Notes From Underground: Back to What’s Driving Markets

We have all been bogged down with tweets coming from the White House about China. Because high-speed traders force us to parse the messages and assess the immediate impact on the markets, we’re hostage to President Trump’s tariff policy. The bottom line is that Robert Lighthizer is left to inform the world when China will acquiesce to the U.S.’s demand for reliable and hardened enforcement mechanisms to solidify any genuine agreement. From my perspective, the critical point on global markets is that once China/U.S. trade agreement is done the president will set his sights on targeting the ENORMOUS TRADE IMBALANCE that favors Germany.

Supporting this view is the fact that the Germans are not very pleased about Secretary of State Pompeo canceling a scheduled visit to Germany on Tuesday. (He headed to Iraq on very short notice.) Yet on Wednesday Pompeo was back in Europe but failed to meet with the Germans.

There are many German politicians concerned about Trump’s threats against the luxury carmakers of Bavaria. What makes Europe such an inviting target for President Trump is the critical European Union Parliament elections taking place May 23-26. There are several pro-nationalist groups struggling to gain ascendance into the E.U. Parliament, which are opposed to the current direction set by the eurocrats in Brussels. Remember the public humiliation that Trump received from German Chancellor Merkel and French President Macron at the G-7 summit last June?

In case investors forget, Trump will remind the world of the photo that went VIRAL of the Europeans staring down the president. Then, ex-Trump adviser Steve Bannon has been actively meeting with anti-Brussels political leaders. (Also, for anyone who missed it, John Brady recommends that fellow readers should seek out Bannon’s op-ed about China that ran in the Washington Post on May 6.) Europe is much more important for financial markets because its economy is weak and its debt load is enormous. The markets are not yet concerned about the elections but wait for the tweeter-in-chief to set his sights on the coming political uncertainty.

The EURO is stable and actually performing well against its European neighbors as the EUR/CHF cross is trading close to its nine-month high, while the EUR/SEK cross is at a 10-year. This may just be market complacency as the vast amount of investors are focused on U.S./China trade talks. What’s interesting is that the EUR/YEN cross closed today below the close of the YEN flash crash that occurred on January 3. Is the YEN rallying as Japanese investors repatriate money during the recent turbulence? Pay attention to movement in the EURO crosses for investor concern about political uncertainty.

***On Tuesday, the Reserve Bank of New Zealand CUT its Official Cash Rate (OCR) by 25 basis points to 1.5%. Traders did not expect this as the consensus was for no change. On Monday night, the Reserve Bank of Australia (RBA) left its rate unchanged at 1.5%. There was a 40% chance that the RBA would CUT but Governor Lowe left rates unchanged, citing the low level of the Australian dollar, as well as uncertainty about the credit situation in the Australian mortgage market.

RBNZ Governor Adrian Orr cited “a key downside risk” related to the growth projection was a “larger than anticipated slowdown in global economic growth, particularly in China and Australia, New Zealand’s largest trading partners.” The statement noted “this lower global growth has prompted foreign central banks to ease their monetary stances, supporting growth prospects.”

This action from a foreign central bank puts a great deal of pressure on Fed Chairman Jerome Powell. The U.S. is held captive by other central banks’ continued easing as it puts downward pressure on their currencies in an effort to stimulate their economies. This is the predicament that keeps me looking for a steepening in the U.S. yield curves.

Separately, on Wednesday Fed Governor Lael Brainard gave a speech in which she discussed the idea of targeting the U.S. yield curve.

Unlike Japan, she mentioned just the one- and two-year rates rather than the long end. “Under this policy, the Federal reserve would stand ready to use its balance sheet to hit the targeted interest rate, but unlike the asset purchases that were undertaken in the recent recession, there would be no specific commitments with regard to purchases of Treasury securities.”

