes and Friday's Jackson Hole meeting, volumes subdued. The Euro STOXX 600 was 0.8% higher, rising earlier as much as 1.1%, while the FTSE MIB rises as much as 1.8% following a rout on Tuesday after the resignation of Italian Prime Minister Giuseppe Conte. The Stoxx autos sector index lead gains, up 2.2%, with Renault surging 4.2% and Fiat Chrysler up 4% after Italian daily Il Sole 24 Ore cited people familiar with the matter as saying the carmakers remain in contact on potential tie-up after publicly abandoning efforts. That put the STOXX 600 Autos Index on track for its best day in a month.
GEA Group, a German food-processing-machinery company, and outsourcing group Capita gained more than 5% after Goldman Sachs upgraded its rating on the stocks.
Asian stocks were fractionally lower, with Japanese and Australian stocks down, while shares rose in Hong Kong and Seoul and were little changed in Shanghai. Chinese shares were effectively unchanged even though the yuan rose for the first time a week after a "friendly fix" by the central bank which set the daily reference rate slightly stronger than expected, and higher than yesterday. After a “market-friendly fixing,” the bias has been to sell dollars Wednesday morning, Stephen Innes, managing director for VM Markets Ltd. in Singapore, wrote in a note. “With small volumes going through, it’s beginning to feel more like your typical August as the markets don’t seem to have much of an axe to grind one way or the other.” Innes added that there’s some pre-risk event position-squaring ahead of PMI data and Federal Reserve Chairman Jerome Powell’s speech in Jackson Hole later this week. “We could be back in the frying pan quickly if the yield curve inverts or Jay Powell reiterates his mid-cycle view of things,” he wrote.
The yield on 10-year government bonds edged higher for a second day, hitting its highest in two weeks. Treasuries underperformed bunds and gilts, while German bonds pared declines after the country sells new 30-year debt at negative yields for the first time. Italian bonds rise amid optimism that fresh elections will be averted. Bunds trimed declines as 30-year sale sees underbidding of 6c and tail of 3c; these are similar to the July sale of benchmark long bond that met underbidding of 5c and tail of 1c; this is even as oversubscription falls on Wednesday to 1.05x from 1.07x prior and is technically undersubscribed at 0.43x versus 0.86x previously after accounting for retentions.
Italian bond yields steadied after falling on Tuesday, as Italian President Sergio Mattarella begins two days of talks that will lead either to formation of the country’s 67th government since World War Two or to early elections.
Investors will be watching policy makers and world leaders as they convene at the latest G7 meeting to consider the weakest global growth since the financial crisis. The Group of Seven leaders, with Trump among them, will gather in France from the weekend as the ECB prepares to cut interest rate.
And while the Fed minutes due Wednesday may provide some clarity on officials’ views, they’re likely to be overshadowed by Chairman Jerome Powell’s address at Jackson Hole in Wyoming on Friday in the wake of Trump’s latest attack on the central bank according to Bloomberg. Much depends on what the Fed does with U.S. interest rates, making markets hyper-sensitive to the minutes - due later on Wednesday - of its last meeting.
“People are looking ahead to Jackson Hole later this week and the message that Jerome Powell may or may not give us on the direction of monetary policy. That is the highlight of the week and we are waiting with baited breath,” said Andrew Milligan, head of global strategy at Aberdeen Standard Investments.
The sentiment was confirmed by Tuuli McCully, head of Asia-Pac at Scotiabank, who told Bloomberg that "the key thing this week is the Jackson Hole speech by Fed Chair Powell. It will be interesting to hear if he sticks to the mid-cycle adjustment tone or if he will promise more."
Futures are fully priced for a quarter-point cut in rates next month and cuts of more than 100 basis points by the end of next year. Morgan Stanley economist Ellen Zentner advised clients to watch for the use of the word “somewhat” when Powell describes future policy. “Acknowledgment that downside risks have increased with no characterization of ‘somewhat’ could be taken as confirmation that it is likely the Fed makes a larger cut in September,”Zentner wrote in a note.
Meanwhile, President Donald Trump showed no signs of backing down in his tussle with China, declaring on Tuesday a confrontation was necessary even if it hurt the U.S. economy in the short term.
Currency markets were mostly subdued as the euro struggled and was last down 0.1% at $1.1092. The dollar index initially rose 0.1% to 98.265, but has since given up gains. Sterling failed to overcome technical resistance and met leveraged selling while the yen came under pressure from Japanese names; it was down 0.3% at $1.2134 and 0.2% against the euro at 91.405 pence.
In commodities markets, U.S. crude rose 17 cents to$56.30 per barrel. Brent added 23 cents to $60.26. Spot gold was weaker at $1,498.15 an ounce.
- S&P 500 futures up 0.7% to 2,918.75
- STOXX Europe 600 up 0.8% to 374.23
- MXAP down 0.3% to 152.50
- MXAPJ down 0.07% to 495.15
- Nikkei down 0.3% to 20,618.57
- Topix down 0.6% to 1,497.51
- Hang Seng Index up 0.2% to 26,270.04
- Shanghai Composite up 0.01% to 2,880.33
- Sensex down 0.5% to 37,133.03
- Australia S&P/ASX 200 down 0.9% to 6,483.27
- Kospi up 0.2% to 1,964.65
- German 10Y yield rose 3.1 bps to -0.659%
- Euro up 0.04% to $1.1104
- Italian 10Y yield fell 6.4 bps to 1.024%
- Spanish 10Y yield rose 3.3 bps to 0.129%
- Brent futures up 1.2% to $60.76/bbl
- Gold spot down 0.5% to $1,500.18
- U.S. Dollar Index little changed at 98.22
Top Overnight News from Bloomberg
- EU poured cold water on Boris Johnson’s attempt to renegotiate the Brexit deal, saying the so-called backstop to prevent a hard Irish border was a vital part of the divorce agreement
- Trump said he would be putting off a planned meeting with Denmark’s prime minister because she didn’t want to talk about a possible U.S. property deal to buy the island of Greenland. In Denmark, members of parliament responded with bewilderment and disbelief
- Central bankers and Group of Seven leaders will convene this week 8,000 kilometers apart with the same thing on their mind: What more stimulus do they need to support the weakest global growth since the financial crisis?
