Mambo Italiano! Italy Falls Into Recession (Again) as Output Shrank More Than Forecast (Italian Bank Assets Plummet, ECB Ineffective)

It is the continuing mambo of Italy falling into recession.

(Bloomberg) —  Italy fell into recession at the end of 2018, capping a year of political turmoil, higher borrowing costs and fiscal tensions that took their toll on the economy.

Output contracted 0.2 percent in the three months through December, following a 0.1 percent fall in the previous quarter, statistics agency Istat said Thursday in Rome. The year-end shrinkage was greater than expected. 

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The data “reflect a marked worsening of the industrial sector’s performance, and of a negative contribution of agriculture,” Istat said in releasing the data. It said services’ activity “stagnated.”

Premier Giuseppe Conte said Wednesday that he expected the fourth-quarter shrinkage, speaking in Milan a day before the official announcement.

Investors have been warily watching Italian economic performance following weeks of negotiations with the European Union over the government’s budget that pushed up bond yields. The latest round of bad news is likely to test market confidence in the government’s expansive program for 2019.

The fourth-quarter contraction was greater than a median estimate in a Bloomberg survey of 28 analysts that called for a quarterly shrinkage of 0.1 percent. The economy expanded 0.1 from the same quarter of 2017, while the full-year growth totalled 0.8 percent on a work-day-adjusted basis. 

The December unemployment rate fell to 10.3 percent, Istat said earlier in the day.

In addition to output declining (resulting in a real GDP QoQ reading of -0.20%), total assets of Italian banks have been plummeting. On the bright side, bank nonperforming loan rates are falling (but are still quite high at 14.4%).

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All this despite the ECB’s Main Refinancing Operations Annoucement Rate of … 0%.

Italy’s sovereign yield curve remains steeply upward sloping with short rates negative (courtesy of the ECB). 10Y SR CDS for Italy is 242.8 (elevated risk).

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Italy shows the limits of central bank zero-interest rate policies. Perhaps ECB head Mario Draghi should sing “Mambo Italiano” instead of distorting economies and asset prices.

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Fed Keeps Fed Funds Rate At 2.50%, Tepid On More Balance Sheet Normalization

Today, The Federal Reserve announced that their target rate remained at 2.5%.

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This was expected.

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But on further balance sheet unwinding, Fed Chair Thurston Powell III had this to say:

“In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes,”

Wednesday’s statement from the policymaking Federal Open Market Committee struck a more tepid approach.

The committee lowered its assessment of economic growth from “strong” to “solid” and noted that its inflation gauges “have moved lower in recent months.”

*Fed removes reference to further gradual rate increases
*Fed says it plans to continue with current floor approach
*Fed says it’s prepared to adjust balance-sheet normalization
*Fed reiterates federal funds target is primary policy tool
*Fed says economic activity rising at solid rate, jobs strong
*Fed says labor market strengthened, unemployment remained low
*Fed says spending grew strongly, investment moderated
*Fed says core and headline inflation remain near 2%

The reaction on the Dow? Investors seem to like Powell’s tepid message.

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And yield on 10-year Treasury Notes fell on the message.

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Fed Chair Thurston Powell III with wife Lovey (aka, Janet Yellen).

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Fed Balance Sheet Fracas Highlights Confusion Over Market Impact (Dazed And Confused? Or Communications Breakdown?)

Are financial markets “dazed and confused” by The Fed’s activities? Or is there a “communications breakdown?” Or are we “over, under, sideways, down” in terms of The Fed and asset bubbles?

(Bloomberg) — Wall Street has become obsessed with the Federal Reserve’s balance-sheet runoff, as investors debate why it’s suddenly roiling markets more than a year after it began.

There’s been no shortage of industry veterans sounding the balance-sheet alarm in recent weeks. . Billionaire Stanley Druckenmiller has called it a “double-barreled blitz” that coDoubleLine Capital Chief Executive Officer Jeffrey Gundlach says the unwind, interest-rate policy and guidance on where the two are headed have resulted in the equivalent of 15 implied tightenings. Billionaire Stanley Druckenmiller has called it a “double-barreled blitz” that could lead to a major policy error. And Guggenheim Partners Chief Investment Officer Scott Minerd has expressed concerns that liquidity constraints could give way to systemic risk.

