Notes From Underground

The markets have been in a lock-step since easy central banks have been pushing bond yields lower and equity prices higher. (Currencies are a mixed bag depending on safe haven status, high yields or commodity-tied.) The correlation is still in play as now previously profitable trades are hearing the clarion call of higher yields leading to lower precious metals, lower bond futures, some softening in commodity prices (oil excluded), a rally in the U.S. dollar and stable equity prices. Those shifting out of some long-held bonds are searching for returns in high quality stocks with a reasonable dividend. Earlier this week, global equity markets were sold as a ridiculous rumor ran through the markets that the ECB was contemplating tapering its QE program, a la the Bernanke Fed. Today, ECB Board member Vitor Constancio ( and vice president from Portugal) denied that the ECB had any inclination to curb its QE program. This led to an immediate rally in equity markets and brought the bond yields lower. Of course a Portuguese central banker on the ECB would be opposed to any tapering of QE as Portuguese 10-year note yields are at 3.51%, a significant premium to the other European sovereign debt markets (except Greece).

In my opinion, President Draghi will NOT taper until inflation begins to approach 2% or the French, Italian and German elections have passed. The ECB has followed the FED playbook. The only way that Draghi would compromise on QE is if the Germans acquiesce to Juncker’s massive fiscal stimulus program. Or, if Deutsche Bank needed to sell bonds to increase its capital and the ECB bent the rules with a backdoor bailout rather than a politically unpopular bail-in. Remember that this is Europe and as always there is one set of rules for the French and Germans and another set for the less important European actors.

Stanley Fischer was at it again last night. Speaking at a New York Fed-sponsored event, the vice chairman offered up his views on low interest rates. Fischer laid out his theory on why rates are very low and why rates may continue to hover at the zero lower bound for quite a while. Fischer stresses that the natural interest rate may remain low because “… the general level of prices has no tendency to move either upwards or downwards.” As Fischer admits “… that chronically low interest rates could well be, at least in part, the result of very low natural interest rates and not just a consequence of the cyclical state of the economy.” Fischer sums up that there may be some credibility to the Larry Summers’s argument about secular stagnation. The proof in that the very low forward yields “… could be yet another indication that the economy’s growth potential may have dimmed considerably.”

The FED vice chair also went through the litany of reasons about too little capital expenditure due to the lack of economic uncertainty because of the Great Recession and also the fact that people are saving more because the “… trauma  associated with the Great Recession may have contributed to a persistent increase in precautionary saving and greater demand for safe liquid assets.” There may be elements of fact in Professor Fischer’s explanation for the present state of global interest rates but it seems that today’s headline in the Financial Times reveals a higher probability explanation for the current secular stagnation affecting the global economy: “IMF WARNS RECORD DEBT OF $152 tn POSES THREAT TO GLOBAL ECONOMY.”

According to Vitor Gaspar, director of fiscal affairs at the IMF, “Excessive private debt is a major headwind against the global recovery and a risk to financial stability.” NOWHERE IN FISCHER’S SPEECH IS THERE A REFERENCE TO A MASSIVE DEBT OVERHANG PLAYING A PART IN PREVENTING GLOBAL GROWTH. The FT article goes on to say, “Levels of borrowing have substantially outpaced global growth in recent years, rising from 200 percent of gross domestic product in 2002 to 225 percent last year. While two-thirds of the debt is held by the private sector, government borrowing has also ballooned since the global financial crisis.” Maybe the threat of rising interest rates and the gigantic debt serving costs is what is forcing people to save more rather than spend. What Say You Stanley Fischer?

The London Telegraph’s Jeremy Warner also picks up on the debt accumulation argument an article titled, “Cheap Money? I Think We’ve Had Quite Enough of That, Thank You.” Mr. Warner picks up on the IMF report, writing, “To growing alarm, the world economy is again up to its neck in debt. In what claims to be the most comprehensive assessment to date, the IMF has found that EXCLUDING BANKS AND OTHER financial institutions global debt risen to a staggering  $152 trillion, or 225 percent of GDP. Far from acting as a firebreak, the financial crisis seems only  to have further accelerated  the accumulation of debt. Central banks have been deeply complicit in the process of pouring petrol on the flames.”

The debt issue will not recede as it keeps growth stagnant and more importantly if debt servicing costs increase the impact on growth will be powerful. The FED has sustained the asset bubbles as the ECB and BOJ have joined the enablers club. They have stoked the habit of low interest rates funding increased borrowing, corporate financial engineering and ever rising equity prices. Will an ECB taper, a BOJ steepening its yield curve and a FED jawboning for higher rates break the habit of ever-increasing debt?

***Unemployment data tomorrow and with the election coming in 30 days  it will take a massive growth in non-farm payrolls and/or average hourly earnings of 0.4% to even think about the FED raising in November. If payrolls are above 250,000, the media will discuss the need to raise quickly. But with the U.S. dollar in rally mode, the precious metals under pressure and food prices dropping the FED will be loath to raise rates. Tomorrow afternoon, Fed Governor Lael Brainard speaks at 3:00 p.m. CST. She will be interesting to hear as she has been very dovish and reticent to lift rates because of the strength of the DOLLAR.

I believe Brainard is Yellen’s confidant and her opinion seems to carry greater weight in the group of FOMC governors. If the data is strong watch the 5/30 and 2/10 yield curves for they OUGHT to flatten as the pressure SHOULD be on short rates. The metals will break and the DOLLAR will rally, but in this I caution: This week has already seen a powerful selloff in metals, bonds and a strong rally in the DOLLAR. A very strong JOBS NUMBER may be in the market and FED speakers may wield a stronger impact. Be prepared by doing your technical work so as to be aware of any powerful price reversals. The recent strength of the DOLLAR may be the most important palliative to recent FED hawkishness.

Tags: BOJ, bonds, central banks, Debt, ECB, Fed, metals, Stanley Fischer, U.S. Dollar

This entry was posted on October 6, 2016 at 8:21 pm and is filed under Central Banks, Debt Market. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.