Double Shot! World Economy Haunted by Risk Just Got a Double Shot in the Arm (How Long Before Mortgage Rates Rise??)

Its a double shot of economic love!

(Bloomberg) — Two of the biggest hurdles constraining the world economyhave just been cleared.

Dogged for most of 2019 by trade tensions and political risk that hammered business confidence, the outlook for global growth will enter 2020 on a firmer footing after the U.S. and China struck a partial trade deal and outlook for Brexit cleared somewhat.

“The China trade deal and U.K. election result have taken out a major tail risk overhanging markets and companies,” said Ben Emons, managing director for global macro strategy at Medley Global Advisors in New York. “Business confidence should see a large boost that could see a restart of global investment, inventory rebuild and a resurgence of global trade volume.”

Like financial markets, most economists had factored in some kind of phase-one trade agreement between the world’s largest economies when projecting the world economy would stabilize into 2020 after a recession scare earlier this year.

But at a minimum, the agreement between President Donald Trump and President Xi Jinping means some of the more dire scenarios being contemplated just a few months ago now appear less likely. 

Bloomberg Economics estimated in June that the cost of the U.S.-China trade war could reach $1.2 trillion by 2021, with the impact spread across the Asian supply chain. That estimate was based on 25% tariffs on all U.S.-China trade and a 10% drop in stock markets.

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Both the VIX and TYVIX are near historic lows.

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With this bevy of good news, how long before residential mortgage rates rise??

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Of course, forecasting is difficult … like forecasting your second wife.

 

The Repo Bash! The Fed Has ‘Absorbed’ 90% Of Treasury Issuance Since September

I call this The Repo Bash. 

The fear of a year-end liquidity crisis is leading to a deluge of overnight repo operations.

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As Treasury issues more and more debt, The Federal Reserve is snatching it up. Or as Lee Adler found, since September 90% of Treasury issues have been absorbed by The Fed.

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Here is Lee’s graphic showing the increase in Treasury debt and the 90% absorption by The Fed.

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This is know as “debt monetization.” Essentially what is happening in Japan.

Treasury Secretary Steven Mnuchin meeting with Fed Chair Jerome Powell to discuss Federal debt monetization.

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Perhaps “Monster Mash” is more appropriate.

Fed Leaves Rates on Hold; Forecasts Show No Change Through 2020

(Bloomberg) — The Federal Reserve left interest rates unchanged and signaled it would stay on hold through 2020, keeping it on the sidelines in an election year while also opening the possibility it might buy short-term coupon-bearing securities to ease money-market strain.

“Our economic outlook remains a favorable one despite global developments and ongoing risks,” Chairman Jerome Powell told a press conference Wednesday in Washington following the decision. “As long as incoming information about the economy remains broadly consistent with this outlook, the current stance of monetary policy likely will remain appropriate.”

The Treasury 10-year yields fell below 1.8%, the dollar declined and U.S. stocks edged higher. Powell spoke after the Federal Open Market Committee held the target range of the federal funds rate steady at 1.5% to 1.75% and its median forecast showed no rate change through next year.

“The FOMC’s monetary policy message is that the Fed is on hold and that it would take some significant change in the outlook to induce the Fed to move,” Roberto Perli, a partner at Cornerstone Macro LLC in Washington, wrote in a note. “Powell, however, made some news when talking about the problems affecting the repo market.”

Powell told reporters that the committee might consider widening reserves management-related Treasuries purchases to include short-term coupon-bearing securities, if necessary, to ease liquidity strains in money markets.

Here is the current Fed “Dots Plot” indicating a hold on rate changes through 2020, but rising after the 2020 election.

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The Fed has helped push relevant rate to around 1.576%.

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Jerome Powell should be happy that someone hasn’t painted a picture of him ala Mexican revolutionary hero Emiliano Zapata.

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Jesse?

Supernatural! US Payrolls Smash Expectations With 266K Jobs Added (Average Hourly Earnings Climbed 3.1% YoY)

Supernatural!

Hiring roared back in a big way in November. U.S. employers added 266,000 jobs last month, topping all expectations, according to a Labor Department report Friday. The surge was boosted by General Motors Co. workers returning to work after a 40-day strike.

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Meanwhile, average hourly earnings climbed 3.1% from a year earlier, beating forecasts.

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The US jobless rate dipped to 3.5% and the underemployment rate dropped to 6.9%.

