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July 11 – Bloomberg (Rich Miller): “Federal Reserve Chairman Jerome Powell is starting to sound a bit like he’s the world’s central banker. In Congressional testimony this week, he repeatedly cited a slower global economic expansion in laying out the case for easier U.S. monetary policy. ‘There’s something going on with the growth around the world, particularly around manufacturing and investment and trade,’ he told the House Financial Services Committee… as he all but promised an interest-rate cut at the end of this month.”
Chairman Powell was decisive. While not directly announcing an imminent cut, he essentially pre-committed to reducing rates at the July 31st meeting. Record stock prices don’t matter. Booming corporate Credit is no issue. June’s big gain in payrolls and a 3.7% unemployment rate are not part of the decision function. A Friday afternoon Bloomberg headline resonated: “A Stock Market Dying to Know What Powell Knows About the Economy.”
The so-called “insurance” rate cut is all about the global environment, with monetary policy’s traditional domestic focus relegated to history. The reduction will be justified by “crosscurrents,” “uncertainties” and below-target inflation. But is the global economy really in such bad shape to warrant preemptive monetary stimulus during a period of market ebullience? What Does Powell – and his cadre of global central bankers – Know?
China’s GDP is expected to expand between 6.0% and 6.5% this year. While slowing, growth throughout EM is forecast between 3.0% and 4.0%. Nothing to write home about, but euro zone GDP is expected to exceed 1.0% this year. Japan could see 3.0% 2019 GDP growth. Bank American Merrill Lynch today lowered their forecast for 2019 global GDP growth to 3.3% from 3.6%. Deserving of even lower rates and more QE?
I don’t believe the primary impetus behind the global central bank swing toward additional stimulus is economic. Indeed, I see Powell, Draghi, Carney, Kuroda and the like confirming the Acute Global Financial Fragilities Thesis. This fanciful notion of “insurance” stimulus will be debated for years to come. A system suffering from risk aversion, illiquidity and Credit contraction would be expected to experience some perk from monetary stimulus. But a global financial “system” already excessively embracing risk, wallowing in liquidity abundance and generating record Credit growth will be only further destabilized by greater stimulus.
I’ve been long fascinated by how things turn “crazy” at the end of cycles. My thesis is the world is in the late stage of an extraordinary multi-decade Credit Bubble. From this perspective, we should not be surprised by phenomenal late-cycle excess.
July 9 – Bloomberg (Samuel Potter, Laura Benitez, and Anooja Debnath): “The global bond rally is so fierce that even on an off-day investors keep piling in. Such is the frenzy for government debt just now that Italy, long considered Europe’s fiscal problem child, on Tuesday attracted demand of around 17.5 billion euros ($19.6bn) for bonds that won’t mature until 2067. With yields near the lowest since before the populist coalition came to power in June 2018, investors fell over themselves to allocate to the 3 billion euro offering… Negative yields are creeping in at Europe’s fringes. The number of corporate junk bonds trading with a sub-zero handle in euros now stands at 14 — at the start of the year there were none. Money managers are killing it on debt that won’t mature for nearly 100 years.”
July 10 – Financial Times (Tommy Stubbington): “In the bizarro world of global debt, even bonds from Europe’s emerging markets are spewing out negative yields. Sky-high bond prices… are increasingly spilling into what was once considered risky territory. All of the Czech Republic’s euro-denominated debt, for example, now trades at sub-zero yields… Short-dated Hungarian bonds and a growing slice of Poland’s debt are following suit, with Warsaw’s 10-year yields just fractionally above zero. Emerging market investors, who traditionally viewed these markets as their domain, are being forced to look further afield for returns, fueling a debt rally from Croatia to Kazakhstan.”
Bizarro World, indeed. Why is financial history strewn with markets succumbing to bouts of end-of-cycle insanity? The obvious answer is greed – greed that became deeply ingrained after a protracted period of being richly rewarded (with fear and caution punished mercilessly). The longer the cycle the more intense and resilient the greed dynamic. The more of the “house’s” money available to gamble, the more extravagant the bets. I would add that prolonged cycles typically have some type of underlying government support that over time comes to underpin confidence and risk-taking (playing an especially critical role late in the cycle).
