Notes From Underground: A Fresh Glance at Markets

Exactly two weeks ago we at Notes From Underground published, “Powell Seeks To Reestablish The Authority of Markets…Maybe?” While I was off enjoying my daughter’s wedding, the December S&P futures had closed at 2895 on Oct. 5 (unemployment Friday). I warned that the market was misjudging Chairman Jerome Powell as he seemed impervious to equity and bond market corrections. The algos are built on the FOMC being quick to defend the elevated levels of the bond and equity markets.

With the exception of presidents Bullard and Kashkari, the Powell Fed has remained stoic about the need to reach an undefined NEUTRAL LEVEL for overnight interest rates. Last week the airwaves and newspapers were filled with comments from previous FED Governors noting what a great job Chairman Powell and the FOMC is doing in moving interest rates to neutral. Yet the central bank has been facing a barrage of criticism from President Trump and other residents of the White House.

CNBC trotted out former Chairman Alan Greenspan and the last Vice Chairman Stanley Fischer. Greenspan was very good in noting that Trump’s public comments about the FED are not ordinary because he was pressured by the presidents he served under many times to be reticent in raising rates (politics before appropriate policy). It is Sara Eisen’s interview with Stanley Fischer that revealed an inside view of a couple of issues I’ve raised with Rick Santelli and in this blog over the last eight years.

EISEN: Do you think the U.S. can stay–if you look at the markets, the Chinese market suffered so much worse–so has its currency, the U.S. has been remarkably resilient in the face of trade risks,can that remain the case?
FISCHER: And I always say we the central bankers cut interest rates severely to encourage growth and TO SUPPORT EQUITY PRICES [emphasis mine]. That adjustment hasn’t been fully made yet. Prices have gone down a bit but they haven’t gone down relative to where they were 20 or 10 years ago and that adjustment may not be over.
This is the argument made in the last blog as to why Powell will be a different type of FED Chairman. An undefined neutral interest rates will certainly have an impact on current asset values and that process of realignment may not have run its course as of yet. But be cognizant for all doubters who say that central bankers SEVERELY cut interest rates in an effort to support equity prices. The Boockvar QT analysis is spot on in highlighting the potential impact for various asset classes. For all you made algo programmers it may be time to recalibrate.
EISEN: [Inquiring about an aggressive Fed even though] “… inflation not appearing to be out of control?”
FISCHER: It’s a global problem. Every country … can’t understand why inflation is low. Listening to other countries, they think its competition from lower-income countries that is keeping wages down. That’s a possibility but we don’t really know. It could have something to do with lower productivity growth that is usual at this stage of the business cycle. But it’s simply a problem that has to be understood and it isn’t fully understood.
This is the issue that I have referred to with Rick Santelli as the NAIRU VERSUS NEHRU dilemma. My problem with Fischer’s forthright response is that the FED and other central banks’ massive QE programs were in response to an inflation problem that they admit they can’t comprehend. While U.S. equity markets and global debt markets have been elevated in value who will bear the brunt of the global asset unwind when FED interest rate rises force bubble-like asset classes revert to long-established mean valuations? So much liquidity was created to solve a minimally understood problem. THIS IS THE ISSUE THAT CREATES THE MOST MARKET UNCERTAINTY GOING FORWARD.
***The problem highlighted by Eisen/Fischer is revealed in the current Italian /EU confrontation. There is continued pressure from Brussels on the Italian government to reduce its proposed budget deficit for 2019. As readers of NOTES know, I believe it is Rome that holds the upper hand in these negotiations. The European banks, pension funds, insurers and global financial institutions are loaded with all sort of European sovereign debt. (Even more so since the ECB has artificially inflated asset values by its continued QE program.) Rome knows that the higher Italian yields are forced by the rhetoric of Brussels eurocrats, the greater the losses for institutions forced to sell in any type of panic.
On Friday, Moody’s downgraded the sovereign rating on Italian debt. The problem for the global financial system is this: Under BIS rules, sovereign debt carries a ZERO RISK WEIGHTING, which means that banks do not have to maintain reserves against sovereign debt holdings. ANY INVESTORS WHO BELIEVE THAT ZRW IS AN APPROPRIATE STANDARD, EMPTY YOUR POCKETS FOR YOU ARE NOT A TRUE FIDUCIARY AND OUGHT TO RETURN YOUR EARNINGS.
German banks, and even the Bundesbank, are laden with Italian, Spanish and Portuguese debt. The central banks forced all investors to accept massive risk for a minimal additional amount of return. The Italian government, under the management of Salvini and Di Maio, are well aware of the strength of their position. Brussels, under the leadership of President Juncker, is placing itself in an untenable position. The Italian coalition is building up its prestige with its voters as they push for a stimulus program to  enhance growth. Italy has already suffered under the fiscal austerity of the Northern Europeans. They have nothing to lose.
Yes, interest rates will rise as markets sell Italian debt in anticipation of the EU’s plans for retaliation. But traders and investors, as well as global policy makers, best know who will be punished by the retaliatory efforts. This is a far more difficult situation than the apologists for Brussels and ECB are willing to admit. Imagine the situation in Germany where Chancellor Merkel is under siege for failed policies. Imagine if the Bundesbank and German banks were struggling under the crippling losses on Italian debt and needed a bailout? Chancellor Angela Merkel sustained major losses in last week’s elections. The Italians are very attuned to the fragility of the current political situation in Europe.
More to follow tomorrow, but a quick note, the S&P’s 200-day moving average is in play, which reflects the unease in financial markets. We are getting a quality test of market sentiment, even as STRONG EARNINGS are failing to sustain stock market rallies. Maybe Stanley Fischer has it right.

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5 Responses to “Notes From Underground: A Fresh Glance at Markets”

  1. Asherz Says:

    For most of the last decade Risk On has been sustained by the Fed, ECB and BOJ. The 2013 attempt to change the formula in the alchemist’s monetary test tubes, saw Little Ben run for the hills. Not a financial Spartacus.
    We are now looking at the periphery EM nations in a downward spiral. The third biggest economy in Europe is sticking its tongue out at the Brussels Bureaucrats and the Implications that will mean for European banks. However the biggest Holloween ogre out there is what is happening in China. Its debt levels, bank fragility, stock market weakness, and currency downward spiral, is the main threat to the global economy. This is the second biggest GLOBAL economy. Current earnings are a rearview mirror picture and not a palliative.
    If these factors become threatening in a 2008 scenario on steroids, what do Powell and his Central Bankers cohort do? Continue on their current path?
    I’m not convinced.

  2. Judd Says:

    Thanks for the heads up. When you get defensive it’s time to take action. I used VXX to articulate Risk Off

  3. Trader 1 Says:


    U speculated that a EU Construction type bond could be issued to appease Italy & keep debt off Italy Balance Sheet.

    Any speculation on time frame this would be announced??

    • Yra Says:

      Trader–just got off a phone call with somebody inquiring about that—-don’t know but the only way to placate the Italians would be this type of eurobond which would be the liftoff for a genuine european debt instrument—it could be based on the same capital key that the ECB presently”adheres” to–so if a 500 billion euro bond were raised it could be used to fund German infrastructure spending with 18%,France 14% and Italy 12%—just wondering if Merkel waited too long as her power dissipates but if we saw this I would get long Europe versus the U.S. although the initial response would be bullish all equity markets—just my opinion

  4. Chicken Says:

    Over $650B of margin debt, outstanding.

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