A link to the full report is posted in the Subscriber's Area. 

The graphic of mortality versus contagion included in the appendix of the report is the best one yet comparing COVID-19 with other killers.

The proximity of the Spanish flu to the range of potential outcomes from the new virus is obviously a topic of conversation. The Spanish flu came in three waves, in Spring 1918, Autumn 1918 and Winter 1919 and disproportionately killed young people. COVID-19 on the other hand tends to most kill people with compromised lung function and older people.

Energy led the decliners as oil prices fell below $47 a barrel, while bonds of rental car Hertz Global Holdings Inc. slumped as much as six cents on the dollar. Leveraged loans tied to American Airlines Group Inc. and Travelport Worldwide Ltd. also slipped. The high-yield CDX index, which trades on price, was down a full point at one stage.

High-yield bond investors are trying to assess the big unknown: whether the coronavirus will be just a short-term problem if it can be contained, or, far worse, turn into a pandemic that could pose a long-term drag on the economy and spark a recession.

“The sell-off is accelerating,” said William Smith, a portfolio manager at AllianceBernstein. “Initially we were seeing more weakness in liquid securities, but today there are multiple situations where bonds are down more than five points.”

Riskier credits are less well able to ride out earnings volatility than better capitalised companies. That’s generally why they need to discount their bond offerings. Spreads in the sector were priced for near perfection heading into the end of 2019 as the stock market continued to rebound following the provision of $400 billion in stimulus to the repo market. The potential knock-on effect to demand for consumer products resulting from the virus scare is an obvious risk.

Berkshire Hathaway Energy is now celebrating its 20th year under our ownership. That anniversary suggests that we should be catching up with the company’s accomplishments.

We’ll start with the topic of electricity rates. When Berkshire entered the utility business in 2000, purchasing 76% of BHE, the company’s residential customers in Iowa paid an average of 8.8 cents per kilowatt-hour (kWh). Prices for residential customers have since risen less than 1% a year, and we have promised that there will be no base rate price increases through 2028. In contrast, here’s what is happening at the other large investor-owned Iowa utility: Last year, the rates it charged its residential customers were 61% higher than BHE’s. Recently, that utility received a rate increase that will widen the gap to 70%.

The extraordinary differential between our rates and theirs is largely the result of our huge accomplishments in converting wind into electricity. In 2021, we expect BHE’s operation to generate about 25.2 million megawatt-hours of electricity (MWh) in Iowa from wind turbines that it both owns and operates. That output will totally cover the annual needs of its Iowa customers, which run to about 24.6 million MWh. In other words, our utility will have attained wind self-sufficiency in the state of Iowa.

In still another contrast, that other Iowa utility generates less than 10% of its power from wind. Furthermore, we know of no other investor-owned utility, wherever located, that by 2021 will have achieved a position of wind self-sufficiency. In 2000, BHE was serving an agricultural-based economy; today, three of its five largest customers are high-tech giants. I believe their decisions to site plants in Iowa were in part based upon BHE’s ability to deliver renewable, low-cost energy.

Of course, wind is intermittent, and our blades in Iowa turn only part of the time. In certain periods, when the air is still, we look to our non-wind generating capacity to secure the electricity we need. At opposite times, we sell the excess power that wind provides us to other utilities, serving them through what’s called “the grid.” The power we sell them supplants their need for a carbon resource – coal, say, or natural gas.

Berkshire Hathaway now owns 91% of BHE in partnership with Walter Scott, Jr. and Greg Abel. BHE has never paid Berkshire Hathaway a dividend since our purchase and has, as the years have passed, retained $28 billion of earnings. That pattern is an outlier in the world of utilities, whose companies customarily pay big dividends – sometimes reaching, or even exceeding, 80% of earnings. Our view: The more we can invest, the more we like it.

Today, BHE has the operating talent and experience to manage truly huge utility projects – requiring investments of $100 billion or more – that could support infrastructure benefitting our country, our communities and our shareholders. We stand ready, willing and able to take on such opportunities.

I found this to be an enlightening discussion of the utilities sector. The long-held perception is that these kinds of businesses can afford to pay out the majority of free cashflow in dividends because they are charging rents on established pieces of infrastructure with easily forecastable maintenance and renewal trajectories. As Berkshire’s experience with wind demonstrates, this ignores the long-term risk of exogenous shocks, technological innovation, changing regulation and infrastructure reaching the end of its useful life.

Contagion experts Peter Sandman, Ian Mackay, and Jody Lanard sum up my view in this passage from Past Time to Tell the Public: It Will Probably Go Pandemic, and We Should All Prepare Now:

“We are near-certain that the desperate-sounding, last-ditch containment messaging of recent days is contributing to a massive global misperception about the near-term future. One horrible effect of this continued 'stop the pandemic' daydream masquerading as a policy goal: it is driving counter-productive and outrage-inducing measures by many countries against travellers from other countries, even their own citizens back from other countries.

