Twenty-four hours that confounded – as well as clarified. Chairman Powell has, again, been widely criticized for his messaging. With the markets and President Trump breathing down his neck, he’s been in a no-win situation. Data have not supported commencing an aggressive easing cycle, while markets raced far ahead of the FOMC. Especially with dissention mounting within the Committee, Powell had to attempt a modest reset of market expectations. This wasn’t going to be uneventful.
July 31 – CNBC (Patti Domm): “Stocks cratered, the dollar hit a more than two-year high and bond yields ripped higher after Fed Chairman Jerome Powell suggested that policymakers were not embarking on a new cycle of rate cutting… ‘Let me be clear: What I said was it’s not the beginning of a long series of rate cuts… I didn’t say it’s just one or anything like that. When you think about rate-cutting cycles, they go on for a long time and the committee’s not seeing that. Not seeing us in that place. You would do that if you saw real economic weakness and you thought that the federal funds rate needed to be cut a lot. That’s not what we’re seeing.’”
Reuters’ Ann Saphir: “You called it a mid-cycle adjustment to policy and, I mean, what should we take this to mean? And what message do you mean to send with this move today about future rate moves?
Powell: “The sense of that… refers back to other times when the FOMC has cut rates in the middle of a cycle. And I’m contrasting it there with the beginning, for example, the beginning of a lengthy cutting cycle.”
Saphir: “So we’re not at the beginning of a lengthy cutting cycle?”
Powell: “That is not what we’re seeing now. That’s not our perspective now or outlook.”
Powell responding to a question from Bloomberg’s Mike McKee: “What we’ve been monitoring since the beginning of the year is effectively downside risks to that outlook. From weakening global growth, and we see that everywhere. Weak manufacturing, weak global growth now particularly in the European Union and China. In addition, we see trade policy developments, which at times have been disruptive and then have been less so. And also inflation running below target. So, we see those as threats to what is clearly a favorable outlook.”
Markets were less than thrilled to hear “what is clearly a favorable outlook.” Powell also stated, “overall the US economy has shown resilience”
Marketplace’s Nancy M. Genzer: “So when we have our next recession, the Fed will have less room. It will happen. The Fed will have less room to maneuver cutting interest rates since you’re cutting now, how big of a problem will that be? …You won’t be able to cut as much if rates are low, and you will have less ammo in that sense.”
Powell: “You’re assuming that we would never raise rates again, that once we’ve cut these rates they can never go back up again. As just as a matter of principle, I don’t think that’s right. In other long cycles, long US business cycles have sometimes involved this kind of event where the Fed will stop hiking. In fact, we’ll cut and then we’ll go back to hiking.”
It’s been a long time since a Federal Reserve Chairman spoke with such candor – and markets were utterly confounded. After fondly receiving “insurance cut” and “ounce of prevention,” equities were immediately repulsed by the notion of “mid-cycle adjustment.” And how could Powell broach the subject of the Fed contemplating ever raising rates again? Does Powell not understand what the markets expect of him? Where is the clear message? What happened to the beloved “an ounce of prevention is worth a pound of cure?”
The problem is equities have been demanding a pound of prevention. The Fed is in uncharted waters on so many levels. To be sure, never have markets so determined financial conditions domestically as well as globally. This is a far cry from the old days when the Fed would subtly adjust overnight lending rates to, on the margin, influence bank lending. Subtlety no longer suffices, as speculative global markets have come to demand a regular fix of policy “shock and awe.”
The course of monetary policy would be much clearer if only the FOMC could accomplish one accurate prediction (one good model!): Will risk markets be dominated by a “risk on” or “risk off” speculative dynamic? If “risk on” continues to dominate, the FOMC would not move forward with an aggressive easing cycle. “Risk off,” conversely, would put immediate and intense pressure on the Fed to drive rates lower (and expand its balance sheet). Enamored by the Fed’s newfound “insurance” approach, the equities market fully expects the Fed to completely disregard the “risk on” scenario. At least some members of the FOMC, apparently including the Chairman himself, are understandably uncomfortable with the markets commanding Fed policy.
