Doug Noland: Lost Control

Consumer price inflation continued to run hot in January. CPI increased a stronger-than-expected 0.6% during the month, boosting y-o-y inflation to a 40-year high 7.5%. Hyperbole is unnecessary. Inflation is out of Control. The Fed would prefer us to believe otherwise, offering assurances that it is prepared to use “all its tools” to return inflation back to its comfortable 2% target level.

No one believes the FOMC has the stomach to pull a Volcker. Larry Summers today called for the Fed to immediately hold a special meeting and conclude QE a month early. Seems like the minimum they could do. I’m not holding my breath. Others suggest a 50 bps hike in March. Reasonable enough, though our cautious central bank is pushing back.

Inflation is a global phenomenon outside the Fed’s Control. The Fed sits back and monitors supply chain issues like the rest of us. The Federal Reserve is certainly not today in Control of global energy and commodities prices. Here at home, the Fed doesn’t Control corporate pricing or wage decisions. While on the subject, geopolitical and climate change developments are way outside the Fed’s sphere of influence. After $5.1 TN (and counting) of new “money” in 126 weeks, it’s fair to conclude the Federal Reserve has Lost Control of Inflation.

At this point, the Fed would have to significantly tighten monetary policy – and inflict some real pain – if it were determined to wring inflationary pressures out of the system. This they clearly Control. Yet they don’t dare adopt this approach, as it comes with a high risk of losing something they desperately aim to maintain a semblance of Control over: the financial markets.

“It is nothing short of preposterous that in an economy with 7.5% inflation, that in an economy with the tightest labor market we’ve seen in two generations, that the central bank is still as we speak growing its balance sheet.” Larry Summers, February 11, 2022 (Wall Street Week with David Westin).

“Whatever it takes” central banking was preposterous from day one. Restarting QE in 2019 was preposterous. “Printing” Trillions of new (electronic) “money” has been preposterous. Ditto for buying corporate investment-grade and junk bonds through ETF shares. And as far as I’m concerned, punishing savers with zero rates is preposterous. But after purchasing over $5 TN during the past 28 months, it’s difficult to get all worked up over a few more weeks of buying.

What is a big deal, however, is that the Fed is losing Control of the markets. Rate markets are now pricing in 6.3 25 bps rate hikes by the FOMC’s December 14th meeting. This is not the normal exercise of the markets rather efficiently deciphering Fed intentions. I doubt there’s any FOMC consensus for such aggressive moves.

Rate markets are sending a powerful message that the Fed should commence aggressive tightening measures. Fed officials must look at the rate markets with nervous disbelief, and then glance over at faltering equities Bubbles with trepidation. For a long time now, stocks and bonds were all one big happy family, keen to enjoy quality time together compliments of their moneyed Uncle (central banks). Playing in the sandbox was such a delightful and harmonious experience.

The clan over the years “matured” and turned unruly. Myriad severe development issues are increasingly on full display. The halcyon sandbox days are over for good, replaced by a confluence of insecurity, greed, and now constant infighting. To be sure, rich Uncle’s years of lavish generosity fostered a bunch of spoiled malcontents. The lax benefactor has come to realize he can no longer finance all the dysfunction and is desperate to craft a plan for exiting the relationship without unleashing mayhem. Some have structured their lives to stand on their own, while others’ very survival is at stake. All have developed bad habits, with some succumbing to deadly addictions. One camp says, “It’s time to get on with our lives without being further warped by all this charity money.” Another is threatening to do harm to themselves. There’s no clean way out. Uncle fears calamity and harbors serious regret.

There were tantrums aplenty this week. Panic?

February 9 – Reuters (Francesco Canepa): “As guardians of stability in prices and financial markets, the last word central bankers want to be associated with is ‘panic’. Yet that is precisely the term used by two top European Central Bank watchers to describe the message communicated by ECB President Christine Lagarde since she opened the door to a rate hike in 2022 to curb record-high inflation. Investors took Lagarde’s words last week – which were unexpected, as she had earlier all but ruled out a rate hike this year – as a signal the ECB would tighten policy soon, sending borrowing costs soaring across the 19-country euro zone.”

It’s turning into a rout. Greek 10-year yields surged another 37 bps this week to 2.62%. Outside of the March 2020 spike, Greek yields ended the week at the highest level since June 2019. Greek yields are up 111 bps in only four weeks and 131 bps y-t-d. Italian yields jumped another 21 bps to a 21-month high 1.95% (up 67bps in two weeks). Portuguese yields rose 20 bps (2-wk gain 55bps) to 1.17% – the high since April 2020. And Spanish yields jumped 18 bps (2-wk gain 52bps) to 1.22% – the high back to February 2019.