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On the unexpected bounce in jobs, the 10Y-3M yield curve is no longer screaming recession.

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And the US Treasury Actives curve and US dollar swaps curves are pretty similar from 2 years to 10 years.

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Supernatural!

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Recession Around The Corner? Evidence From Treasury Market And S&P 500 Earnings Sentiment

It has been the longest bull market in modern history, enabled by massive Central Bank intervention. But with trade wars raging, Brexit, Presidential impeachment over something, etc., there remains a significant risk of a recession over the next 12 months.

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If we look at the normalized change in the 10Y-3M curve minus normalized change in 10Y yields, we can see a heightened recession risk.

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Lower yields and steeper curves are not a good recipe.

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And then we have the decline in S&P 500 earnings estimates.

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Recession coming?

The Way Out for a Global Economy Hooked On Debt? Even More Debt (??)

Apparently, debt control is out of the question in this era of low interest rates. There is seemingly only one way out … and that it is MORE debt.

(Bloomberg) — Zombie companies in China. Crippling student bills in America. Sky-high mortgages in Australia. Another default scare in Argentina.

A decade of easy money has left the world with a record $250 trillion of government, corporate and household debt. That’s almost three times global economic output and equates to about $32,500 for every man, woman and child on earth.

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Much of that legacy stems from policy makers’ deliberate efforts to use borrowing to keep the global economy afloat in the wake of the financial crisis. Rock bottom interest rates in the years since has kept the burden manageable for most, allowing the debt mountain to keep growing.

Now, as policy makers grapple with the slowest growth since that era, a suite of options on how to revive their economies share a common denominator: yet more debt. From Green New Deals to Modern Monetary Theory, proponents of deficit spending argue central banks are exhausted and that massive fiscal spending is needed to yank companies and households out of their funk.

Fiscal hawks argue such proposals will merely sow the seeds for more trouble. But the needle seems to be shifting on how much debt an economy can safely carry.

Central bankers and policy makers from European Central Bank President Christine Lagarde to the International Monetary Fund have been urging governments to do more, arguing it’s a good time to borrow for projects that will reap economic dividends.

“Previous conventional wisdom about advanced economy speed limits regarding debt to GDP ratios may be changing,” said Mark Sobel, a former U.S. Treasury and International Monetary Fund official. “Given lower interest bills and markets’ pent-up demand for safe assets, major advanced economies may well be able to sustain higher debt loads.”

A constraint for policy makers, though, is the legacy of past spending as pockets of credit stress litter the globe.

At the sovereign level, Argentina’s newly elected government has promised to renegotiate a record $56 billion credit line with the IMF, stoking memories of the nation’s economic collapse and debt default in 2001. Turkey, South Africa and others have also had scares.

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As for corporate debt, American companies alone account for around 70% of this year’s total corporate defaults even amid a record economic expansion. And in China, companies defaulting in the onshore market are likely to hit a record next year, according to S&P Global Ratings.

So called zombie companies — firms that are unable to cover debt servicing costs from operating profits over an extended period and have muted growth prospects — have risen to around 6% of non-financial listed shares in advanced economies, a multi-decade high, according to the Bank for International Settlements. That hurts both healthier competitors and productivity.

As for households, Australia and South Korea rank among the most indebted.

The debt drag is hanging over the next generation of workers too. In the U.S., students now owe $1.5 trillion and are struggling to pay it off.

Even if debt is cheap, it can be tough to escape once the load gets too heavy. While solid economic growth is the easiest way out, that isn’t always forthcoming.

Well, despite the conventional economic wisdom that public debt growth is fine as long as GDP grows at the same rate, the USA has almost always experienced higher rates of debt growth than GDP growth (YoY).

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Modern Monetary Theory (MMT) makes as much sense as this 1960s/1970s photo. (Is that New York Times opinion columnist Paul Krugman??)

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Achy-Breaky Curves: US Treasury Curve Flat For 5 Years, THEN Rises (Swaps Curve Inverted)

The US Treasury actives curve has gone achy-breaky.

That is, going out to 5 years, the US Treasury actives curve is overall flat, with undulations.

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And the US dollar swaps curve is higher at 3 months than at any other point on the curve.

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Here is a video of me forecasting the US Treasury yield curve.

