August 20, 2019
They banned it. And that has had major consequences for the liquidity that banks used to provide in global markets. Hence, that is, in part, why the swings in markets have become so violent (post-financial crisis).
Of course (related), it has also damaged their, historically, very profitable market making businesses (which is classified as "trading revenue").
The line of managing the risk of market making activities and speculative trading, by the big banks, is a blurry one. And the Volcker Rule put the burden on the banks to prove that their trading activity is against their market making activity. That weakened the market making businesses of the banks and increased compliance costs. And the major Wall Street banks haven't been the same since. If we look at the five largest investment banks, the total revenue from fixed income, commodities and currency trading at banks has been cut in half since 2009.
Today, two of the five bank regulators approved revisions to the Volcker Rule that soften that scrutinty on bank market making activity.
This is a big step in a process that could unlock tremendous pent-up value in bank stocks.
August 19, 2019
Olli Rehn, voting ECB member and the central bank head of Finland, was vying for the head job at the ECB earlier this year. He didn't get it. It went to the IMF chief, Cristine Lagarde.
Remember, as we discussed last week, the catalyst for the melt-down in global bond markets was the one-two punch from the ECB and the Fed back in December. The ECB officially quit QE. Days later, the Fed hiked again, into an ugly decline in the stock markets, and, moreover, Jay Powell said their quantitative tightening program was on “auto-pilot.” This sent a clear message/reality check to markets that (at least a portion of) the $14+ trillion in global liquidity that the big three central banks have pumped into the world — that promoted stability and little to no inflation – was getting sucked out.
With that, we now have the ECB, importantly, heading back to the QE business. And it may involve outright buying stocks.
Let's take a look at how that might impact German stocks. As you can see in the chart below, the DAX remains 14% from the record highs that were made in early 2018 (German stocks have been in drawdown for 17 months) …
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The Bank of Japan has been in the business of buying Japanese stocks for a long time. But under the Abe plan, it has become a key tool in the massive QQE program at the Bank of Japan since 2013. With the BOJ involved in stocks, it reduces the risk premium in the stock market. And in a world of zero interest rates, the lower risk in stocks is an incentive for capital to chase the higher potential returns of stocks. The idea is that it ultimately drives demand and inflation in the economy.
How has it worked out for Japanese stock prices? Here's a look at the chart … |
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As you can see in the chart, the Japanese stock market has doubled since the BOJ started in 2013. During the same period, U.S. stocks have about doubled too (not unrelated).
But after six years of outright buying ETFs, the BOJ is now the top shareholder in 55 of the 225 companies in the Nikkei 225. And they own more than 75% of the Japanese ETF market. It has worked for stock market investors. But many would argue it hasn't worked for the economy. Growth in Japan has run about 1% annualized over the period. And inflation, a little less. But Japan's asset purchases (including stocks) have been a big contributor to what has been feeble global economic recovery, rather than a global depression. We will see next month if Europe has been forced to follow Japan’s lead (buying stocks). If you haven't signed up for my Billionaire's Portfolio, join now — get your risk free access here.
August 16, 2019 Yesterday, we talked about the one-two punch from the Fed and ECB last December, that set up for a global liquidity shock.
Let's take a look closer today … As we know, the Fed went on a three year monetary policy "normalization campaign." But the view from the Fed proved premature. After an initial hike in late 2015, the global economy found trouble again. And by early 2016, the Fed was forced to stand-down. They didn't hike again until Trump was elected, and the prospects of aggressive pro-growth policies were coming down the pike. Leaning against those policies, the Fed hiked another 200 basis points over 25 months. And at the beginning of 2018, they began "quantitative tightening" (i.e. shrinking their balance sheet). Since January of last year, the Fed has removed $642 billion from the global economy. Meanwhile, the BOJ was continuing to pump about $25 billion a month into the global economy. And the ECB was good for about $20 billion. The ECB and the BOJ not only served as the offset to QT, but they combined to represented a buffer against shocks to the global economy (still in 'do whatever it takes' mode). But the balance sheet of the three most powerful central banks in the world peaked in August of last year. And then the ECB quit QE in December. |
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With that, as you can see in the chart above, the liquidity provided by QE has been on the decline. But maybe most importantly, is the potential (if not noticeable) shock to the system created by the "rate of change." In combination the three most powerful central banks had been pumping liquidity into the global economy at a double-digit rate throughout the post-crisis period. Now we have a negative rate of change.
