This is a syndicated repost published with the permission of Credit Bubble Bulletin . To view original, click here. Opinions herein are not those of the Wall Street Examiner or Lee Adler. Reposting does not imply endorsement. The information presented is for educational or entertainment purposes and is not individual investment advice.
October non-farm payrolls expanded a stronger-than-expected 128,000 (expectations 85k), in a month when the GM strike reduced payroll growth by upwards of 42,000 and another 20,000 positions were lost to a shrinking census workforce. September’s job gains were revised 44,000 higher to 180,000, and August payrolls were revised up 51,000 to 219,000. At 3.6%, the unemployment rate is near a 60-year low. Average hourly earnings were up 3.0% y-o-y, versus a ten-year average of 2.3%. And at 34.4 hours, Average Weekly Hours were right at the 10-year average (as well as the average from boom-times 2006-2007).
October 30 – Financial Times (Brendan Greeley and Colby Smith): “The Federal Reserve cut US interest rates by 25 bps for the third time this year but signalled that it has finished easing monetary policy for the time being, pending clearer economic data. The US central bank… said that uncertainty on the economic outlook justified its latest cut but chairman Jay Powell said that a preliminary US-China trade deal and lower risk of a no-deal Brexit had the potential to increase business confidence… After a two-day meeting in Washington, the Fed’s rate-setting committee made two significant changes to the language of its monetary policy statement. It said it would ‘assess the appropriate path’ for rates instead of saying it would ‘act as appropriate to sustain the expansion’… ‘This is a hawkish cut,’ said Peter Tchir, the head of macro strategy at Academy Securities.”
With a “hawkish” rate cut and stronger-than-expected October job growth, one might have expected some pressure on bond prices. Ten-year Treasury yields did rise (3bps) to 1.85% on the release of the Fed statement, only to reverse sharply lower during Chairman Powell’s press conference to end the session at 1.77%. Yields then dropped eight bps Thursday and rose only two bps on better payrolls data – to end the week down nine bps to 1.71%.
Modest adjustments to the FOMC’s policy statement could be interpreted as leaning “hawkish.” An hour-long discussion with the Fed Chair was decidedly “dovish.” Powell made it clear the bar to raise rates in the foreseeable future is being set at a height that would challenge the world’s leading pole vaulter.
Somehow, “inflation” was spoken 53 times during the course of an hour, testament to the degree contemporary policy doctrine has hopelessly diverged from reality.
From the Chairman’s prepared statement: “Inflation continues to run below our symmetric 2% objective. Over the 12 months through August, total PCE inflation was 1.4% and core inflation was 1.8%… We are mindful that continued below-target inflation could lead to an unwelcome downward slide in long-term inflation expectations.”
Question (New York Times’ Jeanna Smialek): “You’ve previously sort of compared this rate cutting cycle to the insurance cuts in the ’90s, and in both of those instances, the Greenspan Fed took those cuts back after a while. They raised rates again fairly quickly. And, I guess I’m just curious what the onus is for doing that in this cycle. What would make you guys decide it’s appropriate to raise interest rates again?”
Powell: “…The reason why we raised interest rates is because, generally, is because we see inflation as moving up or in danger of moving up significantly, and we really don’t see that now… So, we really don’t see that risk, and inflation expectations have also kind of moved down and sideways both surveys and market based over the course of this, of really the recent months. And… we think that inflation expectations are very important in driving actual inflation, and we’re strongly committed to achieving our 2% inflation objective on a symmetric basis. We think it’s essential that we do that. So, we’re not thinking about raising rates right now.”
Question (The Wall Street Journal’s Nick Timiraos). “You described the recent slide, Chair Powell, in inflation expectations as unwelcome. You said that inflation expectations are very important. What, if anything, would the Committee be prepared to do to address this slide in inflation expectations if it continued?”