The notion of the Fed hitting a targeted rate, especially during times of massive Treasury financing, echos Ray Dalio’s recent concerns about the onset of some sort of Modern Monetary Theory. It is really difficult to see how U.S. curves will invert in this environment as foreign central banks continue to ease and the FED pivots away from any type of tightening rhetoric.

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33 Responses to “Notes From Underground: Back to What’s Driving Markets”

  1. Mike Temple Says:

    So, if the Fed is going to load up on 1 and 2 yr UST, doesn’t this strongly imply that the Fed will also ease?


    • yraharris Says:

      Mike—-I would normally assume so but for the moment there are so many variables in play they could ease without easing—a 5 basis point cut in IOER remember that piece of work –for the third time

  2. Michael Temple Says:

    Well, with 1 Yr/2Yr/5Yr all yielding far less than IOER, any such Fed buy program of the 1 Yr and 2 Yr would INVERT them even more through the IOER rate.

    Not the look the Fed is trying to capture/project. Yes, the 2/5 inversion might disappear, but the IOER/2 Yr might invert by 25/50 bp if Brainard’s QE program gets activated.

    Methinks the Fed is cutting rates along with that QE program.

  3. Michael Aaron Temple Says:

    The Fed has been in complete “reaction” mode ever since the December turn as markets faced down the abyss at SP 2350ish.

    Arcelor Mittal reported abysmal numbers this morning, highlighting European slowdown. SKorea (bellweather for semiconductors) is stalling again. Trump’s trade war with China is suddenly not so easy to win. I still think they will “punt” forward with additional negotiations, but I think markets are starting to become leery about trusting so much in anything Trump is peddling these days.

    Also, let’s not underestimate the potential for a growing loss of confidence in the US as the Dems vs Trump has now devolved into a contempt citation of AG Barr and the subsequent DEFIANCE of the White House to comply with any Democratic Congressional subpoena.

    Leaving my own political views out of it, what is clear is that the political dynamic/chaos/temperature is surely rising as much as that in the Straits of Hormuz. At what point does foreign capital (read Chinese and Germany) decide to tell Trump to stick it by refusing to show up at our auctions and, perhaps, even sell some USTs and USDs.

    My point……..To be long stocks right now, one has to be copacetic betting on Mr. Trump. Not sure that is a well-reasoned investment thesis.

    As stated before, you will be proven right…..Fed is going to be cutting rates (my hunch is by July 4th at latest) and that QE is 2H 2019 event.



    • yraharris Says:

      Mike Temple—you make many good points.The wildcard in my opinion may be how big the infrastructure bill will be and even though it will take a great deal of time to get the economic impact the market will react with a hallelujah—and the Fed may become ever more cautious

  4. phoo Says:


    To be long stocks is to be long USA. As Berkshire buys Amazon in Q1, that’s not an investment thesis on Trump , it’s an investment thesis on where amzn is 10, years, 20 years, 50 years from now. That’s it. You hate Trump, I get it.

    • Michael Temple Says:

      Hey Phoo
      Respectfulky, leave politics out of this. I have never once said yay/nay about Trump personally and have only truly opined on his financial thinking/actions.

      As for your Betkshire/Amazon observation, a whole lot can happen. In between now and 20 years hence.

      From October 2007 to October 2008, Amazon lost nearly 95 pct of it’s Vale from $113ish to $5ish. Amazon will not be immune if all markets get destroyed in any market meltdown scenario in the coming months/years.

      Objectively speaking, Trump loves to sow chaos and act like a whirling dervish in virtually all matters. Generally speaking, stocks don’t like that kind of “crazy” especially if the economic worm has turned.

      So, please lay off the politics and stick to economic and/or market opinions.

  5. Chicken Says:

    Looking for a bright side and I realize I’m swimming against the tide and all present forms of conventional wisdom, but you might say I’m relieved someone in DC finally claims to possess reading comprehension skills.

    It’s nearly enough to coax me into testing the waters.

  6. Lembit Says:


    You mentioned in Judd’s room a book that you have 3000 copies. Could it be possible to buy one from you?