“But possibly more horrible: the messaging is driving resources toward 'stopping' and away from the main potential benefit of containment – slowing the spread of the pandemic and thereby buying a little more time to prepare for what’s coming.”

For readers who can spare the time, I suggest tuning out media noise – much of it dwelling on the malevolent distraction of which individual may have been spreading Covid-19 – and going straight to research papers being released daily by PubMed Central, the data bank of the US National Library of Medicine.

That way you avoid the sort of misunderstanding I just heard on the BBC, which stated that the death rate is comparable to flu. No, it is not. The average morbidity of flu annually is 0.1pc; Covid-19 is an order of far greater magnitude.

The latest tracking data as of Feb 22 (unreliable, but the best we have) is that the mortality rate is 4pc in Wuhan, 2.8pc in Hubei, and 0.8pc in other regions of China, though all figures are creeping up as slow deaths hit the data.

There can be long lag times after infection so it is too early to infer ratios from South Korea, Italy and Iran, but this is surely more like the Spanish Flu of 1918 than anything we are used to. Chinese data suggests that roughly 14pc of those infected over the age of 80 are dying.

You can read most of the PubMed abstracts free and can see what is coming out of labs in China – some of them excellent – or in Hong Kong, Korea, Japan, Europe and North America. There are already 80 peer-reviewed papers. The unfiltered findings are arriving almost in real time. They give you an extra edge.

The annual seasonal flu becomes a pandemic every year. The coronavirus shares enough similarities with the flu in how it spreads to become a pandemic. Meanwhile, it is far more deadly.

This graphic, produced by the New York Times a few weeks ago gives us a good picture of what we are dealing with. The mortality rate is anything from 8 to 40 times more deadly than flu while the transmission or contagion factor is about the same or higher.   

A link to the full report is posted in the Subscriber's Area.

“The Fed has got your back and they will do whatever is necessary to support asset prices” That is the mantra of stock market investors who have been following a diversified or balanced investment strategy for the last decade. In between there have been occasions when the mantra was challenged, particularly following Jay Powell’s appointment as Fed chair. However, the pivot to easier policy and the response to the repo tightness in Q3 have reasserted belief in the mantra.

“What do you do with your cash?” said Luke Hickmore, investment director at Aberdeen Standard Investments in Edinburgh, where he helps run a number of bond funds. “Leaving it standing there makes no sense and the experience over the last 10 years is that there is no pain in buying bonds. Learnt behavior is that it is safe. Inflation is nowhere and central banks start buying every time yields go higher.”

Heavy demand for tax-exempt income drove yields on even the riskiest municipal bonds to 3.58% on Friday, the lowest since Bloomberg’s records began in 2003. The influx has compressed spreads across the country and caused some debt in high-tax states like California and New York to yield less than top-rated benchmark securities. Municipal mutual funds have reported inflows for the 58th straight week on Feb. 13.

With 30-year debt yielding 1.92% in the USA, 1.59% in Australia, 1.42% in Canada, 1.05% in the UK. 0.36% in Japan and 0.04% in Germany bond investors, and particularly pension funds, are at a loss for where to invest to generate the returns necessary to meet their future liabilities.

Kraft Heinz Co. was downgraded to junk status by Fitch Ratings, which predicted the company’s leverage will remain high for an extended period as the maker of Jell-O and Classico pasta sauce works to stabilize declining sales.

The food company was cut to BB+ from BBB- by the credit-ratings company, with a stable outlook. Fitch said the company may need to divest a sizable portion of its business in order to reduce its debt.

The downgrade follows Thursday’s earnings report, in which Kraft Heinz reported a drop in fourth-quarter sales that sent its bonds and stock tumbling. It was the latest sign that the company’s turnaround plan still has a long way to go.

Kraft Heinz said Thursday it would release a more detailed turnaround plan around the time of its next earnings report in early May, though many investors and analysts had been looking for it sooner.
 

Kraft Heinz’ dividend was 62.5¢ in 2018, 40¢ in 2019 and is expected to be 20¢ in 2020. The decline in the share price has supported the yield, which is currently 5.98% but the outlook for additional dividend cuts puts that under question. The company is likely to be a case study in how intangible values cannot be used to underpin a credit rating during a time of technological and social upheaval.

“Pretty much every client we talk to wants to buy the dip,” wrote Tobias Levkovich, Citigroup Inc.‘s chief U.S. equity strategist in a note. “And that is not comforting.”

