The Unwind of the Fed Balance-Sheet Unwind May Be Buoying Stocks

May be? How about definitely, along with improved expectations for economic growth.

(Bloomberg) — The Federal Reserve says that its Treasury-bill buying program isn’t the same as quantitative easing. But the advance in U.S. equity prices alongside the central bank’s growing balance sheet suggests to some that the effects may not be wildly different.

The central bank, driven by the need to tamp down problems in funding markets with liquidity injections, has expanded its balance sheet from as little as $3.76 trillion at the end of August to $4.05 trillion. That growth has, in effect, already reversed close to 40% of the shrinkage that the Fed began in late 2017. The S&P 500 Index, meanwhile, has climbed more than 7% since the end of August and this week reached new record highs.

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To calm funding markets and improve its control over short-term interest rates, the Fed has used measures including the implementation of repurchase-agreement operations and a $60 billion per month program to acquire T-bills. Officials argue that the T-bill buying isn’t QE because, unlike several of the central bank’s previous asset-purchase programs and reductions to its benchmark rate, it isn’t aimed at lowering long-term borrowing costs and affecting the economy.

Peter Boockvar, chief investment officer at Bleakley Financial Group, says that in the eyes of the market this is just semantics.

“Markets view any increase in the size of the Fed’s balance sheet as QE,” he wrote in a note to clients on Monday.

Stocks, have of course, also been buoyed by other factors, ranging from an improving outlook for global growth and the prospects of a U.S. China-trade deal to better-than-expected earnings and the Fed’s three quarter-point rate cuts this year. But previous QE episodes were certainly instrumental in helping to fuel the post-crisis rally in equities, and signs of history repeating could well be adding to market buoyancy.

Of course, continued robust consumer consumption is helping.

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But California Democrat Eric Swalwell insists on saying “Everything is NOT beautiful.”

Did Eric Swalwell just out himself as Adam Schiff’s whistle blower in the Trump investigation??

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Fed Warns Prolonged Low Interest Rates Could Spark Instability (NOW A Warning??)

You gotta love The Federal Reserve. After 11 years of interest rate repression, The Fed now admits that continuing low interest rates could spark instability.

(Bloomberg) — Continuing low interest rates could dent U.S. bank profits and push bankers into riskier behavior that might threaten the nation’s financial stability, the Federal Reserve said in a report released Friday.

The latest version of the twice-yearly report, meant to flag stability threats on the Fed’s radar, highlighted the rate squeeze facing banks and insurers, noting that it could erode lending standards.

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“If interest rates were to remain low for a prolonged period, the profitability of banks, insurers, and other financial intermediaries could come under stress and spur reach-for-yield behavior, thereby increasing the vulnerability of the financial sector to subsequent shocks,” the U.S. central bank said in the report.

Fed Chairman Jerome Powell suggested to lawmakers on Thursday that low interest rates might be a permanent part of the economic landscape.

“We’re in a world of much lower interest rates,” he told members of the House Budget Committee. “That seems to be driven by long-run structural things and there’s not a lot of reason to think that will change.’

Fed Governor Lael Brainless said in a statement Friday that the low-for-long environment “and the associated incentives to reach for yield and take on additional debt could increase financial vulnerabilities.”

The bulk of the work on the report was done before September’s repo market tumult, which prompted the Fed to pump reserves into the banking system to boost money market liquidity. Still, the report does briefly address problems with the short-term repurchase agreements.

“Pressures in the repo market spilled over to other markets, including the federal funds market,” the report said. “The Federal Reserve took a number of steps beginning in mid-September to maintain the federal funds rate within its target range and to ensure an ample supply of reserves. Pressures in short-term funding markets subsequently abated.”

The central bank appeared to take a more relaxed view of the rising stock market than it did in its last report in May.

While equity prices remain high relative to corporate earnings, they are consistent with the low level of interest rates, the Fed said.

“Over the past couple of years, equity prices have been high relative to forecasts of corporate earnings,” according to the report. “However, other measures of investors’ risk appetite in domestic equity markets are in the middle of their historical ranges.”

You mean like the Shiller CAPE (Cyclically Adjusted Price Earnings) ratio … that is near the level seen on Black Tuesday of 1929.

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And then we have former Fed Chairs Ben Bernanke and Janet Yellen who kept The Fed Funds Target Rate (Upper Bound) at near zero from late 2007 to late 2015 (and then FINALLY raised the target rate in Dec ’15).  As Meryl Streep uttered in Death Becomes Her, “NOW a warning?”

