Notes From Underground: Much to Be Thankful For. Now Back to Work

Tonight, we at Notes From Underground will clean up some unfinished business. We will discuss a couple of important speeches and articles from the past two weeks.

Then I will answer the questions Mike Temple made on the previous blog post. In responding to some of Mike’s points I come back to the idea of INFRASTRUCTURE, which I addressed in a few other blog posts. The reason I foresee aggressive fiscal stimulus put forth by the G-20 is precisely because of some of the fears that Mike raises about the damage coming to the investment grade corporate bond market while the FED’s shrinks its balance sheet and raise interest rates. It may be having a greater impact than the FOMC wants to acknowledge.

If the outcome from the FED‘s recent and continued policy causes the DOLLAR to appreciate, the effects will be somewhat deflationary. Emerging market debt will be spooked as the cost of dollar-denominated corporate debt will become onerous. The debt servicing costs for U.S. investment grade debt will rise because of the vast amount of debt piled on during the QE policy during the Bernanke regime. U.S. government debt servicing costs are also rising as borrowing costs are pushed higher in response to Fed policy of rate hikes coupled with tightening reserves. Plus, the uncertainty over the impact of the ECB’s ending QE with an impending Italian banking and budget crisis adds to the uncertainty challenging the global economy.

As an aside, this weekend THE WASHINGTON POST ran a story by Josh Dawsey and Damian Paletta titled, “Trump Wants to Cut Deficit but Still Demands Pricey Spending.” The idea that President Trump is concerned about deficits is from the theater of the absurd. This president has made the policy error of raising defense spending, which will prevent any effort to constrict federal spending. As long as the monster of the military-industrial complex gets fed, all other government programs will be supported for that is the give-get that drives the budget process in Washington. Trump’s concern over deficit cuts is political chicanery at its best. Pay no attention to the man behind the curtain.

Now that the 2020 election cycle has begun, Trump wants an infrastructure program in an effort to stimulate the economy. In addition, the recent equity market weakness necessitates the need for fiscal stimulus. Trump will blame the stock market weakness on the “LOCO FED” so that lifts FISCAL STIMULUS into the position of being “THE ONLY GAME IN TOWN.”

***There were three important interviews or speeches in the last two weeks that I wish to cite in reference to the global macro world:

1. CNBC interviewed Fed Vice Chairman Richard Clarida and he raised some important issues for the FED to consider. Clarida raised the issue of the slowing global economy several times. He said:

“It’s important for your viewers to understand that although our mandate is full employment and price to building in the U.S., to achieve that we have to understand and factor in the global economy. And there is some evidence of global slowing. Certainly speaking for myself, that’s something that is going to be relevant as I think about the outlook for the U.S. economy. You know, because it impacts big parts of the economy through trade and through capital markets and the like.”

It is refreshing to hear from an influential voice at the FOMC table that there are concerns about the global economy. The role of the U.S. dollar as the world’s reserve currency ought to give the FED a triple mandate: Dollar strength can cause havoc for a world swimming in a pool of dollar-denominated debt.

2. There was a Wall Street Journal story on November 16 by Joseph C. Sternberg titled, “Why Central Bankers Missed the Crisis.” Sternberg cites the views of Claudio Bario, which are important because he heads up the economic research department for the Bank for International Settlements (BIS). In addition to the significant historical perspective, Sternberg notes that Bario questions the efficacy of the Phillips curve for failing to account for the structural forces of globalization.

“The big structural force Mr.Bario identifies is GLOBALIZATION [ed note: emphasis mine], under which international competition puts sustained downward pressure on inflation.”

If the FED and others fail to understand the dynamic nature of the global financial structure then monetary policy outcomes will struggle to be appropriate.

In a paper the BIS published this year there is a warning we all need to heed: “On one hand, globalization and other [often benign] factors make it harder for central banks to gin up inflation. On the other hand, by slashing rates in pursuit of that hard-to-attain inflation target, they create IMBALANCES IN THE FINANCIAL SYSTEM THAT LEAD TO CRISES LIKE THE ONE IN 2008,” (emphasis mine). This is the dilemma that the global financial system faces and should lead to questioning the false certainty of central banks dependent on academic theories. It is this questioning that makes the Sternberg article so important.

3. On November 20, Bundesbank President Jens Weidmann delivered a speech to the insurance association of Europe titled, “Securing Stability–Challenges From the Low Interest Rate Environment.” The speech provides much perspective on the Great Financial Crisis, which is important. What’s of greater interest is Weidmann’s view about the NATURAL RATE of interest. It is quite possible that Herr Weidmann will be the next President of the ECB so we should pay attention. Weidmann cites the 80-year old study of American economist John H. Williams:

“The natural rate is an abstraction; like faith, it is seen by its works. One can only say that if bank policy succeeds in stabilizing prices, the bank rate must have been brought in line with the natural rate, but if it does not, it must not have been.”

Further, Weidmann raises a very significant point for all investors: “But the concept of the natural rate refers to characteristics of the real economy, so it would be appropriate to apply a risk-bearing return on capital.”

As the markets begin to concentrate on the vast amount of debt plaguing the global economy it is time to get back to work and focus on how the servicing of global debt is going to impact monetary flows around the world. If you thought this was easy you have chosen the wrong vocation. Investing in the global macro world is not a hobby. Now, back to work and rid your mind and body of the impact of TRYPTOPHAN.

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14 Responses to “Notes From Underground: Much to Be Thankful For. Now Back to Work”

  1. Mike Temple Says:

    Yra
    Thoughtful analysis. Even if I acknowledge to you that BIG INFRASTRUCTURE spending will become part of the Arsenal going forward, I fear that it will come only AFTER all heck breaks loose in the markets.