The S&P 500 edged higher Thursday, extending the week’s gains to more than 3.5%, as the Stoxx Europe 600 Index climbed to a record and stocks soared in Asia. A gauge of European credit risk hit its lowest since 2007.

Yet the battle against the virus could suffer a setback as factories reopen in China in the coming days and more people come into contact with each other. On the other hand, if factories fail to reopen, the economic impact could prove much more severe.

At Robeco, money manager Jeroen Blokland is eyeing the rally warily. The head of multi-asset funds at the Rotterdam-based firm recently cut an overweight allocation to stocks to neutral because of the spread of coronavirus. He says it’s not yet time to dive back in.

“Every investor is looking for the bottom and wants to find it a little bit earlier than his neighbor,” he said. “We need a little bit more confirmation that the outbreak will be contained before moving again.”

The stock market responds to liquidity because that has an influence on all asset prices and regardless of other short-term factors the Treasury yield is below that of the S&P500 which is generally supportive of the buy the dip strategy. Nevertheless, the stresses coming to bear as a result of the Wuhan Acute Respiratory Syndrome (WARS) are significant and need to be taken seriously.

how is the Yield Curve inversion? The famous inverted US yield curve - only when measured by 3mth/10y (NOT 2y/10y) - has been a reliable predictor of US recession 12-24 months ahead when measured from start point and provided inversion lasted more than 3mths. So somewhere between May 2020-May 2021 we should expect recession. History suggests that this inversion always reverses well before recession arrives. Mainly because Fed eases short rates to avoid recession. So, déjà vu?? Regards

Thank you for this question which may be of interest to other subscribers. The question of the yield curve and how good a lead indicator it is tends to be discussed and dismissed before every recession. This occasion has been no different and it would be foolhardy to think boom and bust have been banished just because some Davos attendees have proclaimed it so.

Chinese officials took issue with U.S. comments about the country’s response to the coronavirus outbreak, and promised they would bring the infection under control.

“U.S. comments are inconsistent with the facts and inappropriate.” Chinese Ministry of Foreign Affairs Spokeswoman Hua Chunying said in statement posted online Friday. The World Health Organization “called on countries to avoid adopting travel bans. Yet shortly afterward, the U.S. went in the opposite direction, and started a very bad turn. It is so unkind.”

U.S. officials said this week that they had difficulty getting specialists from the Centers for Disease Control and Prevention to the front lines of the outbreak in China, and late Thursday the State Department advised Americans traveling in China to come home. Commerce Secretary Wilbur Ross on Thursday also said the outbreak may help bring jobs back to the U.S.

China’s ambassador to the United Nations, Chen Xu, said during a press conference in Geneva that the country had been transparent about the disease.

“We have conducted our business in an open and transparent manner with the outside world,” he said.

Xu said that China would work with the World Health Organization to bring the disease under control, following a declaration by the WHO that the outbreak was an international emergency. The declaration will “not only coordinate global prevention control measures but enables us to mobilize international resources to respond to the epidemic,” he said.

“Official” figures are just below 10,000. This Lancet article suggests 76000 infections. The death toll is reported at around 200 but if that is the case why are crematoria running 24/7? The biggest challenge the Chinese administration has is their claims of full disclosure are being met with doubt because they have such a poor record of reporting accurate facts about any part of the economy. Little wonder that other countries are taking more forceful measures to isolate the country until the infection rate peaks and begins to decline.  

The ship was bound for La Spezia in the Liguria region, with 1,000 crew and 6,000 passengers, 750 of whom came from China, a port spokesman said.

It is looking like the ill person did not in fact have the coronavirus but the fact that 1/8th of the passengers are from China highlights just how influential Chinese tourists are for the global sector. The cancelling of flights both to and from China is going to have a material effect on all tourist destinations and the longer it lasts the greater the impact will be.

The order deluge meant Austria joined the likes of Spain and Italy in setting demand records this month as investors chase the safety of bonds. Fears that the spread of the coronavirus will derail an economic recovery have sent yields tumbling, fueling a huge jump in the world’s stockpile of
negative-yielding bonds.

Austria’s Treasury ended up placing 3 billion euros of the 10-year bonds Wednesday with a yield of minus 0.111%. For investors, that’s still more appealing than equivalent German debt trading at around minus 0.40%. The European Central Bank has a minus 0.50% deposit facility rate.

“Despite the negative interest rate, the issue was met with very strong demand and the transaction was 10-times oversubscribed,” Markus Stix, managing director of Austria’s Treasury, said in a statement.

The total of negative yielding debt continues to rebound, led by a surge in demand for Eurozone sovereign bonds. The total now sits above $13 trillion and has clearly broken the downtrend evident since August. 