Powell: “As I mentioned, we do think that inflation expectations are, they’re quite essential, quite central in our framework of how we think about inflation. We need them to be anchored in a level, at a level that’s consistent with our symmetric 2% inflation goal. And, we think that we need to conduct policy in a way that supports that outcome… We’re also, as part of our review, looking at potential innovations, changes to the way we think about things, changes to the framework, that would lead us, that would be more supportive of achieving inflation on… a symmetric 2% basis over time… We’re in the middle of thinking about ways that we can make that symmetric 2% inflation objective more credible by achieving symmetric 2% inflation. And, it comes down to using your policy tools to achieve 2% inflation, and that is the thing that must happen for credibility in this area.”
Responding to a question from Fox Business’s Edward Lawrence on the possibility of rate hikes next year in the event that some current uncertainties are “cleared up,” the Chairman stated: “You come back to the question of raising rates, so that’s really about inflation, and you know, we haven’t yet, we’ve just touched 2% core inflation to pick one measure.”
And Powell’s response to the risk of “Japanification” posed by Japanese journalist Naoatsu Aoyama: “…There are significant disinflationary pressures around the world. …We don’t think we’re exempt from those pressures, and we are, therefore, strongly committed to having inflation expectations anchored at the level that is consistent with the symmetric 2% inflation objective. That’s what we’re committed to, and we’ll use our tools to achieve. So, we take the risk very seriously… The risk is that what we’ve seen is other economies getting on a disinflationary path, but it’s been very hard for them to get off. Once inflation expectations start sliding down, inflation moves down… …We think that the right thing to do is to do what we can now to hold and really move inflation expectations up…”
Music to the Markets. If markets maintain high confidence in one specific outcome, it would be that the trend of global disinflationary pressures continues (and likely worsens). At this point, everything points to the Fed and global central bankers fixating on consumer-based inflation, leaving the likelihood of any tightening of monetary policies over the short- and intermediate- term as remote. At the same time, markets see the probability of central banks being disappointed by below-target inflation rates as high. Further aggressive monetary stimulus is anticipated. And with global policy rates already so low, this ensures the future will see even greater reliance on QE. And, clearly, central bankers are determined to ignore excesses. The chorus: Music to the Markets.
And if Powell suggesting the prevailing focus on higher inflation wasn’t specific enough, the downgrading of the financial stability (mentioned only six times) mandate was surprisingly direct.
Question (Market News’ Jean Yung): “I wanted to ask about financial stability risk. Recently, the IMF and some other global policy makers have been expressing concerns over the high level of risk in corporate debt. So, as rates get lower in the U.S. and around the world, are you more worried about financial stability reach for yield?
Chairman Powell: “So, we monitor financial stability risks very carefully all of the time. It’s what we do since the financial crisis… Currently, we don’t see large imbalances. This long expansion is notable for the lack of large financial imbalances like the ones we’ve seen certainly before the crisis happened. So, we have a four-part framework, I’ll quickly mention. The first is leverage in the financial system which is low by historical standards. The second is funding risk which is the risk of runnable funding, and that risk is also quite low for banks but also for the nonbanking financial sector. If you look at asset prices, we see some high asset prices, but not broadly across a range. We don’t see bubbles in that kind of thing. And, that leaves the fourth which is leverage in the nonfinancial sector and that’s households and businesses. So, with households, again, we don’t see leverage. We see them actually getting in very good shape financially in the aggregate. Obviously, plenty of households are not in great shape financially, but in the aggregate, the household sector’s in a very good place. That leaves businesses which is where the issue has been. Leverage among corporations and other forms of business, private businesses, is historically high. We’ve been monitoring it carefully and taking appropriate steps. That’s what I would say, but it’s corporate debt is one part of a larger part of our framework, and it is something that we’re paying quite a bit of attention to, and it’s been part of the last couple of shared national credit exams, and we’ve been monitoring it carefully and taking appropriate action.”
“This long expansion is notable for the lack of large financial imbalances…” “Leverage in the financial system… is low by historical standards…” “…Funding risk which is the risk of runnable funding, and that risk is also quite low…” “We don’t see bubbles…” As for the household sector, “we don’t see leverage”; “very good shape financially”; and “in a very good place.” “That leaves businesses which is where the issue has been.”
