Three central bank meetings, the selection of a new Fed chair, the release of a major new tax policy and the unemployment report provided the markets with great potential for increased volatility. Instead the markets yawned and carried equities to new all-time highs.The central bank decisions went as expected; the unemployment was a bit weaker than projected but the weather problems from the hurricanes have probably not been fully tallied.
The FED chair nominee Jerome Powell had been the odds-on favorite for the last two weeks so the muted market reaction was logical. If you wish to experience a good sense of Governor Powell, watch the 75-minute piece from the Chicago Council on Global Affairs on June 28, 2016. (You can hear me asking a question about risk-weighted assets and who guarantees the ECB at around the 50 minute mark.) One thing I respect about Powell is his candor about the FED‘s forecasts and most other highly respected forecasters: Anything over a quarter out is highly suspect! Powell’s pragmatism is welcomed especially as we have been lulled by the high maths of Bernanke et al and come to believe that series of advanced differential equations provide the ILLUSION OF CERTAINTY. As Powell himself states, “Economics is not a surgical science.”
But rest assured, when Powell becomes Fed Chairman the markets are going to test him. Consider Paul Volcker from 1979-81, Greenspan in 1987 and Bernanke in 2006. Yellen was not tested by a crisis as the Taper Tantrum and the beginning of the Fed’s QE tapering began in the last months of Bernanke’s reign. Yes, Yellen began unwinding QE but her program has been aided by the BOJ and ECB‘s very aggressive stimulus policy. Proof of this can be found in Friday’s weekly close of the 2/10 yield curve at 72 basis points, even as the world’s economic data has continually improved. The FUNGIBILITY of capital flows continues to pressure the long-end of the U.S. yield curve in spite of very solid PMI numbers throughout the economies of the developed world, coupled with repeated fresh daily highs in the equity markets and inflation levels that return a negative REAL YIELD on all short-term interest rate investments.
IT’S THE ECB AND BOJ POLICY THAT IS FLATTENING GLOBAL YIELD CURVES as investors search for extra yield. This is very similar to the 1994 BOND disaster as Orange County went BUST in the search of an extra 30 basis points. A similar situation took place as the financial crisis of 2007 expanded. Investors in various sorts of short-term strategies for a LITTLE extra return got crushed as what was presumed relatively safe investments imploded. Bottom line for Jerome Powell: Will the global markets provide the same support that benefited Chair Yellen?
***Three weeks ago I blogged about a very important geo-political event that took place on October 5: A meeting in Moscow between Vladimir Putin and Saudi King Salman Bin Saud. This was the first visit ever by a Saudi leader to Russia, somewhat on the order of Nixon going to China. Since this visit political events in the Middle East have been heating up as the Kurds, Syrians, Turks and Saudis are maneuvering to attain some political advantage over other actors in the region.
Also, since this historic event the crude oil has rallied SIX DOLLARS. Coincidence? Today, the Saudi story took on a new importance as King Salman and his nephew the Crown Prince Mohammed Bin Salman consolidated his power by arresting several high-ranking Saudi officials and even going so far as to detain the highly respected Prince Alwaleed. It was later reported there was a downing of a Saudi helicopter that was inspecting the border area of Saudi/Yemen with some high level Saudi officials aboard. Sounds like the Gulf of Tonkin.
The Saudis seem to have increased their desire to challenge the Iranians since the King’s visit to Moscow. The most significant news out of Saudi Arabia over the weekend was that the Prime Minister of Lebanon resigned because of the overwhelming influence of Hezbollah in Lebanese politics. The resignation took place while Prime Minister Saad-al Hariri was in Saudi Arabia. This takes on added importance because by law the Lebanon Prime Minister has to be SUNNI. So the resignation taking place in Saudi Arabia in response to increased Iranian sponsored Iranian Shiite influence in Lebanon SHOULD BE OF GREAT CONCERN To ALL MARKETS. Nothing is as it seems. 2+2=5 is a beautiful thing in the world of global macro trading.
Tags: Fed, Janet Yellen, Jerome Powell, monetary policy, QE, Saudi Arabia, Sunni
November 6, 2017 at 8:29 am |
Yra,
Thanks for the reminder of Orange County.
My thesis has always been that the next downturn in asset prices across the board is going to begin with some kinda blow up in the bond markets. In your opinion is this off base or more on the mark???
November 6, 2017 at 8:54 am |
Trader—-as an analyst who has studied under some of the most dynamic political economists thus Austrian and Marx theories I believe everything begins with credit–
November 6, 2017 at 2:35 pm |
Probably begins with the long bonds?
Because that’s where the CB’s should lose control first. As CB’s can control the quantity of money or the long rates, but not both. When inflation rises (it’s already starting with more in the pipeline), CB’s will lose the keys to the money printing press, so up go the bond yields in response to rising inflation expectations and CB’s no longer able to print money for bond-buying.
Immediate collateral damage: failing pensions, annuities and insurers globally that hold the longer bonds that plunge in value as yields rise, even if just modestly from the lowest levels in history. That starts the contagion and in a highly-leveraged world, others fall like dominoes. It all begins with this fall in the bond market. Likewise, the “death of the bond market” in the latter 70’s kicked off a vicious double-dip recession and plunge in most asset classes.
Today is a more precarious situation than the late 70s, exacerbated by higher leverage, more speed & interconnectivity, financial assets concentrated into ETF’s with liquidity mismatch, and a new generation of central bankers worldwide who are wrongly fighting the last war (the 2008 global recession and equities collapse) instead of the coming inflationary spike and bond market collapse.
November 6, 2017 at 8:48 pm
David Richards–high quality post.See ZHOU’s comments today from China–“High leverage is the ultimate origin of macro financial vulnerability…In sectors of the real economy this is reflected as credit that has been expanding too quickly.”My bones in macro were made analyzing the petro dollar loans to the less developed countries.I interviewed at banks in Chicago,several who were recycling petro dollars for financing imports of oil from OPEC—I didn’t posses an MBA just graduate work on global finance as a political tool and multinational corporations –they walked me to the door and that was it—when Continental Bank collapsed because of those very loans I had many TED spreads on–long T-bills and short euro dollars—not boasting just providing you with my longevity in this business when fundamentals mattered
November 6, 2017 at 1:18 pm |
“The problems will emerge among those investors who have borrowed money to buy assets—in America the volume of such debt exceeds the level reached in 2008. The big question is which is the most vulnerable asset class.“
The next financial crisis may be triggered by central banks
https://www.economist.com/news/finance-and-economics/21729750-process-withdrawing-monetary-stimulus-fraught-danger-next
November 7, 2017 at 12:44 pm |
“The next financial crisis may be triggered by central banks”
What, it’s not different this time?
November 6, 2017 at 3:13 pm |
thought you might be interested in this if you’ve not seen it already.
https://uk.reuters.com/article/germany-politics-europe/franco-german-bonds-would-be-a-good-move-senior-merkel-ally-says-idUKL8N1MH1HO
November 6, 2017 at 8:38 pm |
jdogdog—thanks for this .I would say that this is an effort by some in Merkel’s camp to try to pry the Social Democrats into the coalition as the FDP I seriously doubt would be in favor.This is certainly the camel’s nose under the tent–maybe they can use these to fund the British nuclear reactor at Hinkley point built by the French firm Areva–interesting as Germany has gone to being non-nuclear.Good post,thanks agian and gives us something to think about.Before this could take place France would have to find a way to get its fiscal deficit under control–also the Italians and Spanish will be quietly opposed as they still need Drahgi to keep their borrowing rates down