Doug Noland’s Credit Bubble Bulletin: No Mystery

This is a syndicated repost courtesy of Credit Bubble Bulletin . To view original, click here. Reposted with permission.

January 30 – Financial Times (Sam Fleming): “After putting traders on notice six weeks ago to expect further increases in US interest rates in 2019, the Federal Reserve… executed one of its sharpest U-turns in recent memory. Leaving rates unchanged at 2.25-2.5%, Jay Powell, Fed chairman, unveiled new language that opened up the possibility that the next move could equally be down, instead of up. Forecasts from the Fed’s December meeting that another two rate rises are likely this year now appear to be history. Changes to its guidance were needed, Mr Powell argued, because of ‘cross-currents’ that had recently emerged. Among them were slower growth in China and Europe, trade tensions, the risk of a hard Brexit and the federal government shutdown. Financial conditions had also tightened, he added. Yet the about-face left some Fed-watchers wrongfooted and bemused. Many of those hazards were already perfectly apparent in the central bank’s December meeting, when it lifted rates by a quarter point and kept in place language pointing to further ‘gradual’ increases.”

The Wall Street Journal’s Greg Ip pursued a similar path with his article, “The Fed’s Mysterious Pause.” “Last December, Mr. Powell noted his colleagues thought they’d raise rates two more times this year, from between 2.25% and 2.5%, which was at the lower end of estimates of ‘neutral’—a level that neither stimulates nor holds back growth. On Wednesday, he suggested the Fed could already be at neutral: ‘Our policy stance is appropriate right now. We also know that our policy rate is in the range of the… committee’s estimates of neutral.’ If indeed the Fed is done, that would be a breathtaking pivot. Yet the motivation remains somewhat mystifying: What changed in the past six weeks to justify it?”

No Mystery. Don’t be bemused. The Fed Chairman was prepared to hold his ground, but the ground was suddenly giving way. Between the December 19th and January 30th FOMC meetings, acute systemic fragilities were revealed.

Not to dismiss economic weakness in China and Europe – or even tenuous U.S./Chinese trade talks and the government shutdown. But January 3rd was pivotal, not coincidently the wild market session ahead of Chairman Powell’s January 4th U-turn. Recall the currency market “flash crash” – with an 8% intraday move in the yen vs. Australian dollar, along with the dramatic widening of credit spreads (and a 19bps surge in Goldman Sachs CDS prices). Markets were careening toward dislocation.

Chairman Powell appeared somewhat downtrodden during his Wednesday press conference, a notable shift from his confident demeanor in December. We can assume Powell and other Fed officials have been alarmed by how swiftly booming securities markets succumb to instability and illiquidity. I believe Powell wanted to see markets begin standing on their own; that, in contrast with his three most-recent predecessors, he would be in no rush to come to the markets’ defense. He was content to see overheated markets commence the cooling process. A correction would actually be constructive for system stability. The predicament: Overinflated Bubbles don’t calmly deflate.

Circumstances forced the Fed’s hand. Old fears soon reemerged of escalating market instability getting ahead of the Fed. Better to act quickly before market/liquidity issues turned intricate and precarious. While not blatantly shock and awe, kind of along the same line. And responding to criticism of blurred messaging, the course of FOMC policymaking must appear coherent and decisive.

There will be no more rate hikes anytime soon. Now heeding market alarm, the Fed will also be reevaluating the runoff of its securities holdings. The Fed would prefer to convey that it remains “data dependent” in an environment of extraordinary uncertainties, while tepid inflation provides the Fed convenient cover for embracing “patience.” Well enough, but markets saw it for what it was: The Fed “caved” – just as the markets knew it would. No longer in doubt, the latest incantation of the “Fed put” is alive and well (irrespective of job or GDP growth). Indeed, the new Chairman’s hope for lowering the “put” strike price (Fed support not invoked before a significant market decline) was rather hastily quashed by acute market fragility.

There’s really nothing like a short “squeeze” to get market speculative juices flowing. How about a synchronized global squeeze across myriad asset classes? Only weeks ago, global markets were alarmingly synchronized to the downside. Now it’s everyone off to the races – lockstep (seemingly inebriated). Stocks and corporate Credit; EM currencies, stocks and bonds; Treasuries, bunds and JGBs; Italian bonds; crude and commodities and so on.

Here in the U.S., “Stocks Wrap Up Best January in 30 Years.” The DJIA surged 1,672 points (returning 7.2%) during the month. The S&P500 returned 8.0%, robust gains overshadowed by the broader market. The S&P 400 Midcaps jumped 10.4% in January, with the small cap Russell 2000 rising 11.2%. The average stock (Value Line Arithmetic) gained 11.2%. The Banks (BKX) rose 12.4%, with the Nasdaq Financials up 9.7%. The Nasdaq Composite also rose 9.7%. The Goldman Sachs Most Short index jumped 12.5%. The Philadelphia Oil Services index surged 19.3%.

Some of the problem-children EM currencies bounced strongly. The South African rand gained 8.2% in January, the Russian ruble 6.6%, Brazilian real 6.2%, Chilean peso 6.0%, Colombian peso 4.6%, Thai baht 4.2%, Indonesian rupiah 3.0% and Mexican peso 2.9%. The Chinese renminbi gained 2.7% against the dollar in January.