- China detained an employee of the U.K. consulate in Hong Kong under local law, the Foreign Ministry said, confirming earlier reports he was being held. The issue was an internal Chinese matter and not a diplomatic dispute, the ministry said, adding that detainee Simon Cheng is a Hong Kong citizen
- Germany saw weak demand for the world’s first 30-year bond offering a zero coupon, after a global debt rally that has pushed yields across Europe into negative territory
- British exporters are to be enrolled in a key customs system so they can trade with the EU after the scheduled Brexit deadline on Oct. 31. The U.K. tax authority will automatically issue more than 88,000 companies with an Economic Operator Registration and Identification number over the next two weeks, the Treasury said in a statement on Wednesday
- Norway’s $1 trillion wealth fund, Norges Bank Investment Management, rose $28.5 billion in the second quarter ahead of market turmoil that drove equities lower over the past month and saw bond yields plunge further below zero
- Chancellor of the Exchequer Sajid Javid may wait to name a successor to BOE Governor Mark Carney until after Britain’s planned Oct. 31 departure from the EU, according to a person familiar with the process
- U.K. now plans to only participate in EU meetings where it has “significant national interests involved,” according to a letter signed by PM Boris Johnson’s EU Adviser David Frost
- U.S. economy doesn’t appear to be headed toward a recession, San Francisco Fed President Mary Daly said. “When I look at the data coming in, I see solid domestic momentum,” Daly she wrote in a post on Quora.com
- Just over a year after agreeing to front Italy’s oddball coalition as its prime minister, Giuseppe Conte handed his resignation in to President Sergio Mattarella Tuesday night, leaving his brief political career up in the air
- U.S. President Donald Trump said he can cut taxes by indexing capital gains to inflation without congressional approval, a move the White House has been considering for months
- Wall Street watchdogs handpicked by President Trump eased the Volcker Rule’s controversial ban on banks making speculative investment
Asian equity markets traded subdued as the region conformed to the dampened global risk tone with markets cautious ahead of the looming FOMC minutes and the Jackson Hole Symposium. ASX 200 (-1.0%) underperformed with broad pressure across its sectors. Nikkei 225 (-0.3%) was also lower but with downside stemmed as exporters found some solace from a gradually weakening currency, while Hang Seng (+0.1%) and Shanghai Comp. (Unch.) traded indecisively after the PBoC’s quasi liquidity efforts resulted to another net daily drain and amid ongoing trade uncertainty as US President reiterated he is currently not ready to make a trade deal with China but suggested something will happen maybe sooner later. In addition, reports noted that outflows from funds focused on China investments recently widened to its highest since early 2017. Finally, 10yr JGBs returned flat as the initial upside from the cautious risk tone later faded after hitting resistance at the 155.00 level and near its record highs, while the BoJ were only in the market today for Treasury Discount Bills.
Top Asian News
- Hong Kong Protests Enter Crucial Period Before China Anniversary
- Cigarette Maker ITC Is Said to Mull Bid for India’s Coffee Day
- Yemen Vows to Confront U.A.E.-Backed ’Coup’ as Infighting Rages
- China Traders Bet Big on a Lagging Bank Stock in Hong Kong
European equities are higher across the board [Eurostoxx 50 +1.2%] despite a subdued Asia-Pac handover with some citing a possible market squeeze. Market participants note that stocks are driven by a couple factors: 1) Today’s session commenced at a low base as stocks yesterday were pressured by Italian concerns. 2) low volumes heading into key risk events including FOMC/ECB Minutes (full previews available in the Research Suite) and the annual Jackson Hole Symposium, US volumes have also been low. Sectors are all in the green, with underperformance seen in defensive stocks as investors seek riskier equities. Consumer discretionary is the marked outperformer with gains led by Pandora (+13.6%) as its earning-led optimism continues, whilst Fiat Chrysler (+3.5%) and Renault (+4.9%) shares rebounded amid reports on continuing merger talks. In terms of other individual movers, GEA group (+5.1%) rests closer to the top of the Stoxx 600. On the flip side, Alcon (-2.5%) shares fell following earnings after-hours yesterday.
Top European News
- U.K. Steps Up Brexit Preparedness for Firms as Deadline Looms; U.K. Budget Deficit Soars as Britain Prepares for Brexit
- Norway’s Wealth Fund Delivers $28.5 Billion Gain Ahead of Plunge
- Eastern Europe Domestic Swine Fever Cases Climb Fivefold in July
- Berlin’s Fintech Wealth Is Attracting at Least One Private Bank
In FX, the Greenback has waned again, with the DXY fading just ahead of 98.500 and the more significant pinnacle reached at the start of the month when the index scaled fresh ytd highs (98.932). Usd/major pairings remain relatively mixed and rangebound in advance of potentially market-moving and game-changing events to come in the form of FOMC minutes, preliminary PMIs, ECB minutes and then the JC gathering that kicks off tomorrow and runs through to Saturday. In the interim, US existing home sales may provide some impetus as the DXY meanders between 98.302-145.
- JPY/NZD/CHF/GBP - Another upturn in broad risk sentiment has pushed the safe-haven Yen, Franc and Gold back down from yesterday’s peaks towards 106.60, through 0.9800 and 1500 respectively, but the Kiwi and Pound have also lost ground against the Buck, with Nzd/Usd retesting 0.6400 and Cable retreating from circa 1.2175 to 1.2130. Note, technical resistance at the 21 DMA (1.2172) and ahead of 1.2200 (1.2197 Fib retracement) could have stymied Sterling again along with more clarification from EU officials that any alternatives to the Irish backstop would be facilitated via the PD not the WA.
- AUD/CAD/EUR - The G10 outperformers, or at least holding up better than the rest as the Aussie retains sight of the 0.6800 handle, Loonie pivots 1.3300 and Euro continues to straddle 1.1100, awaiting aforementioned highlights for the week (on paper at least). Aud/Usd remains supported in wake of RBA minutes underlining a wait-and-see approach after recent rate cuts, while Usd/Cad has retreated from Tuesday’s apex amidst a rebound in crude prices and looking for further direction from Canadian CPI data and the single currency is still showing resilience in the face of Eurozone political instability in Italy and Spain.
- NOK/SEK - The Scandi Crowns are benefiting from the latest revival in risk appetite and Eur/Nok has topped out ahead of 10.0000 despite weaker than forecast Norwegian unemployment, while Eur/Sek is drifting down from 10.7600+ towards 10.7100 in tandem.
- EM - A generally firmer tone across the region, with the Rand drawing encouragement from soft SA inflation even though this may prompt more SARB easing, as Usd/Zar breached key chart support around 15.2800 to probe under 15.2200 before returning to 15.2500 and consolidating.
WTI and Brent prices are firmer amid the improvement in risk appetite coupled with support from a larger-than-forecast drawdown in API crude stocks (-3.5mln vs. Exp. -1.9mln). Elsewhere, reports stated that Canada’s Alberta has decided to extend it current production curbs by a year, until the end of 2020 amid slow pipeline progress. Due to the extension, the base limit will increase to 20k BPD from 10k BPD per producers (effective Oct 1st), thus helping out the smaller producers as the first 20k BPD of production will be exempt from cuts. Turning to geopolitics where Fox News, citing sources, reported that an Iranian oil tanker (Bonita Queen) is heading to Syria and carrying around 600k barrels of crude, which would violate Western Sanctions. This comes just days after Iranian tanker Adrian Darya 1 (formerly Grace 1) was released from Gibraltar after being seized regarding suspected exports to Syria. On today’s docket, participants will be eyeing the widely followed weekly DoE inventory data for an immediate catalyst ahead of the FOMC minutes, with headline crude expected to drawdown of 1.889mln. Elsewhere, gold is lacklustre and trades around the 1500/oz mark amid a seemingly improved risk tone and some potential profit taking ahead of the FOMC minutes later. Meanwhile copper moves in tandem with the current risk sentiment and trades higher on the day, albeit prices remain below 2.6/lb. Finally, Dalian iron ore futures declined to 10-week lows amid the ongoing supply/demand imbalance, with traders citing further downside in light of BHP’s bleak outlook for the base metal.