The S&P500 dropped a quick 1.7% on Powell’s comments. The implied rate on December Fed funds future rose a not earth-shaking 5.5 bps in Wednesday trading to 1.84% (anticipating another 30 bps of cuts by year-end). Equities were in a bit of a tantrum. Bonds – they remained cool as a cucumber. Interestingly, ten-year Treasury yields declined four basis points on Fed Wednesday to 2.02% – the low since December 2016. Long-bond yields declined six bps to 2.53%.
Equities may have been confounded by Powell, but some clarity was apparent in bond trading. Treasury yields are moving on factors outside of FOMC policy. And, clearly, global yields are fixated on something other than central bank policies. Additional clarity was created less than 24 hours later. Presidential tweets:
“Our representatives have just returned from China where they had constructive talks having to do with a future Trade Deal. We thought we had a deal with China three months ago, but sadly, China decided to re-negotiate the deal prior to signing. More recently, China agreed to…”
“…buy agricultural product from the U.S. in large quantities, but did not do so. Additionally, my friend President Xi said he would stop the sale of Fentanyl to the United States – this never happened, and many Americans continue to die! Trade talks are continuing, and…”
“…during the talks the U.S. will start, on September 1st, putting a small additional Tariff of 10% on the remaining 300 Billion Dollars of goods and products coming from China into our Country. This does not include the 250 Billion Dollars already Tariffed at 25%…”
“…We look forward to continuing our positive dialogue with China on a comprehensive Trade Deal, and feel that the future between our two countries will be a very bright one!”
Markets were not buying Mr. Brightside. Stocks had rallied strongly Thursday pre-tweet. Having fully recovered from the Powell swoon, the S&P500 was trading to within less than half a percent of all-time highs. Then the S&P sank a quick 2.1% (Nasdaq100 2.7%) on the Trump Tariff Tweets. Why such an emphatic reaction? Wasn’t the President simply replicating the strategy that had Mexican authorities responding feverishly to ensure the tariff threat didn’t become reality?
I view the markets’ responses to the President’s threat of additional Chinese tariffs as providing important analytical clarity. Let there be no doubt: Chinese developments have become the critical factor for global markets. And the issue is not the possibility of 10% tariffs on an additional $300 billion of Chinese imports. The critical issue is Chinese financial and economic fragilities, and the very real possibility that an escalating trade war pushes a vulnerable China over the edge.
Ten-year Treasury yields sank 12 bps Thursday to 1.87%. After the 5.5 bps Powell Wednesday afternoon increase, the implied rate for December Fed fund futures sank 17 bps to end the week at 1.665%. Ten-year Treasuries ended the week down 23 bps to 1.84%, the low going back to November 7, 2016 (when Fed funds were at 0.40%). Long-bond yields dropped 22 bps to 2.38%. From before Trump’s Tariff Tweets to Friday’s close, the safe haven Japanese yen gained 2.3% against the dollar (high vs. dollar since scary January 3rd). The Swiss franc rallied 1.6%. From Thursday’s lows, Gold surged $40 to the high going all the way back to May 2013.
August 2 – Reuters (Virginia Furness): “The 30-year German government bond yield turned negative for the first time ever on Friday, leaving the euro zone member’s entire yield curve in negative territory as investors scrambled for safer assets… An early rally in German government bonds which saw the yield on its 10-year note fall below -0.50 bps for the first time ever accelerated as trading wore on.”
German bund yields ended the week down 12 bps to a record low negative 0.50%, with French yields sinking 12 bps to negative 0.24%. Spanish (0.25%) and Portuguese (0.29%) yields dropped to record lows. Swiss 10-year yields closed the week at a record low negative 0.89%. Ten-year yields were also negative in Denmark (-0.45%), Netherlands (-0.39%), Austria (-0.28%), Finland (-0.25%), Sweden (-0.21%), Slovakia (-0.18%), Belgium (-0.17%) and Slovenia (-0.03%). Bloomberg’s tally of negative-yielding debt ended the week at a record high $13.988 TN.