The bond market has confounded investors for the past several years as rates have declined or stayed low when almost everyone expected them to rise. The consensus now is that there won’t be much change in intermediate rates this year, with the 10-year U.S. Treasury yield remaining about 2% because the economy is sluggish and inflation continues to be low. While we agree that traditional economic factors will not drive rates higher, we believe supply and demand will play an important role. The big buyers at the Treasury auctions are the Social Security Administration, the Federal Reserve, Japan and China. The Federal Reserve will probably do some buying, but we should realize that their bond ownership has climbed recently from $3.8 trillion to $4.2 trillion, even as the Fed’s stated objective has been to shrink its balance sheet. China and Japan have been upset with Trump’s trade policy and have been less-than-enthusiastic buyers at recent auctions. The Social Security Administration, which has been a perennial buyer of Treasuries, may pull back since its benefits payments will exceed its inflows in 2020. These conditions suggest to us that the yield on the 10-year U.S. Treasury will move somewhat higher to 2.5% during the year, and that is the ninth Surprise.

Funding social security as the total sum set aside for future liabilities is drawn down is going to represent a significant drag on government finances in the USA for the foreseeable future.

Midst all the alarm regarding corona virus, I was surprised that the financial media has paid so little attention to the following:  https://thesoundingline.com/feds-balance-sheet-has-shrunk-20-billion-since-the-start-of-january/

If an over-extended was looking for an excuse to correct, surely this was it!

Your comment would be appreciated.

Thank you for this question which may be of interest to subscribers. I covered the topic of balance sheet expansion in the Big Picture Friday audio but I’m happy to revisit the question here.

The Fed has added $400 billion to its balance sheet over the last four months by purchasing short-dated Treasuries. That has the same effect on the stock market as the liquidity infusions back in 2017 had. We have just had one of the most inert advances in years where volatility remained low for a prolonged period, just like in 2017.

Economists had a broad range of forecasts for when the Fed would stop buying Treasury bills, though June 2020 received the highest response at 43%. Respondents overwhelmingly expected officials will taper the monthly purchases rather than stop them suddenly. The Fed has been buying $60 billion in T-bills each month since October.

A scarcity of bank reserves was blamed for an unexpected spike in overnight funding rates in September. This led the fed funds rate to stray briefly out of its target range. The new cash created by the Fed’s T-bill purchases has since relieved that scarcity. The Fed, intent on ensuring an ample supply of reserves, has said it will continue the purchases at least into the second quarter.

The news headlines are full of news about the coronavirus and the number of countries where it has been found continues to rise every day. That injected a degree of caution in the markets that was not present a week ago. The clearest effects are evident in safe haven assets where Treasuries, precious metals and the Dollar have steadied.

Unfortunately, the Fed made a critical design error in its daily interventions. They are offering to supply repo to the dealers at prevailing market rates. In other words, they are giving the dealers every incentive to take repo from the Fed as opposed to the market. In essence, the Fed has become the lender of first resort when it should be the lender of last resort and offer repo at a penalty rate. The Fed should be willing to help a dealer in need, but it should come at a price.

So, after four months of these Fed repo operations, new problems are emerging. More specifically, the Fed might be going too far and oversupplying this market. The effective federal funds rate is signaling there are enough reserves in the banking system. This month it traded at 1.54%, breaking below the interest on excess reserves (IOER) floor of 1.55% for the first time in 14 months. This is happening as the Fed announces it will continue to plow ahead with Treasury bill purchases and supplying hundreds of billions of dollars of repo supply until April, if not later.

What should the Fed do? It has already telegraphed it will raise the IOER rate by five basis points to 1.60% at the Federal Open Market Committee meeting next week. Presumably, it will also raise the repo offered rate by five basis points to 1.60%. Policy makers should raise the repo rate even higher. Stand ready to offer liquidity, but at a penalty rate.

This won’t fix the problems in the repo market; only rule changes can do that. But at least this will allow the Fed to identify how much supply is needed to get the market back in balance rather than risking a loss of control of the federal funds rate altogether.

The Fed should not be looking to permanently insert itself into the repo market via a standing repo facility. Repo is still a credit market, and, in times of stress, it requires a credit decision when deciding who gets a collateralized loan and at what terms. Central banks are not equipped to make these decisions, and their involvement could create a moral hazard, making things worse.

The Fed panicked with their response to the repo market freeze in September. The “short-term” fix introduced had the desired effect and the monetary markets are once again flowing freely. However, the cost has been prohibitive and the big question today is whether this action is an example of what we can expect from the future or is it a once-off deal.

In the next 10 years, demographic changes will have major effects. Millennials, the largest US generation, will be approaching age 50, while the last of the baby boomers will all be at retirement age. Artificial intelligence and virtual reality are expected to be mainstream. Automation will impact the labor force. Environmental disruption will likely continue, and sustainable investing will be mainstream.