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And then we had the joint rate-repression regimes of Bernanke and Yellen. Note the decline in the 10-year Treasury yield from over 4% in 2008 to under 2% today.

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Yes, The Fed has suddenly come to the realization (after 11 years of low-rate policies) that low rates can spark instability.

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US Treasury Yield Curve Un-inverts (Can’t Turn The Fed Loose) Sag Gone In Treasuries, Not Swaps

Federal Reserve Chair Jerome Powell has said that the US economy is in a good place, and further rate cuts are not warranted. That is, Trump can’t turn The Fed loose.

Various US Treasury yield curves are un-inverting and are all positive.

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The Treasury actives curve is no longer sagging, but the Dollar Swaps curve continues to sag.

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But in terms of Treasury futures, the volatility for 2 year, 10 year and 30 year (Ultra) contracts   are progressively warping for 10 Delta Puts as maturity increases.

2-year:

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10-year:

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30-year (Ultra):

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Every investor needs The Fed to keep propping up asset bubbles!

Of course, the yield curve can revert to a negative state if … the China trade agreement becomes unglued, Democrats succeed in impeaching President Trump, etc.

 

Giddy Up! Mortgage Refis Decline Most In Three Years (Fed To The Rescue?)

According to the Mortgage Bankers Association (MBA), mortgage refinancing applications declined the most in three years on a slight rise in mortgage rates.

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Of course, some of the decline is due to smaller pool of eligible borrowers following a “refi wave.” But still, The Federal Reserve may be prodded into action like in the song “Elvira.” Giddy up!

The MBA purchase applications index fell by 3.5% from the previous week, which is understandable since it is October and the October Country from home sales and purchase applications.

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Actually, it is somewhat surprising that purchase applications are rising despite the decline in “subprime” (FICO < 620) borrowers.

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Yes, it is The October Country for mortgage purchase applications which normally peak in May then decline.

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US Existing Home Sales Decline 2.2% MoM As Mortgage Rates Tick Upwards (Median EHS Prices Fall)

After watching NY Jets’ QB Sam Darnold’s disastrous game against the NE Patriots (he claims he saw ghosts!), the existing home sales report from the National Association of Realtors is a moderate success!

US Existing Home Sales declined 2.2% MoM in September as mortgage rates rose slightly.

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The median price for existing home sales fell as EHS inventory continued its seasonal decline.

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Perhaps Sam Darnold should join the cast of Supernatural as a hunter instead of throwing 4 interceptions and a fumble.

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Let’s hope Browns’ QB Baker Mayfield sees open receivers and not ghosts against the Patriots on Sunday!!

Conference Board Leading Index MoM Prints At -0.1% (NOT Screaming Impending Recession, But Fed Manning The Bilge Pumps!)

The Conference Board leading index printed at -0.1% MoM indicating a slow but expanding economy through early 2020.

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But Jerome Powell and The Federal Reserve are manning the economic bilge pumps just in case.

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Yes, The Fed will be trying to pump liquidity into the economic ship in case it takes on too much salt water.

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“Man the pumps!!!”

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U.K. Bank Credit Rallies as Johnson Strikes Brexit Deal With EU (UK CoCo Prices Jump, But Not Deutsche Bank’s 6% CoCo)

While the UK Parliament has to sign off on the Brexit agreement, bank credit rallies after Boris Johnson reached an agreement with the EU.

U.K. lenders’ riskiest notes jumped, leading a credit rally, after Prime Minister Boris Johnson reached a Brexit agreement with the European Union.

Barclays Plc’s 1.25 billion pound ($1.6 billion) 5.875% CoCo reversed earlier losses and hit 99.5 pence on the pound, the highest since May 2018, according to data compiled by Bloomberg.

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Nationwide Building Society’s 600 million-pound perpetual bond, sold last month, hit a record. Oddly, NBS’s perpetual bond started rising on October 10th, well before PM Boris Johnson announced his Brexit agreement.

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A contingent convertible bond (CoCo), also known as an enhanced capital note (ECN) is a fixed-income instrument that is convertible into equity if a pre-specified trigger event occurs.

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A famous CoCo bond is the Deutsche Bank 6% Perpetual.

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While issued at par (100), the G-spread on the Deutsche’s 6% CoCo bond is … 11%.

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Odd, that DB’s CoCo bond remained relatively calm after the Brexit deal was announced.

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Is that UK PM Boris Johnson or Martin Kernsten, the Nipple King from Parks and Recreation?