US Event Calendar
- 7am: MBA Mortgage Applications, prior 21.7%
- 10am: Existing Home Sales, est. 5.39m, prior 5.27m; MoM, est. 2.3%, prior -1.7%
- 2pm: FOMC Meeting Minutes
- 2pm: FOMC Meeting Minutes
- 6:30pm: Fed’s Kashkari Speaks at Economic Conference in Minneapolis
DB's Craig Nicol concludes the overnight wrap
There may have been a slight lull in newsflow over the last 24 hours however the few scraps of news that we have been fed have left markets somewhat uninspired. By the close of play last night the S&P 500 ended -0.79%, with similar moves for the NASDAQ (-0.68%) and DOW (-0.66%). There was more political volatility in Italy and reports of new tax cuts in the US, but the dominant factor was again trade. US Secretary of State Pompeo told CNBC that Huawei remains a national security threat and also that he is concerned about “other Chinese companies.” That could portend expanded sanctions, though Pompeo did go on to say that he expects the US and China teams to resume trade talks in the short term. Later in the day, President Trump said that he’s “not ready to make a deal with China” and said that Europe would meet any demand if faced with the threat of tariffs on car imports. In sympathy, safe havens were well bid with 10y Treasury yields down -5.1bps and thus reversing Monday’s move, while Gold closed up +0.75%. The yield curve also flattened another 2.0bps to 3.9bps having started the day closer to 7.0bps.
As for those developments in Italy, as expected Conte confirmed his resignation. Conte made it clear that the populist coalition of the League and 5-Star was over, calling Salvini’s decision to spark a political crisis “irresponsible’, although Salvini did try to make a last ditch attempt to smooth things over with 5-Star in order to pass the 2020 budget before heading to the polls. The question now is what will be President Mattarella’s next move. Mattarella needs to assess if a new coalition is viable or whether elections need to go ahead, most likely in October. Of the outcomes it’s likely that the market would view a PD/5-Star coalition as most favourable with 5-Star having adopted a less confrontational stance on Europe and a more responsible stance on public finances in recent times. Plus, if Mattarella allowed them to form a government, it’s likely that he would require assurances on the budget beforehand. However, the medium term risk is that such a coalition is unstable and falls apart leading to an outright victory for the League.
In terms of markets, BTPs outperformed all other sovereigns yesterday, rallying -6.4bps to 1.367%. Bunds fell -4.2bps to -0.694% and while we’re on them, it’s worth noting that we will likely see the first ever 30y Bund sold at a 0% coupon today when the auction is held this morning. Meanwhile the FTSE MIB dropped -1.11% yesterday, slightly underperforming drops for the STOXX 600 (-0.68%) and DAX (-0.55%). Despite the selloff in equities, European HY credit spreads tightened -6bps, while they widened +2bps in the US.
Overnight, markets appear to be struggling for direction with the Nikkei (-0.33%), Hang Seng (+0.11%), Kospi (+0.33%) and Shanghai Comp (+0.02%) pulling in different directions but on fairly low volumes. Futures on the S&P 500 are up +0.30% while there’s not much to report in FX or bond markets.
Moving on and looking ahead to today we’ve got the FOMC minutes from the July meeting out tonight. It’s worth noting that there will be an element of staleness to these now given the tariff developments since then however our economists made the point that they may provide an important benchmark for Fed officials’ outlooks prior to the escalation of trade tensions. They note for example, if the minutes indicate officials’ existing economic views were largely predicated on a flare-up in trade tensions, as St. Louis Fed President Bullard (dove/voter) mentioned last week, this would be relatively hawkish as it would imply officials think they do not need to do much more easing than they have already foreshadowed. However, if trade tensions returning to a boil a day after the July meeting was actually a surprise, which would be implied by Powell saying they had "returned to a simmer" in his prepared remarks to open the press conference, this would be consistent with our economists’ call that more monetary policy easing than was built into the June dot plot is to be expected.
In other news, there was some focus on a NY Times article in markets yesterday which suggested that President Trump could abandon some of his tariffs if the US economy threatens to go into recession. It also mentioned a cut to payroll taxes, which would directly boost labour income. That is a somewhat progressive form of tax cut, so it could tempt Democrats into supporting it, but it remains to be seen if the House will want to hand Trump any legislate wins in an election year. Later in the day, President Trump acknowledged that there have been discussions about payroll tax cuts, though he emphasised "whether or not we do it now, it's not being done because of recession." He also mentioned indexing capital gains taxes to inflation as another possible form of tax relief, which could be done with executive action, thus avoiding Congress, though legal experts are undecided on if that measure would survive court challenges.
Finally, there were a few Brexit headlines to digest yesterday, with the UK doing nothing to signal a change in their policy of insisting that the backstop be scrapped. Media outlets reported that Chancellor Merkel said “we will think about practical solutions,” which was viewed as a possible signal that the EU may be more willing to negotiate. We’re sceptical that her remarks signalled any change in policy, but the pound nevertheless gained +0.36% and +0.86% from the lows.
To the day ahead now, which this morning includes July public finances and net borrowing data in the UK, while this afternoon in the US we’ll get July existing home sales before the FOMC minutes are released. Away from that the EIA crude oil inventory report will also be released.
Photo: An oil tanker burns in the Strait of Hormuz after allegedly being attacked by Iranian boats. (AP/ISNA) Australia is sending a warship, surveillance aircraft and Defence Force personnel to a stretch of Middle Eastern water called the Strait of Hormuz. Here’s why. What is the Strait of Hormuz? The Strait of Hormuz is a narrow stretch of water on a major oil transit route in the Middle East. […]
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Australia is sending a warship, surveillance aircraft and Defence Force personnel to a stretch of Middle Eastern water called the Strait of Hormuz.
What is the Strait of Hormuz?
The Strait of Hormuz is a narrow stretch of water on a major oil transit route in the Middle East.
On one side is Iran; on the other is Oman, with Saudi Arabia nearby.
And approximately one-fifth of the world's oil is shipped through it every year.
In comparison to Australian geography, the Strait of Hormuz is much narrower than Bass Strait.
At its narrowest point, it is approximately:
- twice the distance between Perth and Rottnest Island,
- the length of North Stradbroke Island,
- the distance between Sydney CBD and the Blue Mountains, and
- narrower than the width of Port Phillip Bay.
Why is Australia sending military resources there?
Iran's motivations are not fully understood, but the US has been making efforts to restrict Iran's oil exports since late 2018, when President Donald Trump unilaterally pulled his country out of an international treaty designed to prevent Iran from developing nuclear weapons.
The US sanctions are aimed at crippling Iran's economy.
Fifteen per cent of crude oil and close to 30 per cent of refined oil destined for Australia transits through the Strait of Hormuz.
Prime Minister Scott Morrison said on Wednesday that contributing to an international effort in the area was "to ensure we maintain free flow of commerce and freedom of navigation which is essential to our security and to our economy".
What exactly are we sending?
Australia is sending HMAS Toowoomba, with 177 sailors.
According to the Navy, it is "a long-range frigate capable of air defence, surface and undersea warfare, surveillance, reconnaissance and interdiction".
It will be joined by a P-8 Poseidon surveillance aircraft with a crew of 10.
This aircraft is based on the Boeing 737, extensively modified for maritime surveillance.
There will also be staff sent to the "joint task force headquarters", but it's not clear how many.
How long will we be over there?
The warship will be deployed for six months from January.
The surveillance aircraft will be sent for one month before the end of 2019. It's not clear exactly when they will return.
And the team deployed to the task force headquarters will go over "reasonably quickly".
Again, the Government has not said when this group will come home.
Mr Morrison said the Government would consider when they return "as that deployment approaches its termination, as we do on all of these matters".
"I mean, we can't predict the future. We can only plan and we can only make commitments based on the situation as we understand it."