Investors see these “mega-trends”— an aging population, technology and automation, diminishing resources— creating opportunities for the future.  In fact, seven in 10 want to take advantage of these trends to seek better returns.

As they look ahead, investors have an opportunity to ensure they are well positioned for the future—a future that will be here before we know it.

…In today’s challenging environment, investors seek various strategies to cope

To cope with this environment, 64% of investors are considering adding high quality stocks to their portfolios, while others would increase diversification and raise cash. Already, investors are holding 25% of their assets, on average, in cash. There is a clear connection between investor confidence and planning. Two-thirds of investors with a long-term plan in place are highly confident they will achieve their goals, compared to only 51% of investors without a plan. In addition, eight in 10 plan to discuss the impact of the US Presidential election with their advisors.

A link to the full report is posted in the Subscriber's Area.

The “challenging environment” rhetoric, that has permeated just about all of the 2020 forecasts I have seen, is more a reflection of what people have in their portfolios rather than the background of markets.

The pound faltered and gilts rallied after inflation data backed up Bank of England policy maker Michael Saunders’ call for urgent stimulus to boost the U.K. economy.

Sterling weakened against the euro and 10-year government bond yields dropped to the lowest in seven weeks after the data fueled bets that the central bank will lower interest rates this year. Money markets are now fully pricing in a full 25-basis-point rate cut for May, compared to November a day ago, and see a 65% chance of a move this month.

Saunders’ view on the need for more accommodative policy comes just days after BOE Governor Mark Carney said Britain’s economic growth had slowed below potential and that the Monetary Policy Committee had discussed the merits of near-term stimulus.

“There is more room for easing expectations to rise should incoming data disappoint and that could keep short-term sterling downside risks intact,” said Manuel Oliveri, a currency strategist at Credit Agricole AG.

The UK is determined to avoid the deflationary environment that has seen negative rates prevail in the Eurozone. That entails a willingness to let inflation run hot. Cutting interest rates now can be justified based on Brexit uncertainty as the end of the transition agreement is clearly within sight on December 1st.

The political backlash that followed crisis-era bank rescues hangs over policy makers’ approach to the current problem, analysts said, even as officials work to ensure the smooth functioning of a key piece of the infrastructure underpinning financial markets. Some fear that lending directly to hedge funds could lead to the perception the Fed is fueling risky bets.

“There’s a strong aversion to fat cat bailouts,” said Glenn Havlicek, chief executive of GLMX, which provides technology to repo trading desks.

Many hedge funds trade in the cash market through sponsored repos. The clearinghouse sits between buyers and sellers to ensure that neither party backs out of the transaction. Records of cleared trades also are publicly available, improving the market’s transparency.

The idea of using the clearinghouse appeals to some investors and analysts because the Fed has had trouble getting cash into the hands of the smaller banks, securities dealers and investors who need it the most.

That is because the Fed trades exclusively with a small group of large banks and securities firms, known as primary dealers. Even among these firms, activity is tightly concentrated. A study recently published by the Bank for International Settlements said that liquidity in the repo market rests in the hands of the four largest banks in the U.S. system.

Every time a central bank reduces interest rates, holds them down for a prolonged period and increases the size of its balance sheet, part of the rationale is to support the kind of speculative activity which can get the growth multiplier moving again. The side effect is to encourage simultaneous financial market speculative activity in both public and private assets.

1. The economy disappoints the consensus forecast, but a recession is avoided. Federal Reserve Chair Powell lowers the Fed funds rate to 1%. Without a comprehensive trade deal in hand, President Trump exercises every executive authority he has to stimulate growth and ward off recession. He cuts payroll taxes to put more money in the hands of consumers.

This year I was struck by how close to consensus the majority of the forecasts are, but the first one is certainly headline grabbing. The consensus in the bond market suggests one additional rate cut this year, not three. If the 9th surprise of Treasury yields at 2.5% were to come to fruition it would represent a massive steepening of the yield curve.

If gold’s implicit prediction is right, it has two implications. The first and most important one is a belief that inflation is at last due to return, after many false alarms. The second is that gold is now settled in a bull market. 

So, is gold good value? The metal doesn’t throw off any income streams, and has very few industrial uses, so it is very hard to come up with a measure of fair value. But the following chart, using data drawn up by Charlie Morris of Catley, Lakewood and May in London, is a heroic attempt to arrive at one. Morris devised a formula for fair value using the consumer price index and the average of 10- and 30-year inflation expectations. This indicator briefly showed that gold was wildly overpriced during the worst of the 2008 crisis, a phenomenon that may have been driven by the illiquid markets of the time, that created an unrealistic inflation forecast. Exclude this incident, and we see a steady bull market for gold from 2005 to 2011, followed by a steady bear market, where it moved to a discount. In the last two years, it looks as though it may have started another bull market. By Morris’ calculations, gold is now about 11% over fair value. 