  7. Arthur Says:

    In his interview with Yahoo Finance, Munger dismissed criticism of Trump’s efforts to pressure Federal Reserve Chairman Jerome Powell on interest rates.

    “I think presidents have always done this… and is a bad idea,” Munger says.

    • yraharris Says:

      Arthur–as you know I believe that Trump is reading from the Nixon playbook on how to craft an economy to help ensure reelection–as nixon said –“we are all Keynesians now–Alan Matusow’s book,Nixon’s Economy is the manual and he is adhering to it—Arthur Burns was his whipping boy

  8. Michael Temple Says:

    Trump says he likes Xi, personally. But, he won’t let that stop him from negotiating with hardball tactics for what he wants.

    So, how will Trump negotiate with the E.U. over trade when you consider that Germany is really the E.U. We know Trump does not care for Frau Merkel and she holds him in contempt.

    Who knows, the Chinese deal could be a sideshow and/or sneak preview for the main fisticuffs to come as US v Germany is next.

    I saw a piece clarifying Brainard’s plan for future Fed pegging operations of 1 and maybe 2 yr UST. Such pegging/QE-lite would come only AFTER the Fed hits ZIRP.

    RED EDs looking better and better, imo

    • Trader B Says:

      Mike- I agree with your bet there will be a 50 basis point rate cut at the June meeting. If we are right and you are long the reds, you will make 25 basis points. If you are long Q3 or Q4 2019, you make 50 ticks. How come you aren’t long the whites? What do you think happens to Z19/Z20 if there is a rate cut? It is currently 26 basis points inverted.

      • Michael Aaron Temple Says:

        Trader B
        Yes, the EDZ9 and shorter contracts will do well if Fed cuts in June. I simply like the Reds better because I think once the Fed cuts, the markets will begin to discount even greater cuts in the out months, especially if the initial Fed cut is due to extreme stock market conditions.

        I believe that the Fed will probably adopt ZIRP again in its next cutting cycle, which could catapult the REDS to the 99 handle.

        But there may not be enough time for the whites to hit a 99 handle as the additional cuts come later.

        Simple as that

      • yraharris Says:

        Trader B–you are correct about the whites if there is a 50 basis cut—But I am doubtful of an immediate cut even if this would be the correct action.The reds were a better play because of the 2020 election but now they have been subjected to the cut by year end philosophy so more difficult but that is why I buy the Dec 20 and sell Dec 21 when it goes negative–right now it is a little rich for me but it worth watching.

  9. Julian Says:

    So would the latest round of tariffs compare to Nixon’s “Freeze two” in the great inflation?
    Except it happened after Nixon was re-elected.
    I mean a bunch of goods going up 25% literally overnight looks a bit potentially inflationary?
    Stockmarket gone nowhere for 15 months. Americans dipping into their anemic savings to maintain their standard of living.
    Not looking slightly a bit stagflationary?
    FEDs might shortly be finding themselves in a bit of bind?

    • yraharris Says:

      Julian–Friday i watched the Nixon speech from August15,1971 —it leads me to think that Trump is reading from the Nixon playbook especially as the Nixon surcharge on imports was deemed to be a small inconvenience for Americans and was not a tariff as it was leveled on all imports.But you have a very good analysis–thanks

  10. Michael Aaron Temple Says:

    Frankly, I think the Fed might welcome inflation if it were to steepen the yield curve. Despite its current dovishness, the yield curve is still rather flat, and has pancaked again in the past week or so with 3M/10 yr almost back to flat after blowing out to 10-12 bp.

    Your observation of the impact of increased tariffs is a good one, especially if they stick and are not merely a temporary negotiating ploy. Little noticed in all the headlines this week was a story highlighting how retailers are already bracing for an awful Xmas holiday selling season. Names such as Wal Mart, Macy and Best Buy can see the “writing on the wall” as prices will go up, threatening sales and/or margins.