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Others say not so fast. Strategist at Barclays, Royal Bank of Canada and Wrightson ICAP have suggested the unwind’s link to stocks is weak, at best. Still, the S&P 500 Index plunged more than 3 percent in the hours following last month’s Fed meeting after Chairman Jerome Powell said the rundown was on “automatic pilot,” forcing policy makers to re-craft their message on the fly. And U.S. stocks spiked higher Friday amid reports that the Fed is weighing ending the reductions sooner than previously expected.

The extent to which officials are ready to change tack should become clearer Wednesday following the Federal Open Market Committee’s first meeting of the year. A survey of economists ahead of this week’s decision indicates that most don’t expect the central bank to slow or stop the balance sheet run-off this year, while the median forecast for interest-rate hikes is two in 2019. Regardless of what officials signal, though, Wall Street is likely to remain on edge as it comes to terms with what the balance-sheet unwind actually means for markets.

How did we get here?
The Fed’s unprecedented quantitative-easing programs in the aftermath of the financial crisis pumped trillions of dollars into the banking system. It bought bonds from banks and paid for them by crediting their reserves. Now, with the economy on firmer ground, the Fed wants to siphon off that extraordinary liquidity to contain the potential inflationary effects, prevent asset-price bubbles, and replenish its ammunition to fight the next downturn. The central bank has been letting Treasuries and mortgage bonds on its balance sheet roll off, or mature rather than replacing them, since October 2017. The unwind has gradually accelerated to its current pace of a maximum $50 billion a month.

By contrast, the market frenzy over the balance sheet erupted just weeks ago — a disconnect that raises some eyebrows, particularly among fixed-income practitioners. Wrightson ICAP economist Lou Crandall wrote that “the Fed’s portfolio runoff is a sideshow” for equities, and RBC’s Michael Cloherty has described the impact as “wildly exaggerated.” That said, most agree that more clarity on the process surrounding the Fed’s unprecedented policy maneuver could help.

“The Fed has never done a two-variable experiment at the same time as they’re tightening policy,” said Lisa Hornby, a U.S. fixed-income portfolio manager at Schroder Investment Management. “The market has been scared by the fact that it’s a reversal of the policies that have been happening for years that have helped all risk assets.”

Where is the unwind being most directly felt?
Money markets. The Fed’s crisis-era bond investments created vast excess bank reserves. Post-crisis rules enacted to curb risk-taking have prompted banks to use much of those reserves to meet the more stringent requirements. As the balance-sheet unwind slowly drains liquidity from the financial system, some in the market are suggesting bank reserves are once again poised to become scarce, forcing banks to tap additional funding. Combined with a surge in Treasury-bill issuance — in and of itself partly driven by the government’s need to replace the Fed as a regular buyer — that’s helped push key money-market rates higher, especially in the market for repurchase agreements.

“Even though the Fed might be holding rates at 2.40 percent, the clearing rate for repo is much higher than that and I think that’s a result of this quantitative tightening and balance-sheet unwind,” said Bret Barker, a fixed-income portfolio manager at TCW Group in Los Angeles.

What about the impact on riskier assets?
That’s more complicated. The Fed’s purchases suppressed yields on Treasuries and agency mortgage-backed securities, driving investors into higher-yielding assets such as equities and corporate debt. Narrowing credit spreads enabled a record amount of corporate borrowing, which was used in part to buy back shares. Now, as the Fed normalizes policy, some of the tailwinds are reversing. Yields on Treasury bills from one- to six-months have risen to roughly 2.3 to 2.5 percent, more than the 2.1 percent dividend yield on the S&P 500 Index. Some say the additional tightening impact of the balance-sheet unwind may make credit conditions too restrictive, particularly for over-levered companies, and push the economy into recession.

“A lot of it is sentiment more than the fundamentals,” said Sebastien Page, head of global multi-asset strategy at T. Rowe Price in Baltimore. The markets have “gone through massive liquidity injections and the building up of those balance sheets. So what investors are worried about is the change in direction, so you go from rates going down and liquidity going up, to rates going up and liquidity going down.”

Where does the balance sheet unwind go from here?
It’s fair to say no one — not even the Fed chairman — can say with certainty what the balance sheet will look like in a year’s time. The most recent New York Fed survey shows primary dealers expect it to stabilize at about $3.5 trillion, which at the current rundown rate implies an end to the unwind in early 2020, according to analysis from ABN Amro Bank. Just three weeks ago, Powell said the future balance sheet “will be substantially smaller than it is now,’’ and encountered yet another wobble in stocks. More recent public statements from central-bank officials suggest policy makers are considering stopping the runoff sooner rather than later.