Gold is still far from the confident prediction of runaway inflation that it briefly produced for a few years after the crisis, even though it is buoyed by safe haven demand at present, along with seasonal interest in gold jewelry, notably from China where the lunar new year is almost here, and by resumed interest from central banks.

On the supply side, gold-mining groups are merging, creating a reasonable hope of avoiding over-supply in the near future. So, if this move in gold prices is confirmed by a move down in real yields, followed even by an increase in inflation, then this could be part of a bull market to match the one from 2005 to 2011. The critical question is whether the gold market proves to be right this time in its forecast of inflation.

Gold is often viewed as a hedge against inflation but that is a largely a corollary to its prime position as a monetary barometer. The foreign markets are relative value oriented. One can’t really say a currency is strong or weak unless it is compared to whatever it can be converted into. All fiat currencies are subject to the tendency of governments to print with abandon at the first sign of trouble. Gold does best in periods when competitive devaluation becomes a factor, which is exactly what we have today; with a growing trend of synchronised monetary and fiscal stimulus. Inflation is a side effect of that profligacy.

A link to the full report is posted in the Subscriber's Area. 

The surge in repo rates was not a blip. It was the result of a combination of factors that conspired to drain liquidity from a vital part of the financial system. The solution has been for the Fed to step in as lender of first and last resort because traditional market makers are constrained by regulation and requirements to hold higher cash reserves.

Iraqi Prime Minister Adel Abdul-Mahdi condemned the targeted killing as a violation of the terms underpinning the U.S. troop presence in the country.

Mr. Abdul-Mahdi said he had submitted a formal request for parliament to convene in order to adopt necessary measures “to protect Iraq’s dignity and sovereignty.” He didn’t say what those measures would be.

The killing of the two men is likely to mark the beginning of a dangerous new chapter in the rivalry between the U.S. and Iran, which escalated after supporters of an Iran-backed Shiite militia attempted to storm the U.S. Embassy in Baghdad earlier this week. Mr. Mohandes was deputy leader of the Popular Mobilization Forces, an umbrella group that led the embassy attack.

Anyway we look at it, the geopolitical risk premium just racketed up. Iran’s response to losing the commander of the Revolutionary Guard can be expected to be bloody and will probably splash around the entire region considering how broad Iran’s terrorist network is.

“The data will probably prove to be an anomaly, but the initial market reaction is that it’s bad enough to at least consider the possibility of a Fed rate cut,” said Chris Low, chief economist at FHN Financial. “The combination of geopolitical tensions on top of unexpectedly weak data increases the likelihood of a 2020 Fed rate cut.”

Yields on 10-year Treasuries dropped as much as 8 basis points to 1.79% and remain within 2 basis points of that level. Rates on their German counterparts were down 6 basis points at minus 0.28%. Yields tumbled in most major markets around the world.

I agree that it is unlikely the Iran news is enough to justify a rate cut but the bond market rallied nonetheless. 10-year Treasury yields are now testing the sequence of higher reaction lows evident since September, having found paused in the region of the trend mean. A sustained move above 2% will be required to signal a return to supply dominance beyond the short term.

Disinflation has reigned since 1980, but real interest rates were positive until the last decade.  But for 10 years now, real 10-year Treasury note yields have been flat at zero (see my Nov. 19, 2018 column, “Zero Real Yields Are Tripping Up Investors”).  This and the flat yield curve have pushed state pension funds and other investors far out on the risk curve in search of real returns, bidding up stocks to vulnerable levels.
 
Earlier, the Fed was run by Ph.D. economists who clung to widely-held theories even though they didn’t work. Fed Chairman Jerome Powell is proving to be much more practical, backing away from rigid Fed policies such as the 2% inflation target and a zero-bound policy rate as well as unsuccessful forward guidance.

In this different economic climate, it’s hard to time the end of the current recovery. Still, it will end, due either to Fed overtightening or a financial crisis, like the 2000 dot-com blow-off or the 2007-2009 subprime mortgage collapse. In the current excess supply-savings glut-deflationary world, it’s likely a recession will unfold due to a shock before the Fed overtightens.

The distortions quantitative easing and other extraordinary monetary measures have created will be debated for decades. There is no arguing with the fact that relationships between asset classes which were reliable lead indicators in the past are less relevant in an environment where central banks are manipulating the yield curve. However, we need to remember that bull markets thrive on liquidity and price charts tell us what people are doing with their money.

South Korea’s won has surged through the pack to become the best-performing Asian currency for December after being the outright worst over the previous 11 months.