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High-Beta Stock Trade Seizes Up Right After Everyone Piled In

High beta investment strategies are great … when the market is rising. But low (and negative beta) strategies seem appropriate when investors anticipate an equity market downturn.

Bloomberg — The market, it’s said, finds a way to maximize the pain. For everyone who fell in love with cyclical shares just in time for them to drop the most in two months this week, it’s an adage they can relate to.

Lurches in retail, technology and commodity stocks are spelling trouble for newly christened macro bulls, sending an exchange-traded fund that tracks high-volatility shares to its first decline since October. Back on top are health care, utilities and real estate, defensive sectors that dominated all year.

While none of the moves were huge, they stung fund managers who hoped economically sensitive industries were tickets to redemption after 71% of them trailed benchmarks through October. Betting on volatile shares has been a hallmark of late-season recovery strategies that looked like a sure thing as the S&P 500 rallied. This week was a reminder they’re not.

High-beta ETF falls for first week in five

Among struggling equity managers, a spate of improving economic reports opened their eyes to the possibility a pivot point was at hand for cyclicals. The veil lifted, mutual funds dutifully raised overweight exposure to the highest level in two years, according to Goldman Sachs, increasing allocations toward industrials and semiconductors and away from utilities and staples.

Here is the Invesco High Beta ETF, having a historic beta (relative to the S&P 500 index) of 1.30.

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The Invesco bond fund has a beta of 0.073.

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Invesco’s mortgage ETF (primarily backed by agency MBS) has a beta of … -0.025 relative to the S&P 500 index.

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Lastly, we have the Invesco Muni fund with a beta of 0.044.

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Of course, investors can hedge market downturns using options.

And we are talking about BETA and not BETO!

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Deutsche Bank Slides On ECB Warnings As It Plans To Replace 18,000 Workers with “Robots”

Deutsche Bank made the news, both in terms of an ECB warning and job cuts.

First, Deutsche Bank shares led rivals lower Wednesday after the European Central Bank warned that low interest rates could lead to excessive risk taking that could threaten the single currency area’s financial stability and noted deteriorating earnings prospects for regional lenders.

Deutsche Bank, like a number of Eurozone banks, has been crushed since peaking in 2007.

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Of course, DB’s earning per share have been plunging like the German battleship Bismarck (along with the share price).

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Cutting expenses is one way to increase EPS.

According to MishGEA, Deutsche Bank to Replace 18,000 Workers with Robots. Mark Matthews, head of operations for Deutsche’s corporate and investment bank, told Financial News that machine learning algorithms “massively increased productivity” and “redistribute capacity.”

The London-based news organization said that Deutsche is pushing to “automate large parts of its back-office” via a new strategy called “Operations 4.0,” as part of its $6.6 billion savings initiative over the next three years.

Matthews told FN that the machine learning tools helped to save “680,000 hours of manual work” and that it “so far used bots to process 5 million transactions in its corporate bank and perform 3.4 million checks within its investment bank.”

Of course, Meadows is referring to machine learning algorithms, not robots like in “Lost in Space.”

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Now GMU finance students will understand why I force Python and Matlab on them in my classes!

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To paraphrase the late Johnny Horton, “The Germans had the biggest bank that had the biggest guns.”

Fed Monkey? Mega Bond Sell-Off Spurs $1.2 Billion Outflow From Treasury Fund As Gold Futures Decline

As Europe shows signs of economic life and US recession fears dim, we are seeing an exodus from long-dated Treasuries and a large turnover in gold futures. But are markets expecting more active intervention by The Fed? (Aka, Fed Monkey).

(Bloomberg) — Investors are pulling the plug on a strategy tracking long-dated Treasuries as U.S. stocks trade near all-time highs.

The iShares 20+ Year Treasury Bond exchange-traded fund, ticker TLT, posted its worst week of outflows on record, with traders yanking more than $1.2 billion, according to data compiled by Bloomberg. The 10-year U.S. government bond yield soared in the span, approaching 2%.

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Meanwhile, gold futures fell to a three-month low as contracts equal to over 3 million ounces changed hands in half an hour on the Comex.

In the 30 minutes ended 10:30 a.m. in New York Monday, 33,596 contracts were traded, more than triple the 100-day average for that time of day. Futures have declined in recent weeks as growth concerns ebbed, damping haven demand for the precious metal.

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Is The Fed Monkey recession prevention system working?

A thanks to our veterans on this Veterans’ Day!