    I don’t think this has yet to be fully priced into their share prices or the overall calculations of what Q4 consumer spending may be. It is only 7ish weeks before Q3 begins. So, starting in July, we may begin to see actual guidance begin to be crafted lower by many of these retailers if Trump’s higher tariffs are left in place.

    So, yes, stagflation is quite possible. But, the Fed simply cannot afford to raise rates without causing a big blow up somewhere in the system, in my view. Especially with economic conditions worsening overseas. Just last night, China reported another disappoint monthly auto sales number.

  11. Michael Aaron Temple Says:

    I hope you know I greatly respect your thoughts and analyses. However, I find myself disagreeing strongly with your views on coming rate cuts. I think they will come “fast and furious” here in 2019.

    Put me in the camp that says the 2019 stock market rally has been a vicious vicious bear market rally, especially as last week’s action has done some technical damage. Whether stocks can stage one more “oomph” higher is clearly a possibility.

    But, if/when the real McCoy returns, I think Powell blinks LONG BEFORE we hit the December 2018 lows of 2350ish on S&P.

    Therefore, I think a RATE CUT could occur with stocks down “just” a mere 10% from its highs (SP 2950 to 2650).

    And if stocks fall 10% because China Trade Wars are not so easy to win, then economic numbers will begin to show cracks.

    Again, major retailers are already begin to worry about Q4 Xmas sales and the “full on” Trade War has not even yet begun.

    Lael Brainard’s “trial balloon” of pegging the yield of the 1 yr and 2 yr USTs is predicated upon Fed policy first reaching the Zero bound/ZIRP before commencing that novel new QE-lite program.

    So, lost in those headlines is an implicit admission that the Fed will most certainly return to ZIRP.


    • yraharris Says:

      Mike–I just don’t think it will happen that quick but I am putting on steepeners especially the 2/10 as it plays around with the 200 day—the Fed seems to be very concerned about the flatness of the curve so I look to take a position in this–if the FED were to get aggressive in cutting it would be ahuge winner—so while I disagree as to the time line I believe the concept is dead right on

  12. Michael Aaron Temple Says:

    I think Fed rate cut is going to happen pretty darn quick.
    The trade talks are kaput until at least the June G-20.
    As you can see this morning, 2 yr UST down to 2.22% which is approximately where it raced to when Powell lowered IOER but then cautioned it was just a “technical” move.

    Yield curve is FLATTENING again which has to be of concern to Powell, especially if stock market agita continues. RED EDs up another 4-5 tics and Powell is once again “behind the curve” as Trump’s little Trade War trumps (ha ha) all else. Sentiment is always an important thing in markets. Bullishness allows companies like Lyft and Uber to raise massive amounts of $$ on the back of cash burning, dubious business plans.

    We seem to be losing that bullishness. If the bearishness of Q4 2018 returns, your 2/10 steepener will work out. But, I think the explosion of RED EDs may be the real fireworks as Fed interest rate cuts become reality as Mr Market will be miles ahead of Powell.

    Again, REDs are well bid this morning and yet 2/5 is inverted and 3Mo/10 yr is at +2 in favor of the 10 yr.

    I believe Fed cuts before 4th of July, and may not even wait for a scheduled meeting if stock market really starts to swoon. This past week was “nothing” compared to Dec 2018. And it would be only a sneak preview of what may come if investors begin to factor in a true
    global synchronized slowdown recession. Does anybody really think there won’t be collateral damage from this current China/US tiff?

    Are the burghers in Bavaria hoisting their beer steins in joy this morning? Or the heads of BMW/Mercedes? Again, don’t underestimate the likelihood of “somebody” burning a Buick in Beijing and Mary Barra having to report ZERO Buick car sales in China for the month of June.

    This can really unravel very very quickly.