But he said the nature of the engagement was a "multi-national operation that is focused on freedom of shipping lanes".
"That's what this is about. It's not about anything else."
What will we be doing?
The Government claims Australia will work with international partners the United States, United Kingdom and Bahrain to "uphold" the right to safe passage of maritime trade "consistent with international law".
It's likely the personnel sent to the headquarters will be working on intelligence and logistics.
Commentators believe Australia's other military forces may be involved escorting tankers and monitoring potential threats from the air.
But so far detail is unclear. On Wednesday, Chief of the Defence Force Angus Campbell was asked what Australia's warship would do if a commercial ship was seized by Iranian forces, as has happened before.
"Our people are very well-trained and they'll be operating under international law and their presence will be to support the security of shipping and freedom of navigation," he said.
He did not go into exactly how they could respond in circumstances of conflict.
Violence marked the "tanker wars" of the 1980s between Iraq and Iran, which were also focused on shipping in the Persian Gulf. More than 100 people were killed.
Are they allowed to do this?
There are doubts over exactly what can and cannot be done by Australia's warship in the Strait of Hormuz.
International shipping lanes designated by the International Maritime Organisation run across both Omani and Iranian territorial waters.
Donald Rothwell, international law professor at ANU, said the Strait of Hormuz was recognised as an international shipping route.
Military ships in transit enjoy the right to safe passage too, but this may evaporate when they undertake operations such as escorts.
"The freedom of navigation is not absolute and legitimate constraints can be placed on navigation through the waters of the Strait of Hormuz," he said.
"There would be significant legal issues to my mind in the Royal Australian Navy seeking to escort non-Australian flagged ships through the Strait."
Professor Rothwell also said questions remained about the rules of engagement and whether the Defence Force would be able to exercise self-defence if it was attacked.
Defence Minister Linda Reynolds said Australia was working through international legal issues with the other partners.
"One of the reasons we're sending staff now to the joint task force headquarters is to work through these details," she said.
"We've still got some planning to do with the Attorney-General's Department to actually work through what this will actually involve."
Does this mean we are going to war?
Mr Morrison said Australia's engagement "is all about de-escalating tensions in the region to ensure the freedom of those shipping lanes".
However, US President Donald Trump has previously said he wants to apply "maximum pressure" to Iran.
Mr Morrison rejected suggestions Australia's involvement was related to the US stance.
"This is about freedom of shipping. They're completely separate issues," he said.
"And I think to conflate those issues would be ill-informed."
Authored by By Kevin Zeese and Margaret Flowers via ConsortiumNews.com, Hong Kong is one of the most extreme examples of big finance, neoliberal capitalism in the world. As a result, many people in Hong Kong are suffering from great economic insecurity in a city with 93 billionaires, second-most of any city. Hong Kong protesters waving U.S. flags last week. (YouTube) Hong Kong is suffering the effects of being colonized […]
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Hong Kong is one of the most extreme examples of big finance, neoliberal capitalism in the world. As a result, many people in Hong Kong are suffering from great economic insecurity in a city with 93 billionaires, second-most of any city.
Hong Kong is suffering the effects of being colonized by Britain for more than 150 years following the Opium Wars. The British put in place a capitalist economic system and Hong Kong has had no history of self-rule. When Britain left, it negotiated an agreement that prevents China from changing Hong Kong’s political and economic systems for 50 years by making Hong Kong a Special Administrative Region (SAR).
China cannot solve the suffering of the people of Hong Kong. This “One Country, Two Systems” approach means the extreme capitalism of Hong Kong exists alongside, but separate from, China’s socialized system. Hong Kong has an unusual political system. For example, half the seats in the legislature are required to represent business interests meaning corporate interests vote on legislation.
Hong Kong is a center for big finance and also a center of financial crimes. Between 2013 and 2017, the number of suspicious transactions reported to law enforcement agencies rocketed from 32,907 to 92,115. There has been a small number of prosecutions, which dropped from a high of 167 in 2014 to 103 in 2017. Convictions dropped to only one person sentenced to more than six years behind bars in 2017.
The problem is neither the extradition bill that was used to ignite protests nor China, the problems are Hong Kong’s economy and governance.
The Extradition Bill
The stated cause of the recent protests is an extradition bill proposed because there is no legal way to prevent criminals from escaping charges when they flee to Hong Kong. The bill was proposed by the Hong Kong government in February 2019 to establish a mechanism to transfer fugitives in Hong Kong to Taiwan, Macau or Mainland China.
Extradition laws are a legal norm between countries and within countries (e.g. between states), and since Hong Kong is part of China, it is pretty basic. In fact, in 1998, a pro-democracy legislator, Martin Lee, proposed a law similar to the one he now opposes to ensure a person is prosecuted and tried at the place of the offense.
The push for the bill came in 2018 when a Hong Kong resident Chan Tong-kai allegedly killed his pregnant girlfriend, Poon Hiu-wing, in Taiwan, then returned to Hong Kong. Chan admitted he killed Poon to Hong Kong police, but the police were unable to charge him for murder or extradite him to Taiwan because no agreement was in place.
The proposed law covered 46 types of crimes that are recognized as serious offenses across the globe. These include murder, rape, and sexual offenses, assaults, kidnapping, immigration violations, and drug offenses as well as property offenses like robbery, burglary and arson and other traditional criminal offenses. It also included business and financial crimes.
Months before the street protests, the business community expressed opposition to the law. Hong Kong’s two pro-business parties urged the government to exempt white-collar crimes from the list of offenses covered by any future extradition agreement. There was escalating pressure from the city’s business heavyweights. The American Chamber of Commerce, AmCham, a 50-year-old organization that represents over 1,200 U.S. companies doing business in Hong Kong, opposed the proposal.
AmCham said it would damage the city’s reputation: “Any change in extradition arrangements that substantially expands the possibility of arrest and rendition … of international business executives residing in or transiting through Hong Kong as a result of allegations of economic crime made by the mainland government … would undermine perceptions of Hong Kong as a safe and secure haven for international business operations.”
Kurt Tong, the top U.S. diplomat in Hong Kong, said in March that the proposal could complicate relations between Washington and Hong Kong. Indeed, the Center for International Private Enterprise, an arm of the National Endowment for Democracy, said the proposed law would undermine economic freedom, cause capital flight and threaten Hong Kong’s status as a hub for global commerce. They pointed to a bipartisan letter signed by eight members of Congress, including Senators Marco Rubio, Tom Cotton, and Steve Daines and Members of the House of Representatives, Jim McGovern, Ben McAdams, Chris Smith, Tom Suozzi, and Brian Mast opposing the bill.
Proponents of the bill responded by exempting nine of the economic crimes and made extradition only for crimes punishable by at least seven years in prison. These changes did not satisfy big business advocates.
The Mass Protests and U.S. Role
From this attention to the law, opposition grew with the formation of a coalition to organize protests. As Alexander Rubinstein reports, “the coalition cited by Hong Kong media, including the South China Morning Post and the Hong Kong Free Press, as organizers of the anti-extradition law demonstrations is called the Civil Human Rights Front. That organization’s website lists the NED-funded HKHRM [Human Rights Monitor], Hong Kong Confederation of Trade Unions, the Hong Kong Journalists Association, the Civic Party, the Labour Party, and the Democratic Party as members of the coalition.” HKHRM alone received more than $1.9 million in funds from the NED between 1995 and 2013. Major protests began in June.
