Notes From Underground

As we head into the final two weeks of the year, the global equity markets are “sliding into home.” Equities sold off again on Friday as the Chinese tariff saga is failing to provide support to the market. Weekend news conveyed the idea that the market was reacting to this week’s FED meeting and the very high probability of another increase in the central bank’s target range. This is a stretch because investors have been aware of the FED‘s limitations under its own “forward guidance,” trapped into a rate hike for fear of spooking the market if no increase was decided.

It is a great failure of the FED‘s forward guidance policy that calling off a rate hike WOULD DO MORE HARM TO MARKETS THAN AN INCREASE IN THE FED FUNDS RATE. (I call it the ultimate prisoner’s dilemma for the game theorists populating the FED‘s research centers.) The most important outcome with the FOMC statement will be if the central bank sends dovish signals by acknowledging the global slowdown. That has been the reason that all other central banks have left rates unchanged (SNB, ECB, BOJ, RBNZ, RBA, BOC). The only bank that has raised rates is the Russian central bank (which they did on Friday).

The FED says very little about global conditions, which is incongruous being that the DOLLAR is the world’s reserve currency. Whatever path the FED takes has far greater impact upon the global financial system and yet the U.S. central bank remains very restrained in commenting on global economic conditions. If Chairman Powell is searching for grounds to lessen the possibility of future rate hikes, the STRONG HEADWINDS FROM A SLOWDOWN OF GLOBAL GROWTH provides the perfect rationale.

***There was an important news pieced over the weekend, which said the World Economic Forum (also known as DAVOS), has decided to allow three heavily sanctioned Russian businessmen to attend the most expensive cocktail party in the world in January, reversing an earlier decision. Oleg Deripaska, Viktor Vekselberg and Andrei Kostin have been invited, thus putting a chink in the U.S. sanction strategy. The sanctions are hurting Russian business but the massive energy to Germany and other EU nations render the overall sanctions farcical.

It will be important to watch if the U.S. pulls back from official involvement in Davos or the change in the attitude was cleared with the U.S. Treasury. Many have warned the U.S. that they are relying too much on sanctions in an effort to punish nations not compliant with the desires of American foreign policy outcomes.

***Readers of NOTES have been apprised of the European debt crisis for many years and know that the theme of the ECB being trapped by its QE and Negative Interest Rate Policy (NIRP). A long-held view was that while Jeff Gundlach and Bill Gross were saying that the German bund was a GREAT SHORT PLAY, NOTES advised being long the bund and short the French OAT for a very conservative play on the poor outcomes of the ECB program. Recently, the BUND/OAT spread has widened out to 47 basis points as investors are nervous because of the political violence propagated by the “yellow vests.”

The poor outcome for bond investors was elevated when President Macron capitulated to the demands of the Yellow Vests, rescinding the recently imposed fuel taxes while also increasing government expenditures. French President Macron’s decision has pushed the country’s budget deficit over the Maastricht-imposed restriction of 3 percent. This is a dangerous position for France to take while Brussels is simultaneously criticizing Italy for a budget deficit of 2.4%. The EUROCRATS in Brussels maintain that the French situation is far different from Italy. Pierre Moscovici, the EU economy commissioner maintains the situations are totally different: “The European Commission has been monitoring the Italian debt for several years;we have never done that for France.”

Furthermore, a French Treasury official maintains “the situations in Italy and France are not comparable. Contrary to Italy, we do not question European rules. We agree that having public finances in order and reducing public debt are the right thing to do.” The arrogance expressed by EU officials will not sit well with Rome. Europe will continue to harm itself as it confronts the pushback to Brussels and the ECB.

Tags: bund/oat spread, deficits, ECB, Europe, Federal Reserve, France, Jerome Powell

This entry was posted on December 16, 2018 at 7:09 pm and is filed under Debt Market, Europe, Fed. 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.