    • yraharris Says:

      Mike—the 2/10 needs a rate cut of your speed and size to really become effective—the size of the increasing deficit will do the rest of the work.Unless Trump/Kudlow are going to tariff the U.S. to prosperity

  13. Michael Aaron Temple Says:

    Good Morning

    Besides the global economic indicators that have been flashing yellow/n’ae red for several months, we may now have that YUGE shift in sentiment, as discussed above.

    But, another reason for my “pounding the table” belief that Cuts are imminent is that the key negotiator here is Trump.

    The same man that proudly and stupidly painted himself into a corner against Pelosi and Schumer and mindlessly closed down the federal government for 35ish days, inflicting real economic pain and DISTRESS on over one million federal employees/families/ and associated governmental contractors. At any juncture along the way as the paycheck periods approached, Trump could see and hear how he was holding a losing hand, and yet he petulantly stood his ground because Trump never backs down, even when he is colossally wrong. Backing down is for losers, and he is not a loser. Better to double down and sow more chaos. That is his mentality.

    So, are we to believe that Donald’s better angels are suddenly going to appear during this China “tiff”. Kudlow finally was forced to admit on Fox TV that China does not pay the tariffs, it is is American businesses and US consumers who pay for them.

    And, yet, Trump has again painted himself into a corner. China has just stated they will not negotiate unless Trump removes ALL tariffs first. So, are we to believe Trump is going to rescind his latest tariff hike AND cancel his original 10% one, as well? Come on, just study
    what he did 5 months ago as the Government Shutdown continued for WEEKS on end before he meekly folded.

    Real damage to actual trade, but more importantly, to CONFIDENCE is a comin’.

    This morning UST 2 yr is back down to 2.22% which is approximately where they raced to after Powell lowered IOER but then spoke that it was NOT a policy move, but rather a “technical” adjustment.

    Well, here we are back to 2.22% and things don’t seem so technical this morning.

    Again, back to the topic of CONFIDENCE…..

    Uber is down another $2ish this morning to a $38 handle. IPO investors are down a cool 15% on the “hottest” deal since Facebook.

    I seem to recall that FB initially slipped from its IPO price of $30 down to $17ish before it finally hit its stride and boomed. A similar 40% down move for Uber (and Lyft) is certainly possible, further darkening overall market mood.

    It has long been my view that the SINGLE data point that Powell follows (without openly acknowledging it) is not core inflation, or AHE, or any of the other handy dandy acronyms.

    A simple three letter data point, the “S&P”, is his true Northstar.

    He will NOT wait for a revisit of the Dec 2018 lows of 2350ish to pull the rate rip cord. I think a scary sell off of 10% from the 2950ish high (roughly 300 pts) will do the trick, especially if the China/US trade talks continue to spew venom and not love.

    German bund yields plummeting again. UST 2 yr at 2.22% looks might appetizing to foreigners in search of yield these days, even if the fully hedged cost back into their own currencies ain’t much. Some reports that even Mrs. Watanabe is taking a flier at buying USTs unhedged.


  14. Michael Aaron Temple Says:

    Wow…I wrote that missive BEFORE the Chinese announced their retaliatory measures.

    Your curve steepener is happening BIGLY. Poor soybean farmers, too.

    Does China actually dare to sell USTs?

    If Xi has read his Sun Tzu (of course, he has), he knows that you should always attack your enemy’s weakness, not his strength.

    No need to use “kinetic force”. US is a net debtor, relying on the kindness of strangers’ pocketbook. Just the threat of selling USTs is enough to deliver a market “blow” to Trump.

    Yeah, right, Trump has this all under control. I am quite certain he “game theoried” all of these responses with his colleagues BEFORE he TWEET BLUSTERED again over the weekend.

    Rate cut by 4th of July!!!