The catalysts behind its revival: the agreement of an initial trade deal between the U.S. and China -- South Korea’s two largest trading partners -- and improving local data that suggest that economy is turning the corner following a series of interest-rate cuts.

The won has jumped 1.7% this month after President Donald Trump said Dec. 13 the U.S. and China had reached a phase-one trade deal, helping to limit any further escalation of the dispute that has pummeled emerging-market assets this year.

Investors are clearly willing to give a trade deal the benefit of the doubt and that is now being reflected in the outperformance of Asian and European markets relative to Wall Street. The recent weakness of the US Dollar is an additional indication of capital moving out of US assets.

A link to the full report is posted in the Subscriber's Area. 

Currencies are always a relative value argument so it is not so much about whether one currency is strong or weak but rather which is more attractive compared to the rest. There is no single fundamental that governs the foreign exchange market which leaves a great deal of room for argument about how persistent trends are likely to be. However, I think there have been three clear points in favour of the US Dollar over the last couple of years which are now worth re-examining.

Japan’s Topix index advanced, set for its best quarterly gain since 2016, after the latest economic data out of the U.S. indicated the labor market is solid.

Banks contributed most to the benchmark measure’s Friday gains. The Nikkei 225 Stock Average slipped 0.4% to 23,837.72, as 30 of its components traded without rights to receive the next dividend, including Canon Inc. and Japan Tobacco Inc. Next Monday will be the last trading day of the year.

The Topix extended its gain for the quarter to 9.2%, the biggest such increase in three years. Japanese equities have rallied since September, bolstered by signs of easing tensions between the U.S. and China.

U.S. jobless claims fell to a three-week low of 222,000 in the week ended Dec. 21, in another sign of health in the U.S. economy. Major U.S. equity indexes climbed to fresh records Thursday in holiday-thinned trading.

The Yen tends to strengthen when investors are worried and seeking a safe haven. With worries about trade and geopolitics easing, demand for the Yen is moderating and that is helping to stoke demand for equities.

Before we examine the fourth year, remember back to the stat from the third year; since WWII there had never been a down year.  The fourth year is also tilted to the positive, but not quite as unblemished.  Bush vs. Gore at the turn of the century saw a 9.1% loss.  And then 2008 witnessed a blistering 37% decline with the Great Financial Crisis.

Yet what's interesting about both dates is that they coincided with the end of a protracted bull market.  Will 2020 prove the same?  It certainly feels like that might be a possibility.  But I warn that before those two declines, there had also not been a post-WWII fourth year of the Presidential cycle that had fallen either.  From 1948 to 2000, the returns were all to the green side of the ledger.

Perhaps both declines (2000 and 2008) were the result of a Federal Reserve bent on slowing down the economy. With Powell & Co. increasingly looking willing to let the economy run hot, the fiscal pumping from a President (and party) wanting to get re-elected might keep a bid to risk assets.

The priming of the economic pump and the Fed’s complicity in keeping monetary policy on the easy side during the last 12 months of the Presidential election cycle has been a factor in the US markets for almost a century. It also serves as evidence that Modern Monetary Theory is not all that modern. Where it differs from history is in scale rather than substance.

We are heading into the last week of the year. Therefore, when people come back from their break in early January, it is the trading activity that occurs this week which will have the strongest bearing on their perception of where value is to be found in the first quarter of 2020.

It is quite normal for trends that begin in the last week of the year to persist into the first quarter so I thought it would be useful to simply highlight the markets exhibiting a new condition of relative strength or weakness right now.

The DJ Euro STOXX 50 found support in the region of the upper side of a six-month range at the beginning of December and continues to push up towards its 2015 peak.

The U.K. has the luxury of a deep investor base that hoovers up long-dated, fixed-income assets to make sure it can meet its future pension and insurance liabilities. So much so that the yield on 50-year Gilts is lower than that of their 30-year counterparts, meaning there’s a so-called inversion at the long end of the U.K. yield curve:

The average duration of British government debt is much longer than that of its main counterparts; it’s about 14 years, compared to nearly nine years for German bunds and less than seven years for U.S. Treasuries. There is evidently investor demand in the U.K. for longer stuff, but it requires a genuine commitment from the government to stay the course and not leave any ultra-long issue stranded at the end of the yield curve.

Doing a 100-year deal in concert with more 30- to 50-year issuance would make sure there was plenty of interest at various maturities at the long end of Gilts. A century bond could rapidly build scale into the tens of billions of pounds with quarterly auctions, perhaps with a coupon of about 1.5% (by comparison, Austria’s 100-year issue went for 1.17% back in June). This would be a super-cheap way to really commit to some of the biggest infrastructure projects, such as connecting rail links properly in the north of England.