There were analysts quick to suggest it was no coincidence that Trump’s China Tariff Tweet followed closely on the heels of the snub from Chairman Powell. The President could dismember two fowl with one stone: ratchet up the pressure on Chinese trade negotiators, while signaling to Powell that there’s an easy way and a hard way that will end at the same destination: monetary policy will now be dictated from the Oval Office.
I’ll repeat the same view that I’ve posited since early in the administration. The President is playing a dangerous game with the Chinese. And I can confidently predict for years to come the Fed will be castigated for not more aggressively adopting monetary stimulus. Yet, if not for the dovish U-turn, all the talk of an “insurance cut” and the resulting risk market rally, I don’t think the President tweets Thursday on additional Chinese tariffs. Tariffs, deficits, speculative Bubbles and the like: The Fed and Central Banks as Enablers.
August 2 – Politico (Adam Behsudi and Ben White): “President Donald Trump’s decision this week to ratchet up the trade war with Beijing by slapping more tariffs on Chinese goods came after aides thought they had talked him out of it weeks ago, according to two people close to the discussions. But the president’s annoyance with China finally boiled over this week after Treasury Secretary Stephen Mnuchin and U.S. Trade Representative Robert Lighthizer returned from trade talks in Shanghai and reported that Chinese officials offered no new proposals for ending an impasse that’s persisted since May… Trump’s Twitter announcement… drew a quick reaction from China on Friday… ‘China will not accept any form of pressure, intimidation or deception,’ Chinese Foreign Ministry spokesperson Hua Chunying said… China‘s Ministry of Commerce released a statement that said Beijing would impose countermeasures. ‘The U.S. has to bear all the consequences,’ the statement said. ‘China believes there will be no winners of this trade war and does not want to fight. But we are not afraid to fight and will fight if necessary.’”
The administration is hellbent on cornering the wounded animal. China’s historic financial and economic Bubbles are in trouble. Beijing has been working intensively to stabilize its money market and corporate lending markets. More generally, China’s overheated Credit system has become deranged. Financial conditions have recently tightened dramatically for small banks and financial institutions, while real estate finance remains in a runaway speculative Bubble blow-off. System Credit is on track to approach a record $4.0 TN this year, as Credit quality rapidly deteriorates.
July 28 – Financial Times (Don Weinland): “China’s biggest bank has stepped in to become the largest shareholder of a troubled Hong Kong-listed lender, the latest sign that the state is increasing its financial support for struggling banks across the country. Industrial and Commercial Bank of China said… that one of its subsidiaries would invest up to Rmb3bn ($436m) in Bank of Jinzhou, taking a stake of about 10.82%. Investors have grown concerned over the health of the Chinese banking system in recent weeks following the government takeover of Baoshang Bank, the first such incident in nearly two decades.”
July 29 – Bloomberg: “Chinese authorities, which shocked the market with a regional bank seizure in May, adopted a different approach for helping another troubled lender — a sign regulators are treading carefully as they try to resolve the sector’s problems. Three Chinese state-owned financial heavyweights, including Industrial & Commercial Bank of China Ltd., agreed to buy at least 17% of… Bank of Jinzhou Co. on Sunday. The acquisition by ICBC comes at about a 40% discount to the last closing price of the northeastern Liaoning-based lender, whose stock has been halted since April and which saw its dollar bonds tumble last week amid reports of liquidity strains. The move underscores regulators’ efforts to restore confidence in smaller lenders, a key source of credit to small and medium-sized companies, while reducing the moral hazard of a government backstop that makes all investors whole.”
ICBC’s stock immediately dropped 2% on news of its stake in troubled Bank of Jinzhou. Understandably, Beijing was compelled to quickly and decisively “resolve” the Bank of Jinzhou issue; to quash a panic beginning to catch fire in the “small” bank sector. But festering bad loan and capital adequacy issues will limit the degree to which the major Chinese banks can absorb problems from thousands of smaller institutions.