Another point of contention is whether the portfolio will still include mortgage-backed bonds. Nomura’s head of Americas fixed-income strategy George Goncalves expects a “full roll-off of the legacy MBS book but also a shift to a short U.S. Treasury duration portfolio.”

Amid all this uncertainty, a couple of things about the balance sheet are clear. Markets will have to accept that — at least for the remainder of this economic cycle — the days of maximum policy accommodation are over. In the meantime, will have to be wary of drawing attention to the autopilot and take full control of the market narrative.(Updates to add result of economists survey.

Here is Fed Chair Jerome Powell demonstrating his toxic masculinity by singing “I’m a man.’

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US Economy Growing Above Long-run Trend Without Sustained Inflation (As Gov’t Measures Inflation)

The good news? The US economy is growing above the long-run trend. But without sustained inflation.

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At the last reading Core Personal Consumption Expenditure (PCE) growth was only 1.88%. Compare that to home prices growing at 4.7% YoY (CS) and FHFA’s Purchase Only YoY at 5.76%.

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Zillow’s rent index for all homes YoY is only 0.485, well below The Fed Funds Target rate and Core PCE growth. And The Fed Funds Target rate is above Core PCE growth.

Here is a closer look at the past year. Rising Fed Funds Target rate, stable inflation (Core PCE YoY), decling house price growth and continued balance sheet undwinding.

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Fed Dead Redemption II: Fed Officials Weigh Earlier-Than-Expected End to Bond Portfolio Runoff

First, the expectations for furthering tighening of The Fed Funds Target Rate are near zero, at least according to WIRP.

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Now, according to Nick Timiraos at the Wall Street Journal, Federal Reserve officials are close to deciding they will maintain a larger portfolio of Treasury securities than they’d expected when they began shrinking those holdings two years ago, putting an end to the central bank’s portfolio wind-down closer into sight.

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The Fed indeed may slow the unwind of its balance sheet which is primarily allowing Treasury Notes and Treasury Bonds to mature. Agency MBS are expected to mature at later dates.

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So, The Fed may, at their next meeting, adjust their redemption schedule.

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And alter their redemption caps.

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Clearly, The Fed is trying to keep interest rates from rising too quickly. Good luck with that! It could be that The Fed has run out of ammo.

Case in point? Recent Fed Balance sheet reductions correspond to LOWER 10-year Tteasury yields and 30-year mortgage rates.

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Here is The Fed’ image of itself and “the savior” Ben Bernanke. But here is the reality.

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US Initial Jobless Claims Hits Lowest Level In 50 Years (Since ’69), But Money Velocity Remains Poor Since Financial Crisis

The good news? US initial jobless claims chimed in at 199k, the lowest since 1969.

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Beating the expectation of 218k jobless claims.

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The bad news? Despite the excellent employment news, M2 Money Velocity (GDP/M2) still has not recovered from The Great Recession and global financial crisis.

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The Clinton/Gteenspan “miracle” was a combination of reducing M2 Money stock growth to near zero while GDP boomed after the 1990 recession. Unfortunately, such a miracle is unlikely in to today’s over-stimulated low-interest rate world.

To use a Clue analogy, Greenspan/Bernanke/Yellen/Powell did it with a printing press on Wall Street. Perhaps Fed Chair Jerome Powell is REALLY Colonel Mustard!!

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Fannie-Freddie Soar on FHFA Chief’s Conservatorship Comment (What Is Hip?)

Joseph Otting is the acting director of FHFA while Mark Calabria is Trump’s nominee to be the new FHFA director and Fannie Mae – Freddie Mac regulator.

(Bloomberg) — Fannie Mae and Freddie Mac shares soared Friday amid fresh reports that the Trump Administration is working on proposal that would recommend freeing the mortgage-finance giants from government control.

Joseph Otting, acting director of the Federal Housing Finance Agency, commented on the administration’s plans at an internal gathering to introduce himself to staff and establish open lines of communication, an FHFA spokesperson said in a statement. MarketWatch reported on the meeting earlier Friday.

Otting mentioned, as he previously has, that the Treasury Department and the White House are expected to release a broad plan for housing that will include details about reform and will likely include a recommendation for ending Fannie and Freddie conservatorships, the FHFA spokesperson said. Treasury Secretary Steven Mnuchin has said that the Trump administration wants to end government control of the companies, and Otting intends to work to advance that plan, the spokesperson said.

Shares of Fannie rose more than 31 percent to $2.37 and Freddie Mac climbed 24 percent to $2.25 at 2:05 p.m. in New York. The increases were the biggest since November 30, 2016, when then-Treasury Secretary nominee Mnuchin first said getting the companies out of the government’s grip was a priority.