Sound analysis would today have central bankers downplaying consumer price inflation, while elevating financial stability as the overarching priority. It’s Music to the Markets that the Fed apparently sees no stability risk on the horizon that would pressure the Fed into pulling back on monetary stimulus. This is a momentously misguided.
The mortgage finance Bubble period was dominated by the rapid expansion of household mortgage debt. There were huge excesses involved in both the financial sector’s intermediation of mortgage risk and with speculative leverage. Today’s “notable… lack of large financial imbalances” completely ignores federal government debt said this week to have reached $23 TN, up from about $9.5 TN to end 2008. Moreover, there’s overwhelming analytical support for the view that today’s global sovereign debt markets are history’s greatest episode of asset inflation, distorted markets and speculative price Bubbles.
We’re now a decade into the “global government finance Bubble.” Fundamental excesses have unfolded in sovereign debt and central bank Credit. When Chairman Powell states, “That leaves businesses…”, he is using a conventional analytical framework ignoring the government sector and the central bank. Both have employed unprecedented leverage during this cycle, a massive Credit expansion that continues to support the purported soundness of the household and financial sectors. In contrast to the previous Bubble, the nucleus of the current Credit boom is money-like instruments (i.e. Treasuries and central bank Credit) that have been issued in outrageous quantities without the need for risk intermediation through the financial sector.
From a conventional “financial stability” standpoint, this Credit cycle may appear virtually pristine. Yet Credit Bubbles survive only with unrelenting debt growth. Today’s mirage of “financial stability” depends on ongoing massive federal deficits coupled with aggressive monetary stimulus.
A further rebuttal to Powell’s sanguine commentary on leverage and funding risks is appropriate. Is not recent “repo” market upheaval testament both to problematic leverage and funding issues? Have we already forgotten acute market fragilities unmasked less than a year ago?
It’s clear that speculative securities leverage is a huge facet of the current Bubble, much of it domiciled in “offshore financial centers” and securities funding markets (and derivatives) internationally. Moreover, I’ve used the concept of “moneyness of risk assets” (expanding the previous cycle’s “moneyness of Credit”) as an overarching facet of the “global government finance Bubble.” Dr. Bernanke unleashed central bank inflationary activism to instill the perception of liquidity and safety upon risky financial instruments (equities, corporate Credit, derivatives, etc.), in the process empowering Wall Street opportunism and innovation. The Fed – and global central bankers more generally – are deluding themselves when they downplay the risk of a crisis of confidence and resulting run on the ETF complex and other perceived safe and liquid instruments and strategies (including “repos”!).
And while on the subject of runs…
November 1 – Bloomberg: “It started with an unverified rumor from an obscure social media account: Yichuan Rural Commercial Bank was insolvent. Within hours of the post on Tuesday, more than 1,000 worried customers had lined up to withdraw their money. By Wednesday, a run on the bank had prompted local authorities to arrange more than 30 billion yuan ($4.3bn) of liquidity injections. As branch staff sought to restore confidence, they displayed stacks of cash to convince depositors that there was enough to go around. While the panic appeared to subside on Friday, the episode marked the latest test of faith in more than 2,000 rural Chinese lenders that collectively control $5 trillion of assets. Confidence in their financial strength has dwindled since May, when the government seized a bank for the first time since 1998 and imposed losses on some of its creditors.”
Meanwhile…
October 29 – Bloomberg: “A Chinese company’s bond default is causing market concern that trouble may spread to other firms in the province. Shandong-based steelmaker Xiwang Group Co.’s failure to repay 1 billion yuan ($142 million) of bonds last week, saw investors dump neighboring firms’ notes on contagion fears as companies in this province are well known for providing guarantees for each other’s debt. China Hongqiao Group Ltd.’s dollar bond due 2023 and Shandong Sanxing Group Co.’s 2021 dollar bond have both dropped to their lowest levels after Xiwang’s default… ‘Xiwang’s default onshore has raised concerns that other privately owned enterprises in Shandong, particularly those from the same locality, may have been associated with the firm,’ said Wu Qiong, executive director at BOC International Holdings…”
And a curious development…
October 30 – Bloomberg: “A sell-off in China’s sovereign notes is weighing on its corporate bond market. The yield spread between the country’s top-rated three-year corporate bonds over government securities of the same tenor widened this week to its highest in four months… That’s after the 10-year sovereign bond yield rose to the highest in five months. It’s also hit sales of new company bonds, with the most amount of cancellations this month since June.”