European Credit continues to teeter. CDS prices rose further this week. European banks were again this week at the top of the global CDS leaderboard. Credit Suisse CDS jumped six to 81, trading this week to the highest level since May 2020. UniCredit CDS jumped six to a 15-month high 88 bps. An index of subordinated bank bond CDS rose another three to a 15-month high 143 bps. An index of European high-yield corporate bond CDS gained another 11 to a 15-month high 326 bps (after beginning 2022 at 242bps).

The ECB is still printing “money” and its initial rate increase is still months away. Yet, just the thought of pulling back stimulus has unleashed mayhem at Europe’s vulnerable “Periphery.” De-risking/deleveraging is gaining momentum. ECB policymakers this week unsuccessfully tried to push back against market rate expectations. Christine (German nickname: “Madam Inflation”) Lagarde has Lost Control.

ECB President hinted at ending suppression

Cracks have developed in Credit on both sides of the Atlantic. An index of U.S. investment-grade CDS jumped four to 68 bps, trading this week to the high since September 2020. High-yield CDS surged 14 to a 15-month high 369 bps. Following right behind Europe, U.S. bank CDS prices continue to march skyward. Bank of America CDS rose four this week to a 20-month high 68 bps. JPMorgan CDS rose four to a 20-month high 63 bps. Morgan Stanley CDS rose four to 72 bps, and Goldman Sachs added one to 81 bps.

The Nasdaq100 ended Wednesday’s session with a week-to-date gain of 2.5%. The Semiconductors closed Wednesday up 5.8% in three sessions. The small cap Russell 2000 was up 4.1% w-t-d, and the Midcaps were 3.8% higher. Bitcoin traded Thursday to a five-week high of $45,800. Buy the dip was working, and markets were ready to put recent weakness in the rear-view mirror.

And then came the Thursday/Friday bear market gut punch. The Nasdaq100 dropped 5.3% in two sessions, with the Semis sinking 7.9%. The small cap Russell 2000 and S&P400 Midcaps fell 2.5% and 2.7%. From Thursday’s trading high, Bitcoin dropped a quick $3,800 (8%) to trade down to $42,000.

I’ve been in awe of Chinese Credit for years now. I hold particular awe for the annual release of January data, a month where banks move aggressively to front-load lending for the new year. With records for both bank lending and growth in Aggregate Financing, January 2022 did not disappoint. At a staggering $972 billion (not annualized!), growth in Aggregate Financing was about 15% ahead of forecasts – while trouncing previous record growth of $817 billion in January 2021. At $1.754 TN, three-month growth was 24% ahead of last year – and only slightly below the pandemic period record (Feb. to April 2020).

So much for Beijing’s efforts to restrain runaway Credit expansion. Aggregate Financing expanded $5.092 TN, or 11.5%, over the past year to surpass $50 TN for the first time. Aggregate Financing surged 74% over five years.

Total Loans were also ahead of estimates and at a record level. At $624 billion, January Loan growth was 11% ahead of January 2021’s record. Loans expanded $3.204 TN, or 11.2%, over the past year.

Lending to corporations fueled the Credit spree. Corporate Bank Loans surged an unprecedented $529 billion during January, almost a third higher than January 2021. Corporate Loans were up 11.6% over the past year, 24.9% over two years, 38.5% over three and 68.7% over five years. How much new bank Credit is flowing to impaired developers who have Lost debt market access?

At $133 billion, Consumer (mostly mortgages) Loans were up from December’s $59 billion, but were still 34% below January 2021. Three-month Consumer Loan growth ($308bn) was down 24% y-o-y. Consumer Loans expanded 11.6% over the past year, the slowest pace since November 2008. Consumer Loans jumped 29% in two years, 47% in three and 111% in five years, in Bubble Excess, which has begun to haunt China’s system.

China’s M2 money supply surged (a crazy) $757 billion during January, the strongest expansion since March 2020’s $789 billion. M2 jumped $1.494 TN over the past three months, 50% higher than comparable growth from last year. M2 expanded 9.8% y-o-y, the strongest pace in almost a year.

February 11 – Bloomberg: “The People’s Bank of China reiterated it will encourage banks to expand lending to meet demand and bolster a slowing economy. The central bank will ‘keep liquidity reasonably ample, guide financial institutions to effectively expand loan extension, and make the overall credit growth more stable,’ it said in the quarterly monetary policy published Friday. The PBOC will avoid flooding the economy with stimulus while satisfying the real economy’s reasonable financing need, the report said. It will make monetary policy actions ‘ample, targeted and front-loaded,’ and enhance the structure of credit…”

From a macro perspective, it couldn’t be more ominous. Credit (Aggregate Financing) expanded a blistering $5.1 TN over the past year ($11.4 TN in 25 months!). Yet China’s real estate Bubble is faltering, while the general economy has stagnated.