Over the past month, local currency bond yields were down 137 bps in Lebanon, 93 bps in the Philippines, 50 bps in Russia, 47 bps in Brazil, 34 bps in Cyprus, 33 bps in Hungary and 21 bps in Mexico. Equities gained 19.9% in Argentina, 14.0% in Turkey, 13.5% in Russia, 10.8% in Brazil, 9.6% in South Korea and 9.2% in Colombia. Dollar-denominated bond yields sank 124 bps in Argentina, 100 bps in Ukraine, 50 bps in Turkey, 34 bps in Indonesia and 35 bps in Russia.

January was also a big month for European equities. Major stock indices returned 8.9% in Portugal, 8.1% in Italy, 6.6% in Spain, 5.6% in France, 5.8% in Germany, 6.4% in Switzerland, 8.2% in Finland, 7.6% in Sweden and 8.7% in Austria. January saw 10-year sovereign yields drop 15 bps in Italy, nine bps in Germany, 15 bps in France, 22 bps in Spain, 10 bps in Portugal and 46 bps in Greece.

An overarching CBB theme over the years (debated compellingly generations ago): the problem with discretionary policymaking is that a policy mistake leads invariably to a series of mistakes. The Powell Fed coming quickly to the markets’ defense was a perpetuation of flawed policy doctrine. Moreover, it’s especially dangerous for central banks to so conspicuously buttress the securities markets at this late stage of historic speculative Bubbles. Calming language has an effect akin to electric shock therapy.

Clearly, such actions only further embolden a marketplace conditioned to reach for returns – adopting leverage while disregarding risk. Financial and economic stability are only further undermined. Blatant support of Wall Street will as well further erode public trust in such a critical institution. During the previous crisis, central bank measures were seen as vital to stabilization. I fear they will be viewed as fundamental to the problem in the coming crisis.

The delusion was the belief that zero rates and QE would over time support system stability. The “buyer of last resort” function during a time of crisis should never have morphed into the buyer of first resort for years of booming markets and economies. We’re now a full decade into aggressive stimulus, and global finance is more fragile than ever. Policy rates remain at zero and the ECB only recently ended its historic balance sheet expansion (to $4.7 TN). Yet economies throughout the Eurozone appear in – or headed toward – recession. Amazingly, despite a QE-induced collapse in market yields, Italy faces a recessionary backdrop with its fragile banks hanging in the balance.

Meanwhile, troubling data runs unabated in China. The Caixin China Manufacturing PMI dropped 1.4 points during January to 48.3, the low since gloomy February 2016. It was also the first back-to-back months below 50 (contracting manufacturing activity) since May/June 2016. To see China’s economy weaken in the face of ongoing rapid Credit growth should be alarming to the entire world.

January 27 – Bloomberg: “The number of Chinese companies warning on earnings is turning into a flood, with no industry spared from worsening demand. Some 440 firms disclosed on Wednesday — the day before a deadline to do so — that their 2018 financial results deteriorated… Of the more than 2,400 mainland-listed firms that have announced preliminary numbers or issued guidance this season, some 373 said they’ll post a loss, the data show. About 86% of those were profitable in 2017.”

In a globalized, digitized and serviced-based economy, I never viewed consumer price inflation as the prevailing QE risk in the U.S. For the U.S. and the world more generally, zero rates and Trillions of fabricated “money” have fomented interminable Monetary Disorder (on full display during the past two months). Once unleashed, there was no controlling it. Yet with global markets in a synchronized rally, one easily assumes the Fed and central banks have again worked their magic. Stability has engulfed the world. Nothing could be more detached from reality.

The world is in the throes of a precarious period. Ill-advised central banking has ceded a historic global market Bubble additional rope. Meanwhile, until something snaps it is reckless fiscal policies accommodated by ultra-low rates, along with the precarious market perception that central banks will have no alternative other than reinstituting QE. Central bank-induced Monetary Disorder has completely distorted sovereign debt markets, granting Washington politicians the proverbial blank checkbook. And it is worse than merely a marketplace devoid of “bond vigilantes.” Treasury yields are pressured downward by the fragility of global Bubbles and the expectation of aggressive monetary stimulus as far as the eye can see.

Reckless global monetary management fuels reckless global fiscal mismanagement. Here in the U.S., trillion-dollar plus federal deficits until the market invokes some discipline. And it’s all passed off as business as usual. If I were a bond, I’d be tense. Bailing on “normalization,” the Fed has essentially committed to perpetual loose “money” and stock market support. And in the event the risk market rally turns crazier, there’s just not much slack in the U.S. economy. Ten-year Treasury yields jumped six bps Friday (to 2.68%), although the more interesting move was the 16 bps surge in Italian yields (to 2.74%). Under the circumstances, gold’s $38 January advance was rather restrained.

To see securities markets – risk assets and safe haven alike – rally as they’ve done over recent weeks is something to behold. Sellers overwhelming the markets one month – buyers the next. Legitimate fears of illiquidity supplanted by the utter fright of being on the wrong side of the market and missing a rally. The S&P500 recorded its strongest January since 1987. It’s an apt reminder not to place too much faith in the “January effect”- especially when global markets are acutely speculative. With Monetary Disorder and Dysfunctional Market Structure operating at full-force, no reason not to expect 2019 to be anything but a momentous year.support of President Bashar al-Assad’s government.”

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