President Trump sees the opportunity to use China’s weakened economy to extract trade concessions. As it drifts closer to a systemic crisis of confidence, Chinese finance is the more pressing issue. Remember how such circumstances tend to unfold: very slowly then suddenly quite quickly.
Beijing is blaming the U.S. for Hong Kong unrest. China moved forward with military drills in the Taiwan Strait after the U.S. agreed to sell $2 billion of military hardware to Taiwan. The U.S. has assumed an increasingly aggressive posture to counter the Chinese military in the South China Sea. There is the Huawei issue, along with the U.S.’s use of unilateral economic sanctions (i.e. Iran, Venezuela). On numerous fronts, China believes the Trump administration is determined to inhibit China’s advancement and infringe upon its sovereignty.
If they believed a trade deal would resolve the U.S. administration’s chief concerns, Beijing would likely be more willing to compromise. But at this point I take them at their word: “China will not accept any form of pressure, intimidation or deception.” There is a clear and present risk of problematic escalation.
The offshore renminbi dropped 1.37% this week to 6.976 (vs. dollar), just below the lowest level (6.9805) versus the dollar since November 2018 (and near January ‘17’s multiyear low 6.9895). The onshore renminbi declined 0.88% this week to 6.9405, the low against the dollar since last November. Expect to hear more discussion of ramifications of a renminbi break of the key psychological 7.0 level. How much speculative leverage has accumulated in Chinese Credit? Global finance has never been as vulnerable to a systemic “risk off” market dislocation.
Thursday afternoon from Bloomberg (Harkiran Dhillon): “Oil plunged almost 8% for the steepest one-day drop in more than four years after U.S. President Donald Trump escalated the trade war with China…” Elsewhere, Copper dropped a quick 3.5% to a two-year low. Iron Ore fell 7.4%, Palladium 7.9%, Zinc 4.0%, Lead 3.0%, Tin 2.0% and Aluminum 1.6%. In the soft commodities, cotton sank 7.0% post Trump tweet. Soybeans dropped 3.7% for the week and Corn fell 3.5%.
Global market operators will this weekend ponder a few pressing questions: Does President Trump appreciate he risks opening a Pandora’s Box of “risk off” global market dynamics? And will unsettled markets compel him to back off his tariff threat? He’s not willing to gamble his reelection on China tariffs, is he? Two months back I titled a CBB, “So Much for the Trump Put.” Markets were in a forgiving mood. A subservient Mexico convinced the markets it was a “no harm no foul” successful Presidential ploy. Markets now must regret Mexico having rolled over so easily. China is no subservient rollover.
China is instead the vulnerable marginal global source of Credit and economic growth. Beijing has been working diligently to stabilize their fragile financial and economic systems. It no doubt presents the administration an irresistible opportunity to partake in barefaced hardball. But at this point pushing China closer to the crisis point basically unleashes global “risk off,” with myriad repercussions.
Where are the weakest links in the event of a deteriorating China predicament? Asian currencies were under pressure this week. Australia’s dollar fell 1.6%. On the margin, weak European economies are particularly vulnerable. Germany’s DAX dropped 4.4% this week, and France’s CAC40 sank 4.5%.
The Hang Seng China Financials index sank 4.8% this week. European bank stocks (STOXX 600) dropped 5.7%. And corroborating the view of a highly intertwined global financial Bubble, U.S. bank stocks fell a noteworthy 5.0%.
I would be remiss for not further highlighting gold’s $22 weekly rise to multi-year highs.
China doesn’t have the quantity of U.S. imports to match the Trump Tariffs. But they have ample powerful levers to pull. With my view that China is confronting serious financial and economic crisis, I ponder how an aggravated Beijing might react. When the forces of crisis can no longer be held at bay, might they calculate they would weather a global crisis in relatively better standing than their archrival? Could they interject Taiwan into the equation?
There is ample justification for gold’s runup – experimental activist monetary policy, a world of debt, a historic global securities Bubble, and a troubling geopolitical backdrop.
Original Post 3 August 2019
TSP & Vanguard Smart Investor serving serious and reluctant investors.