Importantly, despite various policy easing measures, stress continues to overwhelm the highly-indebted developers. Real estate transactions have collapsed, and the longer the turmoil persists, the lower the odds of a near-term recovery in buyer sentiment.

February 10 – Caixin Global (Guo Yingzhe and Niu Mujiangqu): “China’s real estate market remained sluggish during the weeklong Lunar New Year holiday as developers and homebuyers responded without much enthusiasm to the recent easing of financing policies… By floor space, new home sales in 40 surveyed cities fell 40% during the seven days through Sunday, compared with the holiday period in 2021, according to… China Real Estate Information Corp. (CRIC). The market was weaker in smaller cities as migrants returning home didn’t buy as much property… The value of sales made by the top 100 developers in January fell 43% year-on-year, and the CRIC analysts projected another drop was on the way for February.”

“Debt Fears Swirl Around Logan as China Property Woes Deepen.” “Country Garden Yuan Bond Posts Record Drop at Close After Halt.” “China Developer Zhenro Plunges 66% on Bond Redemption Concern.” “Chinese Developer Fantasia January Property Sales Fall 78% Y/Y.” “Chinese Property Group Shimao Feels Chill of Sector’s Liquidity Crisis.”

Just a sampling of the week’s developer headlines. Evergrande yields jumped almost 700 bps this week to 88.79%. Logan yields (despite a late-week rally) ended the week up 180 bps to 32.32%. China’s developer crisis worsens by the week, despite myriad stimulus measures. While panic is perhaps too strong, indications this week pointed to heightened concerns in Beijing.

February 10 – Bloomberg: “China’s biggest bad-debt managers are moving to support cash-strapped real estate developers at the urging of policy makers in Beijing, according to people familiar…, adding to official efforts to contain the fallout from a string of defaults. Regulators have told state-owned firms including China Huarong Asset Management Co. and China Cinda Asset Management Co. to participate in the restructuring of weak developers, acquire stalled property projects and buy soured loans… Huarong is among financial institutions in talks with embattled developer Shimao Group Holdings Ltd., the people said.”

If Huarong and the “AMCs” (asset management companies) are viewed as part of the solution, expect mounting systemic concerns. Recall that heavily levered Huarong saw its CDS spike above 1,500 last April as debt fears swirled. Beijing directed Chinese banks to support troubled Haurong, and then in the summer oversaw a $7 billion recapitalization.

It’s worth noting that China Construction Bank CDS jumped four to close Wednesday trading at a two-month high 68 bps (began 2022 at 57). China Development Bank CDS jumped four to end Wednesday at a two-month high 65 bps (began year at 54). Industrial & Commercial Bank of China CDS jumped five in two sessions to end Tuesday trading at a nine-week high 69 bps (began 2022 at 57). Bank of China CDS jumped four bps to trade to a 10-week high 67 bps (began the year at 56). China sovereign CDS gained 2.5 this week to 53 bps, trading this week to the high since December 2nd.

Rampant Credit excess. The banks and AMCs supporting a collapsing developer industry. The “national team” aggressively buying stocks. I don’t expect these increasingly desperate measures to have much more impact than previous Beijing interventions. It’s early, but moving in one direction: Beijing Losing Control.

We’re now a week from February options expiration. Bearish hedges had been crushed, only to return from “put heaven” with Thursday’s and Friday’s market drubbing. It’s difficult to see things calming down next week. The White House on Friday showed heightened concern for a Russian move on Ukraine even before the Beijing Olympics closing ceremonies. Putin, the online trader, could pocket handsome short-term trading profits. Conciliatory – and force the unwind of bearish hedges into expiration. Combative – and hit the adversary’s markets when they’re down and vulnerable.

Friday trading was interesting. Gold pops $32, as financial assets and crypto fall under significant pressure. Silver surged 4.7% this week to go positive y-t-d. The 2022 storyline of Hard Assets over fragile financial assets seems more compelling by the week. The Bloomberg Commodity Index’s small advance pushed 2022 gains to 10.8%. Rising to $93, WTI crude’s y-t-d advance reached almost 24%. The VIX traded back above 30 in Friday trading, after ending Wednesday down at 20.

After trading to 2.06% in early Friday trading, the previously MIA safe haven bid for Treasuries flashed an appearance, with 10-year Treasury yields ending the week at 1.94%. Wild instability in securities and derivatives markets, with golden commodities. It’s about as one might expect when fear grows that central bankers have Lost Control.

Original Post 12 February 2022

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Categories: Perspectives