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David Fuller and Eoin Treacy's Comment of the Day
Category - Fixed Income

China Is Said to Offer Path to Eliminate U.S. Trade Imbalance

This article from Bloomberg News may be of interest to subscribers. Here is a section:

China has offered to go on a six-year buying spree to ramp up imports from the U.S., in a move that would reconfigure the relationship between the world’s two largest economies, according to officials familiar with the negotiations.

By increasing annual goods imports from the U.S. by a combined value of more than $1 trillion, China would seek to reduce its trade surplus -- which last year stood at $323 billion -- to zero by 2024, one of the people said. The officials asked not to be named as the discussions aren’t public.

The offer, made during talks in Beijing earlier this month, was met with skepticism by U.S. negotiators who nonetheless asked the Chinese to do even better, demanding that the imbalance be cleared in the next two years, the people said.

Economists who’ve studied the trade relationship argue it would be hard to eliminate the gap, which they say is sustained in large part by U.S. demand for Chinese products.



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Don't Fear a Potential Recession; Embrace It

Thanks to a subscriber for this report from Morgan Stanley which may be of interest. Here is a section:



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Mnuchin Massacre Christmas Eve Bottom?

This article by Muir for his Macro Tourist blog may be of interest to subscribers. Here is a section:

Remember back a half-dozen years ago when all the hedgies were bearish and David Tepper came out and said something to the effect of; “if the economy weakens, then the Fed will ease and stocks go up. If the economy strengthens, then stocks will go up because earnings will be rising. Therefore I am buying.”

Well, I think it’s almost the exact opposite situation today. If the economy strengthens then Powell will hike and stocks will fall from the liquidity withdrawal. If the economy weakens, then Powell has shown he is loathe to come to the market’s rescue and he will be slow to lower rates.

I don’t think you need to overthink this. The Fed has tightened into either a slowdown, or a recession. The market sniffed it out, but the Fed ignored the signals for a bit and made the sell-off worse. Now the market is in the process of correcting that overreaction by rallying.

But don’t forget that Powell has absolutely no stomach for frothy financial markets, so beware getting too excited about the Fed’s recent dovish talk. This is not Yellen or Bernanke’s Fed. Powell has a different set of beliefs, and although he has succumbed to market pressures for the moment, it won’t take much for the old tone-deaf Powell to return.



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Email of the day on yield curve inversions

Before Xmas I forwarded an article by EPB Macro Economics who assessed that the Fed had already tightened too much and that a marked slowing of the economy was inevitable.  The latest EPB report (see attached) highlights that there has already been an inversion in US Treasuries, and that the Fed interest rate cycle has now peaked, but deteriorating economic data will cause more volatility in equity markets.



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Outlook for 2019: The Game Has Changed

Thanks to a subscriber for this report from KKR which may be of interest to subscribes. Here is a section:



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Powell Pledges Flexible Fed Policy, Won't Quit If Trump Asks Him

This article by Jeanna Smialek and Rich Miller for Bloomberg may be of interest to subscribers. Here is a section:

Federal Reserve Chairman Jerome Powell said the central bank can be patient as it assesses risks to a U.S
economy and will adjust policy quickly if needed, but made clear he would not resign if President Donald Trump asked him to step aside.

“With the muted inflation readings that we’ve seen, we will be patient as we watch to see how the economy evolves,” Powell said Friday on a panel with his predecessors Janet Yellen and Ben Bernanke at the American Economic Association’s annual meeting in Atlanta.

“We will be prepared to adjust policy quickly and flexibly and to use all of our tools to support the economy should that be appropriate to keep the expansion on track,” he said, adding “there is no pre-set path for policy.”



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Email of the day on Target 2 imbalances

Merry Christmas to you and your family. Thank you for all the hard work you have put in 2018 to produce such a valuable service. I'm sure that the Euro's travails are the last thing on your subscribers' minds this festive season but this YouTube video may be of interest to the Collective. It is a lecture given in fluent English) by German economist Dr. Oliver Hartwich last July, entitled 'Target 2 and the Euro Crisis'. He explains this arcane subject with great clarity and humour. 



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Corporate Bond Spreads Keep Widening as Investors Yank Cash

This note by Christopher DeReza for Bloomberg may be of interest to subscribers. Here ii is in full:

U.S. credit spreads widened to the highest levels since the summer of 2016 as funds saw outflows even as major American equity indexes posted a second day of gains.

Investment-grade bond spreads widened 2 basis points to 152 basis points on Thursday. The index has widened every day since Dec. 14 and most trading sessions this quarter

The junk bond index also rose Thursday, although the move was less pronounced. The index widened 1 basis point to 531 basis points, the highest level since Aug. 4, 2016. It’s risen 113 basis points this month
 

Investment-grade funds saw outflows of $4.4 billion for the week ended Dec. 26, the most since December 2015, according to Lipper. Junk bond funds registered the biggest outflows since October.



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To Help Put Recent Economic & Market Moves in Perspective

Thanks to a subscriber for this note from Ray Dalio which may be of interest to subscribers. Here is a section:

For all of the previously described reasons, the period that we are now in looks a lot like 1937.

Tightenings never work perfectly, so downturns follow.  They are more difficult to reverse in the late stage of the long-term debt cycle because the abilities of central banks to lower interest rates and buy and push up financial assets are then limited.  When they can’t do that anymore, there is the end of the long-term debt cycle.  The proximity to the end can be measured by a) the proximity of interest rates to zero and b) the amount of remaining capacity of central banks to print money and buy assets and the capacity of these assets to rise in price.  

The limitation in the ability to print money and make purchases typically comes about when a) asset prices rise to levels that lower the expected returns of these assets relative to the expected return of cash, b) central banks have bought such a large percentage of what there was to sell that buying more is difficult, or c) political obstacles stand in the way of buying more.  We call the power of central banks to stimulate money and credit growth in these ways “the amount of fuel in the tank.” Right now, the world’s major central banks have the least fuel in their tanks since the late 1930s so are now in the later stages of the long-term debt cycle.  Because the key turning points in the long-term debt cycle come along so infrequently (once in a lifetime), they are typically not well understood and take people by surprise.  For a more complete explanation of the archetypical long-term debt cycle, see Part 1 of “Principles for Navigating Big Debt Crises” (link).

So, it appears to me that we are in the late stages of both the short-term and long-term debt cycles.  In other words, a) we are in the late-cycle phase of the short-term debt cycle when profit and earnings growth are still strong and the tightening of credit is causing asset prices to decline, and b) we are in the late-cycle phase of the long-term debt cycle when asset prices and economies are sensitive to tightenings and when central banks don’t have much power to ease credit.



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Email of the day on Fed balance sheet contraction and liquidity

I understand the problem about reducing the FED balance sheet and raising rates at the same time.

The impact on liquidity is however less intuitive to me. While the effect of interest rate hikes is clearer, the effect of a Balance Sheet reduction is less so.

Am I wrong to assume that what technically happens when the FED reduces i.e. sell bonds is that the private sector, through the banking system, receives these bonds? In exchange banks reduce the account balance that they hold at FED.

If banks get Treasuries in their book, they also receive more interest income (coupons) that goes into the system. This money was blocked in the book of the FED until then.

Why is this necessary bad?



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