Building the anti-China movement in Hong Kong has been a long-term, NED project since 1996. In 2012, NED invested $460,000 through its National Democratic Institute, to build the anti-China movement (aka pro-democracy movement), particularly among university students. Two years later, the mass protests of Occupy Central occurred. In a 2016 Open Letter to Kurt Tong, these NED grants and others were pointed out and Tong was asked if the U.S. was funding a Hong Kong independence movement.
During the current protests, organizers were photographed meeting with Julie Eadeh, the political unit chief of U.S. Consulate General, in a Hong Kong hotel. They also met with China Hawks in Washington, D.C., including Vice President Mike Pence, Secretary of State Mike Pompeo, National Security Advisor John Bolton, Sen. Marco Rubio and Rep. Eliot Engel, chairman of the House Foreign Affairs Committee. Larry Diamond, a co-editor of the NED’s publication and a co-chair of research, has been openly encouraging the protesters. He delivered a video message of support during their rally this weekend.
Protests have included many elements of U.S. color revolutions with tactics such as violence — attacks on bystanders, media, police and emergency personnel. Similar tactics were used in Ukraine, Nicaragua, and Venezuela, e.g. violent street barricades. U.S. officials and media criticized the government’s response to the violent protests, even though they have been silent on the extreme police violence against the Yellow Vests in France. Demonstrators also use swarming techniques and sophisticated social media messaging targeting people in the U.S..
Mass protests have continued. On July 9, Chief Executive Carrie Lam pronounced the bill dead and suspended it. Protesters are now calling for the bill to be withdrawn, Lam to resign and police to be investigated. For more on the protests and U.S. involvement, listen to our interview with K. J. Noh on Clearing the FOG.
What Is Driving Discontent in Hong Kong?
The source of unrest in Hong Kong is the economic insecurity stemming from capitalism. In 1997, Britain and China agreed to leave “the previous capitalist system” in place for 50 years.
Hong Kong has been ranked as the world’s freest economy in the Heritage’s Index of Economic Freedom since 1995 when the index began. In 1990, Milton Friedman described Hong Kong as the best example of a free-market economy. Its ranking is based on low taxes, light regulations, strong property rights, business freedom, and openness to global commerce.
“The only way to restore order is through a radical change in Hong Kong’s economic policies. After decades of doing almost nothing, and letting the free market rule, it is time for the Hong Kong government to do what it is there for; to govern in the interests of the majority.”
The issue is not the extradition proposal, Carrie Lam or China. What we are witnessing is an unrestricted neo-liberal economy, described as a free market on steroids. Hong Kong’s economy relative to China’s gross domestic product (GDP) has fallen from a peak of 27 percent in 1993 to less than 3 percent in 2017. During this time, China has had tremendous growth, including in nearby market-friendly Shenzen, while Hong Kong has not.
As Sara Flounders writes, “For the last 10 years wages have been stagnant in Hong Kong while rents have increased 300 percent; it is the most expensive city in the world. In Shenzhen, wages have increased 8 percent every year, and more than 1 million new, public, green housing units at low rates are nearing completion.”
Hong Kong has the world’s highest rents, a widening wealth gap and a poverty rate of 20 percent. In China, the poverty rate fell from 88 percent in 1981 to 0.7 percent in 2015, according to the World Bank.
Hong Kong in Chinese Context
Ellen Brown writes in “Neoliberalism Has Met Its Match in China,” that the Chinese government owns 80 percent of banks, which make favorable loans to businesses, and subsidizes worker costs. The U.S. views China subsidizing its economy as an unfair trade advantage, while China sees long-term, planned growth as smarter than short-term profits for shareholders.
The Chinese model of state-controlled capitalism (some call it a form of socialism) has lifted 800 million people out of poverty and built a middle class of over 420 million people, growing from four percent in 2002, to 31 percent. The top 12 Chinese companies on the Fortune 500 are all state-owned and state-subsidized including oil, solar energy, telecommunications, engineering, construction companies, banks, and the auto industry. China has the second-largest GDP, and the largest economy based on Purchasing Power Parity GDP, according to the CIA, IMF and World Bank.
China does have significant problems. There are thousands of documented demonstrations, strikes and labor actions in China annually, serious environmental challenges, inequality and social control through the use of surveillance technology. How China responds to these challenges is a test for their governance.
China describes itself as having an intraparty democracy. The eight other legal “democratic parties” that are allowed to participate in the political system cooperate with but do not compete with the Communist Party. There are also local elections for candidates focused on grassroots issues. China views Western democracy and economics as flawed and does not try to emulate them but is creating its own system.
China is led by engineers and scientists, not by lawyers and business people. It approaches policy decisions through research and experimentation. Every city and every district is involved in some sort of experimentation including free trade zones, poverty reduction and education reform. “There are pilot schools, pilot cities, pilot hospitals, pilot markets, pilot everything under the sun, the whole China is basically a giant portfolio of experiments, with mayors and provincial governors as Primary Investigators.” In this system, Hong Kong could be viewed as an experiment in neoliberal capitalism.
The Communist Party knows that to keep its hold on power, it must combat inequalities and shift the economy towards a more efficient and more ecological model. Beijing has set a date of 2050 to become a “socialist society” and to achieve that, it seeks improvements in social, labor and environmental fields.
Where does Hong Kong fit into these long-term plans? With 2047 as the year for the end of the agreement with the U.K., U.S. and Western powers are working toward preserving their capitalist dystopia of Hong Kong and manufacturing consensus for long-term conflict with China.
How this conflict of economic and political systems turns out depends on whether China can confront its contradictions, whether Hong Kongers can address the source of their problems and whether US empire can continue its dollar, political and military dominance. Today’s conflicts in Hong Kong are rooted in all of these realities.
* * *
Commenting on today’s trading which featured a feud between Salvini and the former Italian Prime Minister, Gorilla Trades strategist Ken Berman said: Tumisu / Pixabay While bulls took a breather after two blowout sessions, today’s low-volume pullback doesn’t mean that investors should be running for the exits. Even though Treasuries edged closer to their recent multi-year highs due to the resignation of the Italian Prime Minister, U.S. stocks showed […]
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Commenting on today’s trading which featured a feud between Salvini and the former Italian Prime Minister, Gorilla Trades strategist Ken Berman said:
While bulls took a breather after two blowout sessions, today’s low-volume pullback doesn’t mean that investors should be running for the exits. Even though Treasuries edged closer to their recent multi-year highs due to the resignation of the Italian Prime Minister, U.S. stocks showed resilience again, the major indices held up well above last week’s lows, so the rally might soon resume.
All of the key sectors lost ground today and financials was yet again the weakest, due to the declining Treasury yields. Although stocks sold off in the last minutes of trading, due to technical factors, making today’s session look more bearish, there were clear positive signs ‘under-the-hood’. Small-caps showed stability in the face of the global risk of shift, and the stocks most exposed to the trade tariffs, such as Apple (AAPL) outperformed the broader market. Since the trade war is still the most important risk factor for equities, the fact that investors are accumulating the affected issues supports the bullish case.
While the fact that Italian Prime Minister Giuseppe Conte announced his decision to resign wasn’t a major surprise, it confirmed that the European Union (EU) is in for a heated autumn. The risk of a no-deal Brexit together with the Italian political crisis could hurt the already struggling European economy, not to mention the battered euro. Germany and the U.K. are already on the brink of recession, and as the pressure is mounting on the European Central Bank (ECB) and the EU, volatility in European assets could pick up in the coming weeks.