  15. John Bastian Says:

    Now a mote from the unwashed. If there is a rate cut by July 4th it will be because of war in the Middle East and soaring oil prices not this China tit for tat If you can’t stand up to China when you have 3.2% GDP and record low unemplyment when can you? Now to open my mouth and remove all doubt as to my ignorance, so the 10 year auction was “bad” coverage was still over 2 and rate was I believe only 2 basis points higher. As Mike points out US yields look pretty good at these levels. All that said I did buy some GLD out of the money calls this AM but only because of the mullahs in Iran who are desperate and may exercise their virgins in heaven option by attacking US while Pampeo is in Russia

    • Michael Temple Says:

      Meanwhile, I am sure that Buffett is buying more “cheap” Amazon and Apple, per the wisdom of Phoo.

      Trump seems fairly content to double down with Xi and damn the stock market consequences. In fact, Jim Cramer (who is smart but has a shtick of a presence) said he has spoken with Trump confidantes who report that Trump is keenly aware of what he is doing. Trump feels that with Dow at all time highs (last week, that is) he has house money to bash Xi. Moroever, Trump doesn’t care about the date of ABC companies (Apple Boeing Caterpillar) who have sizeable Chinese exposure. Instead, he cares more about solid US companies like Verizon etc.

      In other words, according to Cramer, Trump may actually welcome seeing the ABC stocks take a whupping.

      But, hey, Phoo is right. Twenty years from now, they will be sky high. Uber, too. Meanwhile, let’s just ignore the 10 tic rally in EDM20 this morning and the 3Mo/10yr inversion.

      What do silly bond markets, esp Germany with a New 45 yield on 5 years and neg 7 on 10 years.

      Even if China threat to sell USTs hasn’t deterred UST buyers.


  16. the bigman Says:

    Oops accidently put in my real name

  17. matt Says:

    Hi Yra,

    I have some questions, that I would like to ask through email if possible.

  18. Michael Aaron Temple Says:

    John Bastian
    The 10 tic rally in RED EDs and the corresponding rally in 2 yr USTs is being driven by China trade war fears, not the Saudi tanker attacks today.

    Yes, MENA flare up would definitely add fuel to the fire and increase likelihood of economic fears/slowdown which might nudge Fed closer to cutting.

    But, all by itself here today, Mr Market is leading rates lower because of China Trade War.

    Global yields are plummeting and Powell has to be distressed to see
    short term US yield curve inverting with 2/5 inversion and now 3Mo/10yr flirting again with inversion.

    Simply put, NOT GOOD and that is why RED EDs are beginning to price in almost 1/2 of a quarter point cut when you look out at the June EDM20 contract.

    I know Phoo is going to attack me for saying something about Trump, but here I go. I am apolitical here, just stating things that I see and I believe. But, the way he doubled down on the Govt Shutdown for 35ish days makes me think he is not about to lose “face” to the Chinese, whom he believes have been cheating us for years (they have) and whom he also believes just reneged on their word (not that Trump, himself, hasn’t done the same in his career).

    So, I simply don’t see the story/catalyst to want to buy stocks right here. The overwhelming weight and freight train move of USTs and all global bonds suggests that a SLOWDOWN is soon upon us, if not already baked into the cake after the lastest breakdown in the “Oh So Easy to Win Trade Wars” with China.

    Again, Powell is foolish if he ignores these real time market moves and instead focuses on stale data. Again, retailers are already expressing concern/fear about XMAS 2019 sales TODAY!!!! Tell me how that is anything but negative.

    And that “pop” you just heard was the possible closing of the door to such darlings as Lyft and Uber. Seriously, who is going to want to pony up any $$ for We Work.

    And again, in another shout out to Phoo, Amazon down a nifty 3%ish today while Apple suddenly has a heckuva China problem. Don’t think that Trump doesn’t mind seeing Apple taking a hit.

    Yield curves have been steadfast throughout the 2019 stock market rally that something ain’t right in Denmark…..Now that we see it playing out with the China trade war, it is foolhearty to think that the ship will soon be righted in a meaningful way, other than some aborted dead cat bounces.

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