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This seems to be what is sending global bond markets haywire. And appears to have forced the ECB to reverse course. Yesterday, an ECB official said they need to announce a significant easing package at their September meeting.
If you haven't signed up for my Billionaire's Portfolio, join now — get your risk free access here.
August 15, 2019 The move in global bond yields (market interest rates) continue to plunge today.
The U.S. 10 year broke 1.50%. German 10-year yields traded to (again) new record lows of negative 70 basis points. You can see in the chart below that this move in yields is triggering global capital flows into gold. |
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Interestingly, while we have geopolitical chaos dominating the news wires everyday, if we look back at the month of December, we may find the real driver of this blood-bath in yields. It's the reality that the major central banks (led by the Fed) were too aggressive in moving away from emergency level policy.
On December 13th, the ECB officially ended QE (its nearly $3 trillion bond buying program). German yields were 30 basis points that day. And we have not seen that level since. Now German yields are 100 basis points lower (and in negative territory). A few days later, with the ECB now out of the QE business, the Fed made yet another rate hike and told us all that their quantitative tightening program was on “automatic pilot.” The U.S. 10-year yield was trading 2.86% that day. We haven't seen that level since. The 10-year yield has now been cut in half. That one-two punch from the Fed and ECB was a toxic cocktail (in the, still, fragile post financial crisis environment) that meant a massive and rapid global liquidity withdrawal was underway (and that a very important shock absorber — the ECB — has exited the game). If you bought gold the day the Fed's December rate hike, you've never been underwater. It's up 24%. This is global capital exchanging paper currency for hard currency, foreseeing more money printing. Gold is being revalued to global paper currencies – which should ultimately translate into higher broader commodities prices (not just gold). If you haven't signed up for my Billionaire's Portfolio, join now — get your risk free access here.
August 14, 2019 Yesterday we looked the chart of the 10-year yield, which was disconnected from the brief risk-reprieve that came from the hope that was re-introduced into the trade dispute picture.
As I said, the 10-year yield will be key to watch, for a guide on how far stocks can recovery without more progress made on the trade deal front. Now we know. It wasn't far. After some soft date in China overnight, and a GDP reading in Germany that confirmed a contraction last quarter, global bond yields took a dive. German yields trade to new record lows (deeper into negative yield territory). And the 2-year to 10-year U.S. yield curve inverted. This was news of the day, but there have been few things better telegraphed than a U.S. yield curve inversion. The 3-month to 10-year yield curve has been inverted, for the most part, since May. The chart below shows the 10-year yield minus the yield on the 3-month treasury bill … |
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When the 10-year is paying you less than you could earn holding a short term T-bill, the yield curve is said to be inverted. And this dynamic has predicted the past seven recessions. Why? Because it typically will be driven by a tighter credit environment, namely banks become less enthused about borrowing in the form of short term loans, to lend that money out in longer term loans. Money dries up. Unemployment goes up. Demand dries up. Economy dips.
So, are we seeing a tighter credit environment? No. Below is the Fed's measure of financial conditions. |
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Positive values (above the black line) indicate financial conditions that are tighter than average. Negative values indicate financial conditions are looser than average. Financial conditions are not a threat.