All eyes will be on the FOMC meeting minutes tomorrow, and as last month’s decision to the lower the Central Bank’s benchmark rate wasn’t unanimous, the details could have a significant impact on both Treasuries and stocks. As the minutes will be released in the afternoon, traders could be in for a choppy morning session, even though existing home sales will be out just after the opening bell. Sales are expected to bounce back following last month’s negative surprise, and since we got mixed signals from the housing market this month, a positive surprise could give a boost to the sector.
The two dissenting votes against the Fed’s rate cut last month were scary enough to cause a sell-off in stocks, and tomorrow investors could get a closer look at the decision. In light of the recent negative developments in the U.S.-Chinese relations and the deterioration in the European and Chinese economic numbers, tomorrow, analysts will be focusing on how the FOMC members view the outlook of the domestic economy. Should the global trends be in focus of the minutes, stocks could continue their recovery, but should the strength of the U.S. economy rule the discussion, the pullback could resume.
Although the technical picture improved thanks to the rally of the past few days, and the major U.S. indices are still very strong in comparison to their overseas peers, the short-term trend is still negative on Wall Street. The benchmarks are well above their rising 200-day moving averages of 7,584 for the Nasdaq, 2,800 for the S&P 500, and 25,607 for the Dow, but they are still stuck below their flat 50-day moving averages of 2,946 for the S&P 500, 8,044 for the Nasdaq, and 26,608 for the Dow.
The Volatility Index (VIX) finished today’s session just above its 200-day moving average, despite hitting its lowest level in more than three weeks in early trading. While the ‘fear gauge’ is still above both its long- and short-term moving averages, it continues to show a positive divergence compared to the major indices. Since the VIX is usually higher ahead of key Fed-related events, such as this week’s Jackson Hole Symposium, the index could fall further next week, and that would confirm that this month’s pullback was just a bump in the ongoing bull market.
The major indices broke their three-day winning streak today, as the increasing political uncertainty in Europe weighed on risk assets globally, pushing investors towards Treasuries and gold yet again. The Dow was down 173 or 0.7%, to 25,962, the Nasdaq lost 54, or 0.7%, to 7,949, while the S&P 500 declined by 23, or 0.8%, to 2,901. Decliners outnumbered advancing issues by a more than 2-to-1 ratio on the NYSE, where volume was well below average.
What do you think will have the biggest impact on markets going forward? Who will be the next Italian Prime Minister? Yield Curve? ECB policy? China trade war? Let us know in the comments section!
In what could potentially become a monumental roadblock in US-North Korea nuclear talks, despite all recent good-will expressed between Kim and Trump through exchange of "beautiful" letters, a major annual Japanese defense review seen by Japan’s Yomiuri newspaper will say for the first time that Pyongyang likely already possesses warheads in the form of miniaturized nuclear weapons . “It seems that miniaturization and warheads have already been realized,” Japan’s […]
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In what could potentially become a monumental roadblock in US-North Korea nuclear talks, despite all recent good-will expressed between Kim and Trump through exchange of "beautiful" letters, a major annual Japanese defense review seen by Japan's Yomiuri newspaper will say for the first time that Pyongyang likely already possesses warheads in the form of miniaturized nuclear weapons.
“It seems that miniaturization and warheads have already been realized,” Japan’s annual defense white paper — set to be approved in by mid-September — will say based on a draft copy seen by Yomiuri, among the country's largest national newspapers (according a rush translation of the breaking story) .
While the previous year’s white paper also indicated it was possible that North Korea had achieved miniaturization of nuclear warheads, this year's apparently will say it more definitively as a likely achieved fact.
And like prior years, the annual review lists North Korea ’s military technological development as remaining a “serious and imminent threat”.
It must be remembered that starting years ago, North Korea began publishing images of purported 'miniaturized' nukes, though little could be confirmed at the time.
BBC, for example, had reported in 2016:
Kim Jong-un says North Korean scientists have developed nuclear warheads small enough to fit on ballistic missiles.
State media published images showing the North's leader standing next to what it said was a miniaturised weapon.
The claim is impossible to verify from the images alone and experts have long cast doubt on such assertions.
Also notable is that US ally South Korea will be demoted in rank among a list of countries seen as cooperative with Tokyo on defense, which further comes amid a bilateral trade spat.
Concerning Japan's more powerful neighbor China, the white paper is expected to denote "further expansion of Chinese military operations by sea and air forces in the Pacific Ocean," according to Yomiuri.
Yesterday, after countless demands that the Fed cut interest rates, Trump finally made his first, long anticipated formal demand that the Fed should pursue " some quantitative easing ": …..The Fed Rate, over a fairly short period of time, should be reduced by at least 100 basis points, with perhaps some quantitative easing as well. If that happened, our Economy would be even better, and the World Economy would […]
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Yesterday, after countless demands that the Fed cut interest rates, Trump finally made his first, long anticipated formal demand that the Fed should pursue "some quantitative easing":
.....The Fed Rate, over a fairly short period of time, should be reduced by at least 100 basis points, with perhaps some quantitative easing as well. If that happened, our Economy would be even better, and the World Economy would be greatly and quickly enhanced-good for everyone!— Donald J. Trump (@realDonaldTrump) August 19, 2019
The good news for Trump is that he has now fully figured out that he has the Fed in the palm of his hand, as he demonstrated just hours after Powell's July 31 rate cut when Trump broke the US-China trade ceasefire and re-escalated trade war, in the process sending rate cut odds soaring. The flowchart logic, as shown below, is quite simple: all Trump has to do is engage in action that threatens to destabilize the global economy and Powell - as he certified during the last FOMC meeting - has to respond by cutting further, until he eventually reaches a point where QE may be the only possible outcome (as we explained previously in "How The Fed Is Now Underwriting Trump's Trade War, In One Chart").
As BMO's fixed income team writes today, while economic tensions between the US and China have eased somewhat in recent days after China chose not to respond to being designated a currency manipulator by the Trump Administration, which in turn scaled back tariffs it had threatened to implement on September 1, this de-escalation is in-line with broad expectations of how the conflict between the US and China escalates, with BMO cautioning against losing focus on the 'gray rhino' that remains the biggest threat to the global economy.
For those who have not heard the term before, a gray rhino - unlike a black swan - is defined as a high-impact and obvious threat that is ambling toward the economy but is nevertheless underpriced by financial markets. Not surprisingly, a broad and severe global economic war remains the gray rhino that investors must continue to monitor and position against. Meanwhile, BMO defines an 'economic war' as a situation in which countries (and their various agents, including central banks, SOEs) engage in acts that are designed to harm a competitor more than to help one's self. An obvious example of an act of economic war would be a country having its military cyber unit hack another country's power grid. By contrast, cutting interest rates in order to push inflation upward toward target (even if that act weakens one's currency and thereby incentivizes the shifting of production away from other countries) does not fit our definition of an act of 'economic war'.
So almost by definition, sanctions regimes are acts of economic war. So through its sanctions programs, the US is actively engaged in economic wars against prevailing regimes in Iran, Syria and Venezuela. Similarly, the EU committed acts of economic warfare against Russia by imposing sanctions in retaliation for the invasion Crimea, although that war has been allowed to cool to the point of a de-facto truce.
Which brings us to...