The great late-twenties Bubble doesn’t inflate if not for confidence that the Federal Reserve possessed both the will and capacity to sustain the boom. The mortgage finance Bubble doesn’t inflate without implicit Treasury mortgage debt guarantees and the prevailing view “Washington will never allow a housing bust.” The ongoing historic Chinese Credit Bubble deflates years ago without faith that Beijing will backstop virtually the entire financial system. Confidence that global central bankers will do “whatever it takes” to sustain the boom is fundamental to the ongoing inflation of the all-encompassing “global government finance Bubble.”
But greed and governmental support are insufficient to inflate Bubbles. Bubbles are fueled by Credit. I would add that “money” is also key. Credit booms can’t survive to become “protracted” without the expansion of perceived safe and liquid (money-like) Credit instruments (enjoying insatiable demand). Some monetary disturbance that takes root. A self-reinforcing expansion of “money” and Credit foments Monetary Disorder and, if not contained, culminates in a parabolic spike in the prices of speculative assets.
I have long argued that speculative leverage plays an instrumental role as the marginal source of system liquidity. Especially in our age of contemporary unfettered finance, there is endless capacity to expand finance for the purpose of levering securities holdings. In a “risk on” market backdrop, risk-taking and leverage create liquidity abundance. But as we witnessed again in December, the shift to “risk off” de-risking/deleveraging can swiftly unmask the liquidity illusion.
With China’s financial fragilities turning more acute, EM finance/economies generally vulnerable, the global economy susceptible to heightened trade tensions, and speculative market Bubbles highly exposed – “risk off” lies in wait. Enter Chairman Powell, Central Banker to the World, with assurances of an “insurance” rate cut. The Fed has not only provided extra juice to “risk on,” it has splashed cold water on the dollar. King dollar, after all, would pressure the vulnerable Chinese renminbi and EM more generally.
Curiously, global markets these days seem less focused on China’s economic data and more on Chinese Credit. There’s some rationale. Beijing is ready with additional stimulus if the economy weakens more than expected. What matters most is Chinese lending and Credit growth. Sufficient Credit expansion sustains the Chinese Bubble – that in many ways is sustaining EM economies, markets and global growth more generally.
Weak June trade data confirm Chinese economic weakness. China’s June exports were down 1.3% y-o-y. Indicating notably soft domestic demand, June Imports were down 7.3% from June ’18. China’s trade surplus jumped to a stronger-than-expected $50.98 billion. China posted an almost $30 billion trade surplus with the U.S. Imports from the U.S. sank 31.4% from a year ago (soybean imports down 37%!) to only $9.4 billion. Exports to the U.S. ($39.3bn) were 7.8% below June ’18.
Despite increasing cracks at the “periphery,” China’s Credit boom endures. Total Aggregate Financing (roughly total Credit less most governmental borrowing) expanded a stronger-than-expected $329 billion in June, up more than 50% from May’s $203 billion. June is typically a strong month for Chinese Credit growth, but last month’s growth was 50% above June ’18. Aggregate Financing increased $1.921 TN during 2019’s first half, 31% ahead of H1 2018 growth. Total Aggregate Financing ended June at $31.19 TN, up 10.9% over the past year.
New (yuan) Loans expanded $241 billion during June, the strongest monthly expansion since March ($245bn). June Loans were up from May’s $172 billion but down from June ‘18’s $267 billion. First half Loan growth of $1.405 TN ran 7% ahead of comparable 2018. One-year Loan growth of $2.442 TN was 15% stronger than comparable growth from the previous year.
Consumer (chiefly mortgage) Loans expanded $110 billion last month, up from May’s $96 billion, and 8% ahead of growth from June ’18. Consumer Loans expanded 17.1% over the past year; 39% over two years; 72% in three years; and 138% in five years. No mystery surrounding ongoing apartment price inflation and robust consumer spending.
China’s Special Government Debt issuance jumped to $52 billion during June, triple May’s volume to the strongest expansion since September ’18. At $173 billion, first half issuance was triple comparable 2018. Corporate Loan growth also bounced back strongly in June, rising to $132 billion. First half Corporate loan growth of $909 billion ran 21% ahead of comparable ’18.