But we may see financial conditions tighten, if the stalemate on a trade deal continues for much longer. We're seeing market sentiment beginning to crack. An erosion in confidence can ultimately spill over into economic activity. And that can and will tighten financial conditions. So, this uncertainty is all about trade. Where do we stand on trade? As of yesterday, Trump walked back on the magnitude of the September tariff escalation. But today, Peter Navarro said they can't meet China half way. As we've discussed, the longer this plays out the more leverage Trump loses to get any deal done (i.e. the more likely it is that China holds out through the election). Given the fragility in global markets, the timeline isn't working in the favor of Trump at the moment. That puts the Fed in focus, as a potential Fed rate cut could provide some stability for markets. With the next meeting scheduled for September 18th, I would say, if we have another day or two like today, an intermeeting cut is not out of the question. If you haven't signed up for my Billionaire's Portfolio, join now — get your risk free access here.
August 13, 2019 Yesterday we talked about the converging of geopolitical storms.
But as we discussed, the linchpin remains U.S./China trade (i.e. this standoff is what matters). Why? If we get a deal, we have the ingredients for an economic boom-period. And economic prosperity can solve a lot of problems (i.e. to reduce or even resolve risks elsewhere in the world). On the other hand, the longer it drags out, the more damaging it becomes to the global economy, and the less likely we see a deal. That path leads to very ugly outcomes (puts economic depression and global war in play). Given the significance of this binary outcome, we talked yesterday about the prospects of seeing movement on the U.S./China trade front in the next week or so. The prospects were slim. Chinese political leaders are convening at their annual seaside policy strategy summit. But what did we get today? We got movement. The movement was modest. But with a phone call, and some U.S. walk-back, the market view on a U.S./China trade deal went from a “maybe no deal happens,” to “maybe a deal happens.” The break of this stalemate is reported to have been pursued by Trump. That seems obvious, given how fragile markets looked coming into the morning. So, with a positive China headline, we had a sharp bounce in stocks, and a sharp decline in gold, which fell from new-six year highs made overnight. What didn’t race back so aggressively? Yields. German 10-year yields traded to new record lows, and closed near the lows. U.S. yields traded up 10 basis points, but remain 37 basis points off of the highs of August 1, when Trump ramped up the threats with this tweet … |
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This chart will be key to watch, for a guide on how far stocks can recover without more progress made on the trade deal front.
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August 12, 2019 We open the week with a storm of rising geopolitical issues.
Let's step through them, and then talk about which one matters most … Today, Argentina had a 30% plunge in stocks, and as much as a 37% plunge in the currency (at the worst levels of the day). That was on prospects that the incumbent reform government will lose power in the election, sending an already bust economy off-the rails of the IMF reform plan. Here's what that stock market crash today looks like on the chart … |
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Next, the temperature is rising on the populist movement in Europe. The new UK leader has already put a hard deadline of October 31 for the UK to leave the EU – putting the EU under the gun to make concessions on a deal or take the risk of a "no-deal" Brexit, which could entice European Monetary Union constituents to leave. On that note, the Italian government (the second biggest debtor in Europe) is crumbling, with the prospects new anti-EU leadership could be coming. That would re-introduce the risk of Italy leaving the euro and inflating away its debt load.
As you can see in the chart below, Italian yields are decoupling from German yields (Italian yields rising, as German yields are on record lows). |
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Keep in mind, Italian yields were running around 7% (unsustainable debt service levels) back in 2012, when it looked like Italy and Spain might default and destroy the monetary union. Draghi (the ECB) stepped in and saved the euro by promising to buy unlimited sovereign debt. Now 10-year Italian yields are beginning to rise from under 1.5%.
Next, the most imminent risk (and therefore important risk) remains surrounding China. Will they come back to the table and negotiate in good faith to get a deal done on trade? Will they hold-out and devalue the yuan? Will China overtly intervene and enforce its own law on Hong Kong, breaking its multi-decade accord with the UK? This happens to be the time of year when China's communist party leadership (current and past) is gathering at a seaside summit in China to strategize for official policymaking meetings in October. With that, we probably don’t get any movement on the questions above in the next week (or more).