The ultimate gray rhino, which is a multi-polar economic war that includes multiple major countries or economic regions actively engaged in economic warfare against each other. Much like shooting wars, economic wars have the potential of drawing in new waves of participants until they globalize and spiral completely out of control. So although the latest US-China developments are encouraging (for now), the latest developments in lesser hot spots like UK-EU and Korea-Japan are not all that encouraging. Based on the movement of asset prices over the past year, we question whether some markets (particularly FX) have adequately factored in the risks.
Here BMO is quick to note that an "ultimate black rhino" scenario is not its base case... however, the odds of one are rapidly rising.
And here is the punchline: if a worst-case scenario unfolds, BMO believes the Fed and other central banks will ease more aggressively, given the escalating risks of recession. And, should a recession scenario become the modal view, the Fed would not hesitate to quickly lower policy rates to the zero lower bound again, partly in the hope that rapid rate reductions could minimize the chance of having to ramp-up QE again or venture into negative rates. Other central banks would follow suit in this “race to the bottom”, that many would be hoping is accompanied with local currency depreciation (even perhaps with a bit of official encouragement).
What does that mean for the US?
An outright economic war would be extremely consequential for the US economy and thus monetary policy and the Treasury market. At a first pass, the Fed would react in terms of the impact on growth, inflation, and financial conditions. Economic war would lead to slower growth causing less inflationary pressure (despite any import tax expansion) and tighter financial conditions. All of this would correspond to the Fed responding in force by cutting aggressively – likely back to the effective lower bound – and - Trump, are you listening - restarting quantitative easing.
In other words, if Trump really wants to pressure the Fed into QE, what he needs to do is simple: unleash global trade war that mutates into global economic warfare, which in turn leaves the Fed with no choice but to launch QE.
Of course, merely launching QE doesn't assure a happy ending, and indeed BMO warns that since an "economic war" world would be on the verge of a recession, it would have momentous consequences for asset prices, to wit:
Initially, a dramatic flight-to-quality and liquidity into Treasuries would increase downward pressure on US rates across tenors. Eventually, yields would breach the lows of the last cycle when 2s bottomed out at 0.14% 5s reached 0.53%, or said otherwise, both 2s and 5s would go negative.. In addition, 10-year yields would fall substantially further from here, passing the record low of 1.32% in short order before quickly approaching 1.00%.
Said otherwise, if Trump really chooses to pursue this option, he could kill two gray rhinos with one shot: first getting the Fed to launch QE and second he would push (at least) the short-end of the curve below zero, which would mean that the Fed has finally caught up with other central banks, giving Trump no further reason to complain about the Fed. The only downside: the US and the world would be in a historic recession, and unless central banks can stabilize the global economy, a depression would be assured.
Americans are blessed to have a plethora of benevolent celebrities who are willing to share their infinite knowledge and wisdom with them… After a thorough examination by a team of top-notch doctors, I was recently given some very disturbing news… I was diagnosed with an acute case of stage 4 platonic celebriphilia . In case you don’t know, celebriphilia is a disease where the afflicted have an abnormal and […]
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Americans are blessed to have a plethora of benevolent celebrities who are willing to share their infinite knowledge and wisdom with them...
After a thorough examination by a team of top-notch doctors, I was recently given some very disturbing news... I was diagnosed with an acute case of stage 4 platonic celebriphilia. In case you don’t know, celebriphilia is a disease where the afflicted have an abnormal and overwhelming adoration of celebrity.
My medical team, which includes Dr Phil, Dr Drew and Dr Oz, tells me that the symptoms of celebriphilia include feeling a false sense of familiarity and intimacy with celebrities which leads to the afflicted projecting an inordinate amount of inappropriate intelligence, wisdom and expertise upon celebrities.
My celebriphilia first manifested itself a few years ago when Academy Award-winning actress Gwyneth Paltrow created her “lifestyle brand” Goop. Through Goop, Gwyneth sold new-age, alternative therapies and devices at exorbitant prices, including “vaginal eggs” that were meant to be inserted into the vagina in order to aid “hormonal balance, and feminine energy.”
After re-mortgaging my home in order to finance the purchase, I bought a dozen vaginal eggs from Gwyneth. Now if you are wondering why I would buy vaginal eggs whose miracle powers were debunked in a lawsuit, especially since I don’t have a vagina, then you obviously do not have celebriphilia.
The way I see it is this: if I had a vagina, I would trust my friend Gwyneth to tell me (and sell me) the right wonder egg to stick into it in order to cure whatever ails me. If I’m going to trust anyone regarding my non-existent vagina, you can bet your bottom dollar it would be the woman who played Pepper Potts in the ‘Iron Man’ movies… that alone makes her an authority in vaginacology.
The same is true of anti-vaccination proponent Jenny McCarthy. Jenny is a TV host and former Playboy model, which is the celebrity equivalent of being a PhD in immunology, which is why I faithfully obey her when she orders me not tovaccinate my kids because they could get autism.
Suzanne Somers starred on ‘Three’s Company’ 40 years ago, which is equal to getting a master’s degree in bio-genetic engineering, and so when, contrary to mainstream medical opinion, she claims that “bio-identical hormone therapy” is the fountain of youth… I trust in Suzanne’s knowledge and wisdom.
You may think my celebriphilia is so severe I need to take some medication to temper it… well… you’d be wrong.
Kirstie Alley and her Scientology lord and savior, Tom Cruise, have informed me that psychiatry is a “quack” science and psychiatric drugs are dangerous. Kirstie was on ‘Cheers,’ where everybody knows your name… and Tom Cruise is… well… TOM CRUISE! So they definitely know what they’re talking about and I trust their expertise implicitly and will remain untreated, thank you very much.
My celebriphilia isn’t limited to just medical questions. The infection has spread to my thoughts on foreign policy and politics too. Thanks to celebriphilia, I now blindly trust in Hollywood to tell me what to think. When Hollywood churns out star-studded, pro-war, pro-empire propaganda films and TV shows that have their scripts controlled by the Pentagon in exchange for military equipment, personnel, access and budgetary relief, I absorb the indoctrination unquestioningly.
We celebriphiliacs only get our news from rebellious comedians like John Oliver, Bill Maher and Stephen Colbert, and believe in every establishment talking point they sell us. I wholeheartedly put my faith in these second-rate hack comedians desperate to stay in the good graces of their corporate overlords to tell me the unvarnished truth.
As a celebriphiliac, I get all my insights regarding Russia from Rob Reiner, who is an expert because he played Meathead on the 1970’s sitcom ‘All in the Family.’ When Meathead tells me that we are at war with Russia because they stole our election in 2016, I treat his anti-Russian proclamations with all the respect it deserves.
To get my political opinions, I go to all the top experts… Robert DeNiro, Matt Damon, Bruce Willis, Brie Larson, Alec Baldwin, Tim Allen, Angelina Jolie, James Woods, Chris Evans and George Clooney. Sometimes these experts have conflicting opinions on political matters, like maybe Bruce Willis and Alec Baldwin disagree on tax policy, or Tim Allen and Chris Evans have opposing thoughts on immigration. In order to resolve these deeply troubling quagmires, I do the logical thing and choose what I believe by siding with the celebrity who has the most Twitter followers.