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Its always sunny in the UK!

Free Cat? World’s Best-Run Pension Funds Say It’s Time to Start Worrying (Not Enough Revenue Thanks To ECB Policies And Inflated Liabilities)

State and Federal pension funds are plagued by extravagant promises to pensioners and low yields on pension assets caused, in part, by Central Banks, like the European Central Bank and Federal Reserve.

(Bloomberg) Back in 2012, the world’s best-managed pension market was thrown a lifeline by the Danish government to help contain liabilities. That was when interest rates were still positive.

Seven years later, with rates now well below zero, even Denmark’s $440 billion pension system says the environment has become so punishing that it may be time for a change in European rules.

Henrik Munck, a senior consultant at Insurance & Pension Denmark, an umbrella organization, says the way liabilities are currently calculated “could cause a negative spiral” that forces funds to keep buying low-risk assets, drive yields lower and the value of liabilities even higher.

The warning comes as pension firms across Europe struggle to generate the returns they need to cover their growing obligations. In Denmark, some funds saddled with legacy policies guaranteeing returns as high as 4.5% have had to use equity to meet their obligations.

To calculate liabilities, pension firms use a complex mathematical formula constructed by the European Insurance and Occupational Pensions Authority (EIOPA). The formula is intended to shield funds from erratic market swings that artificially inflate or hollow out balance sheets. But with negative rates more entrenched, there are signs the EIOPA curve, as it’s called, may not be working as intended.

“When pension funds across Europe de-risk simultaneously, it may actually become pro-cyclical: it increases the price movements, and it could result in yet more downward pressure on the EIOPA yield curve, exacerbating the problem,” Munck said.

The curve is comprised of several elements. Its backbone — the euro interest-rate swap curve — has sunk since its implementation about four years ago, driving up the value of liabilities.

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PFA, like many Danish pension funds, started scaling back guaranteed products for retirees many years ago. That’s given it a buffer to help absorb some of the shock of growing liabilities. But not everyone’s as well prepared. “If the discount curve is more volatile and you can’t hedge it, you can — if you don’t have enough capital — be forced to lower risk on the more hedgeable space, to compensate,” Damgaard said.

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Low volatility assets like sovereign debt?? Pretty soon, government pensions will have to deliver cheaper payments to pensioners.

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US Unemployment Rate Falls To Lowest Since 1969, Yield Curve Rises At Short-end (The Great Technology Disruption?)

Despite the hysteria over global warming and Presidential impeachment, the US economy keeps chugging along and now has the lowest U-3 unemployment rate since 1969. 

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While the Dow rose more than 200 points on the employment news …

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the US Treasury yield curve actually steepened in the very short end (but still lower than on October 1st).

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Two of the top three industries for jobs added are 1) education and health, and 3) government. Leisure and hospitality (bartenders and waitstaff) are in 4th place.

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The good news about bartending is that it is difficult to be replaced by technology. Waitstaff can be replaced, just ask the waitstaff at The Olive Garden and numerous fast food restaurants. Education can also be replaced by technology (Northwestern and MIT are two high profile universities offering on-line certificate programs). Healthcare is already being rocked by technology.

So, let’s see how US unemployment and jobs added changes over time with growing technology disruption.

Author Kurt Vonnegut predicted this automated dystopia in 1952 in his novel “Player Piano.”

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An automated burger machine!

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Alarm! VIX Futures Curve Inverts As Dow Drops >500 Points (Tech Stocks Hammered)

It’s NOT always sunny in financial markets.

Today, the Dow dropped >500 points (2%) as of 12:2pm EST. Europe is even worse with the FTSE 100 down 3.23%.

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Meanwhile, the VIX futures curve has inverted!

(Bloomberg) — The front of the VIX futures curve has inverted, pointing to acute concern about the near-term outlook for a stock market that’s come under considerable pressure the last two days.

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Some traders use a VIX curve inversion as a “take cover” signal, noting that would have helped avoid much of the damage associated with risk routs in Q4 2018, during the February 2018 Volmageddon, and amid the August 2015 devaluation of the yuan. On the other hand, it’s also produced numerous false positives. For instance, the Aug. 5 inversion on a closing basis also marked an intermediate bottom for the S&P 500.

For investors in long/short volatility exchange-traded products, this is when the term structure starts to act as a headwind or tailwind for performance.

Tech stocks are getting blasted (Microsoft, Apple, Cisco, Intel).

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Green man strikes again!

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