August 9, 2019 As we end the week, Trump continues to posture for some leverage to get China back to the table, sooner rather than later.
This morning he threatened to cancel the September talks. That may sound like a threat that will lead to the opposite outcome (a later return to talks, rather than sooner). But as we've discussed, Trump seems to be making the bet that ramping up the threats/penalties will thwart China's attempt to play "hold-out" through next year's election. With that, it does appear his formal "currency manipulator" complaint against China may have done the trick (to restore some leverage). We can see it in the steady fixings by the PBOC since Sunday night. The question is: Is the Trump administration willing to take the risk of a "no deal" into the election, which would likely leave the global economy deteriorating sharply as people sit on their hands awaiting an election outcome? I think the answer is a clear no. Consider the White House's China strategy is being highly influenced by Peter Navarro (Assistant to the President and Director of Manufacturing and Trade Policy). And his well documented viewpoint would suggest he and the White House believe the stakes are far too high, to risk turning it over to another administration (with no appetite to force structural reform). For perspective, here's how Amazon summarizes Navarro's 2011 book, Death By China … "The world's most populous nation and soon-to-be largest economy is rapidly turning into the planet's most efficient assassin. Unscrupulous Chinese entrepreneurs are flooding world markets with lethal products. China's perverse form of capitalism combines illegal mercantilist and protectionist weapons to pick off American industries, job by job. China's emboldened military is racing towards head-on confrontation with the U.S. Meanwhile, America's executives, politicians, and even academics remain silent about the looming threat…(more here)."
August 8, 2019 The yuan continues to be the signal for global markets, and for the past two days China has held it steady.
With that, we're getting some recovery in yields and stocks. As you can see in the chart below, stocks have fully recovered the losses that started Sunday night, triggered by the devaluation of the yuan through 7.0 (yuan per dollar). |
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While stocks have recovered those losses, the interest rate market has not fully recovered the losses. The 10-year yield is the key barometer of global financial market sentiment right now (and sentiment on prospects of a trade deal). And it's flashing red (negative).
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My view: We're at the stage where a full recovery in stocks, back to new record highs, isn't happening until a trade deal is done — even if the prospects for more Fed rate cuts are building, and even if the economic data comes in solid.
With that in mind, we run into a big technical area of resistance for stocks today (the 61.8% retracement of the recent correction). |
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But as we've discussed in recent days, I suspect Trump thinks he can get China back to the table this month (rather than next), by escalating the threats. His (currency manipulator) claim to the WTO does indeed increase his leverage. With that, I think the market is well under-estimating the chances that a deal could come in the coming weeks.
August 7, 2019 The global interest rate market continues to price in the worst-case scenario.
What's the worst-case scenario? An indefinite trade war, and one that likely ends up with China in the penalty box, not just with the U.S., but with global trading partners. And an isolation of the Chinese economy would likely lead to a global military war. That's what $15 trillion of negative yielding global sovereign debt is telling us. So the interest rate market is taking signals from the trade war. Global central banks are taking signals from the interest rate markets (not the other way around).
So who is sending the signals on the trade war? Trump. And with the confluence of recent moves (Trump's threat of additional tariffs, China's currency response, and Trump's charge of currency manipulation), those signals have looked more ominous. That triggers more global capital flows into sovereign bonds (namely Treasuries).
The question is, has Trump lost his leverage to do a deal (even with concessions) with China? The markets have voted 'yes,' he has lost leverage, especially after taking the charge of currency manipulator to the WTO. But contrary to most of the viewpoints we heard yesterday, China does have more to lose under the charge of 'currency manipulator.' The WTO is forced to make a judgement on the charge, which means China's other global trading partners are forced into the China-trade-war fray. That has given Trump leverage. In the meantime, we have two paths that are positive for stocks: 1) Global rates going even lower, forces capital that requires return into stocks (as we saw in the post-financial crisis environment). 2) Trump withdraws his charge against China and does a deal, stocks boom.
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