Luckily for me, I am not alone in being afflicted with celebriphilia, as it is a raging epidemic in America. Here in the US we adore our celebrities so much we actually vote them into high office. In the last 40 years alone, we have elected a senile, bad B-movie actor, Ronald Reagan, and a silver-spooned, D-list reality TV con-man, Donald Trump, to the presidency.
In my state of California, the epicenter of the celebriphilia epidemic, we have elected a sex-abusing, steroid-injecting, movie star, Arnold Schwarzenegger, to two terms in the governor’s mansion; and the city of Carmel-by-the-Sea elected Dirty Harry himself, Clint Eastwood, to be mayor 25 years before he berated an empty chair at the RNC convention in 2012.
We American celebriphiliacs not only forgave these men for their shortcomings, we also imbued them with a wisdom, competency and expertise they did not possess, all because of their status as celebrities.
You may think that because I suffer from celebriphilia and treat celebrities like experts on things well outside their skillset, that I am insane. If the definition of insanity is “doing the same thing over and over again but expecting different results,” then considering the level of corruption, incompetence and malevolence on display by “real” establishment experts in government, Wall Street, Big Pharma and the media over the years, be it in regards to 9-11, WMDs and the Iraq war, the housing bubble and ensuing 2008 economic collapse, the 2016 election, Russiagate and the opioid epidemic, then listening to, believing in, or trusting in these “official” experts is equally as insane as buying vaginal wonder eggs from Iron Man’s wife, Pepper Potts.
The bottom line is this: I am not a doctor, nor do I play one on TV, but I have seen other people play them on TV, and I am a certified celebriphiliac, which I think qualifies me to make a formal diagnosis of what ails celebrity-obsessed, and expert-addled America. After careful study and deep thought, I have come to this conclusion: contrary to popular opinion, America is not losing its mind… just like me, it has already lost it.
Summary New estimates show that most of the manic moves in stocks and bonds this month can be explained by many of the self-feeding loops I’ve spent years discussing. In rates, the recent plunge in yields was mostly down to convexity hedging. In stocks, gamma hedging and CTA de-leveraging played a prominent role last week. And it’s all exacerbated by disappearing liquidity. If you’re looking to assign blame for […]
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New estimates show that most of the manic moves in stocks and bonds this month can be explained by many of the self-feeding loops I've spent years discussing.
In rates, the recent plunge in yields was mostly down to convexity hedging.
In stocks, gamma hedging and CTA de-leveraging played a prominent role last week.
And it's all exacerbated by disappearing liquidity.
If you're looking to assign blame for the manic market moves that have, through Monday anyway, defined the month of August, you can point to systematic flows and technically-driven price action.
I've discussed this at length here and elsewhere over the past two weeks, effectively documenting it in real time, but I think it's worth fleshing out a bit further for the audience here in the interest of perhaps shedding a bit more light on something that still isn't well understood by retail investors.
Starting in rates, I talked quite a bit in a Friday post for this platform about receiving flows and convexity hedging and the extent to which that had almost certainly played an outsized role in the frantic rally at the long-end of the US curve. 10-year yields fell below 1.50% and 30-year yields below 2.00% at the height of the rally last week.
We've seen the bottom fall out for yields on several occasions in 2019 and while some of that is down to growth concerns, collapsing inflation expectations, a flight-to-safety and the assumption of lower rates, a large percentage of this month's downdraft in yields is attributable to mortgage investors and banks chasing the rally.
That sprint created some $500 billion in demand, according to JPMorgan, whose rates strategists on Tuesday reminded clients that these flows are easy to see. "[It's] clear from the behavior of derivatives markets, since most of these hedging flows occur in interest rate swaps," the bank noted.
As I wrote Friday on this platform, this sets in motion a self-fulfilling prophecy. The lower long-end yields go, the more convinced market participants become that everyone else is panicking about the outlook for global growth. Those jitters beget still more demand for duration, which pushes yields even lower, forcing more hedging, and around we go.
And then there's the psychological impact on equities. The exaggerated moves in rates described above are part of the reason the 2s10s inverted. That inversion, in turn, dealt a grievous blow to investor psychology last Wednesday, when the Dow suffered its worst one-day drop of 2019.
This is a maddeningly circular and exceptionally precarious dynamic. When fundamental, discretionary investors sell on recession jitters tied to what, as noted above, was an exaggerated move in the bond market, that can push equity benchmarks through key levels, which starts tipping dominoes for systematic deleveraging by the likes of CTAs.
JPMorgan's Marko Kolanovic underscored all of this in a note out Tuesday morning. "This is an important data point for equity investors, as moves in rates (e.g. yield curve inversion) significantly impact investment sentiment”, he wrote, on the way to quantifying how much selling in and around last Wednesday's rout was attributable to programmatic/systematic strats. That figure, according to Marko, was roughly $75 billion, with 20% of it coming from CTAs.
Now, recall how, on August 11, I mentioned in a post for this platform that dealers' gamma positioning likely flipped negative after the FOMC, which meant that selling would beget more selling. Kolanovic on Tuesday underscored that assessment, noting that heading into last week, dealers' gamma positioning betrayed "a sizable short".
Try to appreciate how the dominoes fall. As yields move lower on what are, initially, fundamental concerns, convexity hedging flows turbocharge the bond rally. That has the potential to create a false optic, or to magnify recession concerns (I referred to it as a "Fata Morgana" earlier this year). Last week, that manifested itself in the inversion of the 2s10s, which led to selling in equities. Once stocks fell through key levels, it activated CTA de-leveraging and because dealers' gamma positioning was negative, their hedging exacerbated the situation.
Kolanovic on Tuesday said some 50% of the above-mentioned $75 billion in programmatic selling during or as a result of the August 14 selloff was attributable to index option delta and gamma hedging, which he calls "the single most important driver of price action during both the selloffs and rallies last week".
Mercifully, that positioning is back to neutral now, something Nomura's Charlie McElligott illustrated on Monday as follows:
That, folks, is how modern markets can turn into tinderboxes.
If you're looking to explain why nine of the 14 sessions since the July FOMC have seen S&P moves of 1% or more (top pane in the figure), that's why.
This is exacerbated materially by low liquidity. These flows are hitting during a month when liquidity is seasonally sparse, but this August has been particularly dry. More broadly, liquidity in S&P futures simply never recovered after the February 2018 vol. event.
That's attributable to a variety of factors, but one of the issues is that HFT liquidity provision is volatility-dependent. That is, algos pull back when volatility rises.
Well, needless to say, the interaction of all the dynamics mentioned above has a tendency to push up volatility. If vol. spikes prompt HFTs to reduce liquidity provision, it can make a bad situation immeasurably worse. That goes for bonds too. As JPMorgan pointed out again on Tuesday, "fast market participants represent roughly 80% of the liquidity provision in the hot-run interdealer Treasury market."
Going forward, positioning has once again been washed out a bit, with hedge fund betas very low, for instance. As noted above, dealers' gamma positioning is (basically) neutral now, so that should serve to help tamp down volatility.
But, it is by no means clear that the impact of hedging flows in rates is behind us, and on top of that, the dollar is near YTD highs. Jerome Powell has the potential to exacerbate both the decline in bond yields and dollar strength on Friday if he doesn't strike the "right" tone in Jackson Hole.
Suffice to Boston Fed chief Eric Rosengren did not signal a willingness to back off his propensity to dissent against more rate cuts when he spoke to Bloomberg on Monday.
And President Trump did not signal a willingness to step back from his insistence on those same cuts when he spoke to Twitter.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.