China’s 10-year sovereign yields rose three bps this week to 3.27%, trading earlier in the week at the high (3.33%) since May. With bank failures and corporate defaults poised to significantly escalate going forward, a major expansion of China central government debt should be expected. I continue to ponder the amount of leverage that has accumulated in relatively high-yielding Chinese Credit instruments (government, corporate and financial). A “phase 1” trade deal and associated truce have reduced the odds of trade war escalation becoming a near-term catalyst for upheaval and crisis. At the same time, the risk of acute financial and economic instability in China remains highly elevated.
I suspect China happenings put some downward pressure on global yields this week. And lower yields continue to support equities and corporate Credit markets. One could look at various negative developments (i.e. China, impeachment proceedings, Brexit, global unrest, etc.) and question the rationality for the risk markets’ vision of nothing but blue skies ahead. It’s not entirely irrational. Trouble in China ensures additional Beijing stimulus, along with heightened disinflationary risks that will keep the Fed, PBOC, ECB, BOJ and others pushing monetary stimulus. Impeachment risk? Doesn’t that virtually guarantee President Trump will strike a deal with the Chinese, while avoiding policies, comments and tweets that might upset the applecart?
October 31 – Bloomberg (Margaret Collins): “President Donald Trump resumed his attacks on the Federal Reserve and its Chairman Jerome Powell, a day after it cut interest rates for the third time this year. ‘People are VERY disappointed in Jay Powell and the Federal Reserve,’ Trump tweeted… ‘The Fed has called it wrong from the beginning, too fast, too slow.’”
With the Fed having cut rates three times in three months, while expanding its balance sheet by $239 billion in seven weeks, one would think the President might back off.
November 1 – Wall Street Journal (Michael S. Derby): “The Federal Reserve Bank of New York added $104.583 billion in temporary liquidity to financial markets Friday, when it also added permanent reserves to expand its balance sheet. The Fed’s intervention came in two parts. One was through repurchase agreements that expire Monday, in which the Fed took in $73.133 billion in securities; the other was a 13-day repo operation that took in $31.45 billion. The Fed also bought $7.501 billion in Treasury bills.”
Concluding his prepared comments, Chairman Powell addressed operations to expand Federal Reserve Credit through the purchase of T-bills (to expand bank reserves): “These actions are purely technical measures to support the effective implementation of monetary policy as we continue to learn about the appropriate level of reserves. They do not represent a change in the stance of monetary policy. In particular, our Treasury bill purchases should not be confused with the large-scale asset purchase programs that we deployed after the financial crisis. In those programs, we purchased longer-term securities to put downward pressure on longer- term interest rates and ease broader financial conditions. In contrast, increasing the supply of reserves by purchasing Treasury bills only alters the mix of short-term assets held by the public and should not materially affect demand and supply for longer-term securities or financial conditions more broadly.”
That the Fed would move to expand its balance sheet by hundreds of billions with the stock market at record highs, financial conditions loose, and the economy in expansion, clearly conveys, once again, that the Federal Reserve has no tolerance for market adjustment or correction. Why do we need a multi-trillion “repo” market, anyways? Is it compatible with a financial stability mandate that the Fed openly nurtures speculative leveraging? Silly me: with consumer prices slightly below target – and the U.S. economy “in a good place” – no need to be concerned with egregious speculative leverage at the heart of the financial system. Nothing but Music to the Markets.
Join the conversation and have a little fun at Capitalstool.com. If you are a new visitor to the Stool, please register and join in! To post your observations and charts, and snide, but good-natured, comments, click here to register. Be sure to respond to the confirmation email which is sent instantly. If not in your inbox, check your spam filter.