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Investors in the two companies, which have been under U.S. control since the 2008 financial crisis, have been optimistic that President Donald Trump’s appointees at Treasury and FHFA will allow them to reap a windfall by ending the conservatorship. Hedge funds, including Paulson & Co. and Bill Ackman’s Pershing Square Capital Management, are among the companies’ biggest shareholders.

Fannie and Freddie don’t lend. Instead, they underpin the mortgage market by buying loans from banks, packaging them into securities and making guarantees to investors in case borrowers default.

The statement by Otting, who is serving as interim FHFA director in addition to heading the Office of the Comptroller of the Currency, corroborates earlier reports that the administration is working on a plan. Still, the FHFA spokesperson didn’t offer details on what might be included in any proposal, such as whether Treasury would call for releasing the companies without Congress passing legislation.

Mnuchin has long promised to deal with Fannie and Freddie but two years into the Trump administration he has yet to outline specific steps he wants to take. That’s prompted many lobbyists and housing-policy analysts to question whether there’s an urgency to take bold measures.

Walt Schmidt, head of mortgage-backed securities research at FTN Financial, said he’s skeptical the White House would want to mess with U.S. housing policy with Trump gearing up for a re-election campaign. Any plan could be received poorly, underscoring the fact that the issue poses political risks with uncertain upside.

“The whole GSE system and conservatorship is fairly intractable because of the political ramifications around housing,” Schmidt said. “I don’t know why the administration would want to upset one of the pillars of our economy so significantly going into the next presidential election.”

Will Mark Calabria rock the housing finance boat? Mark is a seasoned DC insider and has worked with the National Association of Homebuilders, so he knows the importance of housing to the US economy. I haven’t talked with Mark since we ate dinner at BLT Steakhouse in DC a while ago when he was still at The Cato Institute.

But will Fannie and Freddie be set free as in  “Let my GSEs  people go.”  Or will Calabria shut them down and turn over housing finance to the largest banks for mortgage origination  (in this case, Quicken Loans)?

It is difficult to tell if anything will be done. It also be could be the Zandi/Parrot model of expanding Fannie/Freddie’s role in mortgage markets or Calabria’s notion of shrinking their footprint. It really depends on “What is hip?” in Washington DC.

Below is Mark Calabria  pleading  to Let Our GSEs Go!. Or will he?

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Golden Ticket? China Relief? Fed Tightening Halt? January Effect? S&P 500 Surges In 2019

Central banks are like Willy Wonka to markets offering golden tickets.

We have the People’s Bank of China wildly expanding their repo purchases to stimulate their economy and have just announced massive investments.


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Then we have Trump administration officials \considering measures to roll back tariffs on Chinese products in order to calm financial markets, the Wall Street Journal reported, a report the Treasury Department quickly denied.

Then we have The Fed taking further rate hikes off the table. It sure looks like it!

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Then there is the January effect (not the January Jones effect) where stocks decline at the end of the year only to rise at the beginning of the next year.

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My bet is on Jerome Powell, The Fed’s own Willy Wonka spreading golden tickets to Wall Street.

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Shutdown! Dow Up 12.8% Since Federal Government Shutdown, Volatility (VIX) Down 50%

The Beach Boys sang it best: Shutdown!

The Dow Jones Industrial Average has risen 12.8% since The Federal government’s partial shutdown starting just before Christmas 2018. But since December 26th (the day after Christmas), the Dow has shot up 12.8%. And the S&P500 volatility index, the VIX, has declined by 50%.

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Its fun, fun, fun for investors. But for nonessential Federal employees, Don’t Worry, Baby because you will receive back pay as soon as the shutdown is over.

Meanwhile, “Help Us Nancy and Chuck” and end the shutdown.

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Quantitative Frightening? VIX 1Y Implied Volatility Declines To Lowest Level Since 2014 As Fed Lets Balance Sheet Unwind

There is a lot of fear and uncertainty in financial markets: the US Federal government shutdown, May’s Brexit defeat, trade anxiety with China, postponement of Nancy Pelosi’s entourage 7-day excursion to Brussels, Egypt, and Afghanistan, the Mexican border wall, etc.

But given all the fear and uncertainty in financial markets, the VIX 1-year implied volatility has actually been declining … and its decline coincides with The Fed’s Quantitative Frightening (QF) or the shrinking of The Fed’s balance sheet.

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Quantitative frighening or numbness?

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