Notes From Underground

There are so many sounds resonating in the global financial world it has been difficult to discern the impact of any particular tweet or headline. NOTES FROM UNDERGROUND hopes to cut through the babel to provide perspective, context and NUANCE. If we at NOTES cannot accomplish this then we’re just screaming into the chasm that is global macro finance. The impact of Chinese tariffs, Middle East maneuverings, QE programs — from the BOJ to the FEDERAL RESERVE (yes I know what the policy makers are saying — it’s not QE) to the ECB — need to be understood as they drive short-term moves but also have much longer consequences.

It seems that the trade tensions between China and the U.S. will be slowly resolved as little steps will be agreed to on the LONG MARCH of China’s quest to be a dominant force in the global economy.

The Middle East is fraught with intrigue as all the regional actors move to solidify recently gained advantages that have resulted from the U.S. retreating from Syria beginning in 2013. Put this in context: As ISIS attempted to establish a caliphate we are left to wonder if others such as Turkey or Iran have the same desires. The ongoing question is whether you can have a caliphate with the control of the two main religious sites: Mecca and Medina. It is the twin pillars of Islam that are needed to maintain a caliphate in the image of the centuries-long Ottoman Empire, which was anchored by Sunni Islam.

The timeline for this to play out is beyond the ability to trade so all major focus is on the effect of turmoil on oil prices. It has been difficult to judge this as even attacks on Saudi oil installations have had less than marginal outcomes as the spike in prices lasted not even a day.

The results of myriad central bank QE programs have had much more impact as BOND prices have sustained illogical levels in the fears of asset purchases. While European sovereign debt has retraced some of its “GAINS,” the overall market remains in negative territory as German bunds are at -39 basis points with Dutch, French, Finnish, Danish, Swiss, and of course Japanese 10-year notes are also at negative yields. The greater absurdity of the EUROPEAN DEBT picture is that Greek and Italian 10-year yields are well below U.S. borrowing costs.

The year long PIVOT by the FED has had an impact on equity markets as Chair Powell went from tightening monetary conditions by unwinding the balance sheet and raising the FED FUNDS RATE to instituting “NOT QE” via purchases of Treasury bills to increase the level of reserves in the banking system, and keep better control over short-term interest rates (i.e. repo and fed funds). As a result, the YIELD CURVES have begun to steepen. As a The 2/5 and 2/10 curves both ended the week above their 200-day moving averages.

This has also resulted in a weaker U.S. dollar, which closed below its 200-day moving average due to the combination of monetary policy and GOOD NEWS on BREXIT resulted in the purchasing  of British pounds and EUROs. Brexit is still too hard to call but many short POUND positions were covered in anticipation of a resolution to the three years of conjecture about the economic impact.

Even Bank of England Governor Carney sounded positive about the potential for the British pound, but BREXIT is still a difficult concept with many uncertainties. But the EU leadership seems to want to move on from Brexit and deal with far greater problems.

This coming year will test the ability of ECB President Christine Lagarde to deal with her dual mandate: A EUROBOND and creating the backdrop for some form of fiscal harmonization for the entire EU project. Readers of NOTES may have noticed that for the past decade I have had few nice things to say about the EU. The EURO was foisted on the EU entity before there was the political will for a genuine federation. A common currency without a UNIFIED DEBT INSTRUMENT was a recipe for disaster. When the EU was facing its EXISTENTIAL CRISIS in JULY 2012, then-ECB President Mario Draghi did everything he could to seize the moment and calm markets. The initial policy was necessary. It was all the QE that came after that has provided the growing angst across the EU.

The ECB‘s massive balance sheet built on the back of negative interest rates has resulted in the financial repression of European savers while the heavily indebted nations have been allowed to exist on life support. This has given rise to political backlash in the Northern EU nations. The German economy is slowing as world trade is under pressure from the Chinese/U.S. tariff dispute, which is raising the calls for a formidable FISCAL STIMULUS in Germany and of course for all other nations. Can you do a massive European stimulus without a unified DEBT INSTRUMENT? Nein.

So will Germany lift the repressive SCHWARZE NULL and let 100 infrastructure projects BLOOM? If this begins to take shape under Lagarde’s regime it will be time to be long European assets. It is something to watch as we head into 2020. To make this discussion even more relevant, I direct readers to a speech Bundesbank President Jens Weidmann delivered last week in New York to the Council on Foreign Relations. Weidmann was considered to replace Draghi as ECB President but was deemed too HAWKISH (i.e. opposed to NIRP/QE) to run the central bank.

Based on the conclusion of his speech to the U.S. audience, it seems that Weidmann is preparing for a MAJOR change in the direction of German thinking. He cites America’s similar problems about fiscal harmonization in 1789 when he said, “Americans eventually opted for fiscal union, but it was embedded in a strong political union resting on democratically legitimized institutions. A new constitution created a federal government with a range of enforceable powers fitted within a sophisticated system of checks and balances.”

Has Lagarde already garnered Bundesbank support and what will be the price tag? Germany has already been saddled with guaranteeing the entire ECB balance sheet as evidenced by Greece and Italy’s preposterously low yields. This will be a continuing theme as it will have wide implications for a world in which the U.S. is scaling back its global footprint. But the question still needs to be answered: Is the German guarantee of the ECB balance sheet an act of fiscal stimulus?

Tags: BOE, BOJ, Brexit, Christine Lagarde, ECB, EU, Fed, Germany, U.S. Dollar, U.S.-China trade, yield curves

This entry was posted on October 20, 2019 at 2:44 pm and is filed under Central Banks, Middle East, UK, United States. 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.