    Please take note….I still remain open to the idea that “risk on” could come roaring back on the back of a Xi/Trump detente or deal before year end.

    But, to me, the edifice of structurally unsound Debt is doomed to collapse given the current Fed tightness.

  2. asherz Says:

    Yra- Nicely done enumeration of all the balls that we have to throw up and catch in an ever increasing complex financial mish mash that the trader/investor has to put into his stew. And made more difficult by all the missteps of our pointy headed central bankers.
    But as I have emphasized time and again there is one glaring overriding problem- global DEBT in a slowing GDP world.
    Where I would disagree with you is your emphasis on the military/industrial complex as the bogey man in our budget process. When we are cannibalizing our airplanes to keep them flying, when our navy is the smallest in decades. When getting combat personnel is challenging. And when China is becoming a military superpower when we have starved our military expenditures through sequestration, our ability to protect our interests has been weakened. Agreed we have fought wars we should not have and there is enormous waste coming out of the Pentagon. But that requires administrative shakeups that would give us a greater bang for the buck.
    The real problem does not lie in the discretionary spending of the national budget. It lies in an area that is kryptonite for any politician, Social Security and Medicare/Medicaid and items that take 70% of the budget. And are on the road to insolvency.
    Trump is a real estate man, and there never was debt he didn’t like. But retaining the dollar as the reserve currency is severely threatened by these trillion dollar annual deficits. Unfortunately the man behind the curtain, like all those running for office, have as their horizon the next election.
    Plato had it right in The Republic when he envisioned a philosopher king, whose horizon extends way beyond two, four or six years. Have we had someone like that since 1789? And could he/she be elected today?

  3. the bigman Says:

    Now several questions from the back of the classroom:

    1. The most recent German GDP had a negative although small negative print. I read that this may have been due to some hiccup in auto production- something to do with emissions. today business confidence in Germany has also stalled with a lower than expected print. Seems to me to be a bad time to approach the Germans about underwritng bridges and roads in Italy. Add to that Brexit on the ropes and riots in Paris. i was wondering if GreenAB the blog’s man in Germany woulc care to comment on these developments

    2. Reading with interest and enjoyment the repatree between the host and Mike Temple. Now for the dumb question. Won’t there be a lot of tax loss selling this month? How will that effect equities if at tall. This will be the first year in a long time with signifcant losses

    3. Finally Yra how about Mexico Just got back Tulum (Soliman Bay to be exact.) Flew Volaris (the Mexican Southwest Airlines from TJ). Planes and airports were packed with locals. We had to wait for 40 minutes for a gate on arrival in CdM. In Quintana Roo trucks everywhere- can see why AMLO wants to build a railroad to there. With a debt to GDP of only 46% it seems that Mexico can afford the infrastructure plans of the new government better than Trump and the Dems here. Yra I know you have mentioned Mexico in passing. What are your thoughts on Mexican peso which is still around 20 to the greenback and infrastructure investment there.

    Thanks to all for a most informative year (by the what there is no trytophan in mezcal and mole) FWIW The Bigman

  4. kevinwaspi Says:

    Sorry, I have just awakened from my Turkey induced coma (you are what you eat), and find everything just fine today. The Dow is up 300+, Oil is “surging higher” (Goldman Sachs also says the recent slide in oil and other commodities was overdone and suggests investors now take long positions) and GM stock is up 6+% as it is closing more plants, eliminating more product, and obviously shrinking itself to prosperity!
    G20 will obviously conclude with a “Kum ba yah photo-op” as it always does, and once again, great men of great wisdom will save us from ourselves.
    Someone please, hand me another Turkey leg, a pint of ale, and a double TRYPTOPHAN laced cigar!

  5. Chicken Says:

    “As long as the monster of the military-industrial complex gets fed, all other government programs will be supported for that is the give-get that drives the budget process in Washington. ”

    Lip service for everything but the Pentagon.

  6. TripleNet Says:

    2Y-10Y spread at 10 year lows.
    CAPE Ratio at 10 year highs.
    Corporate debt as % of GDP at 10 year highs.

    I’m staying short the S&P.

  7. asherz Says:

    As predicted Chairman Jerome Powell blinked. The heat in the kitchen got much too hot. Some had claimed that he was of a different stripe than his predecessors and would stand strong. From an ostensible hawk in October, the brickbats thrown at him from the President and a bad October in the markets, the rates in November are now “Just below neutral.” Meaning the December .25 raise will be the last for now. If things get ugly, will QE be far behind?

    Oh, the days dwindle down to a precious few
    October (edited), November
    And these few precious days I’ll spend with you
    These precious days I’ll spend with you

  8. Mike Temple Says:

    Asher’s
    Not sure whether Powell blinked as much as he may have “walked back” his talk. Clearly, markets are relieved/thrilled that Powell has listened to Trump and Jim Cramer that it was time to “lighten up, Francis”

    Now to the Center Ring of the Circus. Having watched Powell do his “thing” on the sideshow, will Trump dare not deliver the piece d’resistance of a trade detente or deal with Xi this weekend.

    What good is a 40 handle pop in S&P if Trump brushes off Xi and knocks 100 handles off the S&P

    Were that to happen, would everybody then begin to wonder whether the December rate hike could suddenly be “off the table”

    Market players are left to a play a dizzying game of “chicken” with Trump this weekend, especially if stocks hold and/or add to these gains.

    Stay tuned

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