China’s economy is experiencing less and less bang for each renminbi of new Credit. China’s Bubble is acutely vulnerable, yet the borrowing and lending binge runs unabated. Runaway Credit expansion, maladjusted economic structure, and faith in Beijing’s power to sustain the boom have fomented Acute Monetary Disorder. And with China leading the global Credit boom in concert with extremely loose monetary policies globally, one has the recipe for rather historic global end-of-cycle craziness.
Combine China’s historic Credit expansion with an ECB balance sheet that almost doubled to $4.75 TN in three years of QE; a Bank of Japan balance sheet that expanded $1.2 TN to $5.2 TN since the end of 2016; and U.S. Credit growth back to record levels, and one has ample fuel for global craziness. Rampant speculative leverage pushes things past the breaking point.
It’s become an acutely fragile global Bubble. The Fed, ECB and global central banks have moved to provide support, effectively throwing gas on the fire. There are conspicuous cracks, yet liquidity abundance and speculative impulses prevail. Turkey’s strongman President fires the head of the central bank for not aggressively cutting interest rates and the lira is down less than 2%. Cracks in India’s financial system widen, and the world barely notices. Italy’s 50-year bond auction is massively oversubscribed with a yield of 2.88% – with foreign “investors” accounting for 80% of the demand. Negative yields for junk issuers in the euro zone. Eastern European sovereign debt at or near negative yields. S&P500 surpasses 3,000 in the face of a deteriorating earnings outlook.
There was the “permanent plateau” shortly before the 1929 crash. Tech stocks embarked on a final speculative melt-up in Q1 2000 in the face of rapidly deteriorating industry and economy fundamentals. And “still dancing” in the summer of 2007, and so on. Monetary Disorder ensures late-cycle market detachment from reality.
Lost in all the exuberance, late-cycle excesses sow the seeds of self-destruction. After trading at negative 38 basis points in Monday trading, 10-year bund yields jumped almost 20 bps to trade at negative 18.5 bps by Friday morning. Spanish yields surged 25 bps this week – Portuguese yields 22 bps, Greek 21 bps and French yields 15 bps. Yields this week surged 46 bps in Lebanon, 42 bps in Turkey and 25 bps in Cyprus. Stronger-than-expected French industrial production were said to ameliorate concerns for the European economy. It has the early appearance of a key reversal following a speculative blow-off.
Ten-year Treasury yields jumped nine bps this week to 2.09%. June core CPI was reported up a non-disinflationary 2.1% y-o-y. Perhaps, with trade wars, tight job markets and rising real wages, inflation is not dead and buried after all. Things get interesting if the Treasury market starts to focus on massive supply, waning foreign demand and the potential for an inflation surprise.
Friday evening from the Financial Times (Robin Wigglesworth): “Has the Federal Reserve Fallen Victim to Bond Market Bullies?” “The bond market ‘vigilantes’ of old used to bully wastrel governments. Now they appear to have moved on to a grander target — the US Federal Reserve.”
Crisis-period QE changed the functioning of global markets. Permanently including QE in central banks’ standard toolkit has transformed global finance and Capitalism in ways not comprehensible at this juncture. The bond “vigilantes” are extinct. This has provided central banks unprecedented latitude to discard convention and follow their every whim. It has also conveniently removed a major risk (spike in yields) for equities. But is has also opened the fiscal floodgates, where monetary policies ensure the accommodation of huge deficit spending at extremely low borrowing costs. QE and the resulting death of the vigilantes have also empowered the strongman leader to subvert central bank independence.
Remember James Carville’s, “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.” That was before QE. Today’s bond market intimidates no one. Threatening – or even firing – the head of a central bank for not cutting rates – is a non-issue for today’s bond market. Ditto massive deficits. Why worry about supply, myriad excesses or politicizing monetary management when the magic of QE can make everything good?
Today’s “crazy” is incredibly dangerous. No check and balances. Markets have lost the capacity to self-adjust and correct. Sovereign debt, the foundation of global finance, has succumbed to unprecedented price distortions – and it only gets worse from there: The Speculative Blow-Off for Global Financial Assets. And I appreciate it all appears reasonable and unsustainable – so long as securities prices continue to inflate. But it will function poorly in reverse. The crazier things get the more unsustainable Bubble prices become.
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