Borrowing vast sums at record low rates makes sense if the proceeds are invested in growth promoting endeavours like education, critical infrastructure and primary research. If invested in glamour projects and growth hindering strategies like high cost energy or military hardware then the benefits which accrue will be less impressive. One way or another, fiscal austerity is over and that means the government will have a growing and ongoing funding requirement.

In addition to a significant increase in Chinese agricultural purchases in exchange for tariff relief, officials have also said a phase-one pact would include Chinese commitments to do more to stop intellectual-property theft and an agreement by both sides not to manipulate their currencies.

Put off for later discussions are knotty issues such as longstanding U.S. complaints over the vast web of subsidies ranging from cheap electricity to low-cost loans that China has used to build its industrial might.

The new duties, which were scheduled to take effect at 12:01 a.m. Washington time on Sunday unless the administration says otherwise, would hit consumer goods from China including smartphones and toys.

Even amid the positive signs on trade, Chinese foreign minister Wang Yi highlighted the other confrontations between the two sides. On Friday in Beijing, Wang said that U.S. actions had “severely damaged the hard-earned basis for mutual trust” and left the relationship in their “most complex” state since the two sides established ties four decades ago.

China has been the primary target of the USA’s tariff regime and its economy has suffered as a result. The European exporters that rely on Chinese demand to fuel growth have also been deeply impacted by the tariffs and the removal of this as a concern represents a significant improvement in prospects.

A link to the full report is posted in the Subscriber's Area. 

Corporations have jumped at the once in a generation opportunity to borrow at record low levels in record amounts. That has understandably increased leverage ratios. Equity is generally more expensive that fixed income as a source of capital, so buybacks have been a logical financial engineering solution to reduce the average cost of capital.

This box focuses on the distribution of liquid assets in the US banking system and how it became an underlying structural factor that could have amplified the repo rate reaction. US repo markets currently rely heavily on four banks as marginal lenders. As the composition of their liquid assets became more skewed towards US Treasuries, their ability to supply funding at short notice in repo markets was diminished. At the same time, increased demand for funding from leveraged financial institutions (eg hedge funds) via Treasury repos appears to have compounded the strains of the temporary factors. Finally, the stress may have been amplified in part by hysteresis effects brought about by a long period of abundant reserves, owing to the Federal Reserve's large-scale asset purchases.

And

Since 17 September, the Federal Reserve has taken various measures to supply more reserves and alleviate repo market pressures. These operations were expanded in scope to term repos (of two to six weeks) and increased in size and time horizon (at least through January 2020). [icon]  The Federal Reserve further announced on 11 October the purchase of Treasury bills at an initial pace of $60 billion per month to offset the increase in non-reserve liabilities (eg the TGA). These ongoing operations have calmed markets.

It is easy to point the finger for the surge in repo rates last September at the feet of the big US four banks. However, that would be to ignore the fact banks have been forced, through the imposition of greater financial regulations, to hold more treasuries as insurance against another calamity. The low participation in the repo market by its traditional market markets created a dearth of liquidity. The US Treasury’s desire to increase its cash holdings, following the increase in Federal debt limit, was probably the catalyst for the subsequent squeeze.

The additional supply reduction would take the kingdom’s production down to levels not seen on a sustained basis since 2014, according to data compiled by Bloomberg.

After the announcement, Prince Abdulaziz predicted that Saudi Aramco, which just completed an IPO at a valuation of $1.7 trillion, would soon soar above the $2 trillion. The kingdom plans to pump 9.7 million barrels a day, he said. That’s a reduction of about 300,000 barrels a day from its output in November and 100,000 below the year-to-date average, according to data compiled by Bloomberg.

There was always a risk that Saudi Arabia would attempt to massage energy prices in order to get the valuation for Saudi Aramco they desired. The IPO priced yesterday at $1.7 trillion which will represent a $25 billion windfall for the kingdom. If the price pops on the upside following the IPO that will give a windfall to the large numbers of domestic investors, many connected to the ruling class, who invested in the IPO. That is obviously a desirable outcome from a domestic perspective for Saudi Arabia.

In Brazil, the inflation pick-up comes as economists and company executives sound the alarm on rising meat prices due to dwindling supply. China, the world’s top meat consumer, doubled pork imports and shipped in 63% more beef in October than a year earlier as the country struggles to ease shortages due to African swine fever.

“The food price shock has arrived” in Brazil, said Leonardo Costa, an economist at Rosenberg Associados. “We’re increasing our 2019 inflation call to 4% because the increase in food and
beverage costs will be even stronger in December.”
 

If inflation is rising, and this appears to be a global phenomenon that will reduce the ability of central banks to continue to cut interest rates. That was certainly a factor in the RBI’s decision to hold rates steady in India today and similar decisions are likely across emerging markets as the full impact of higher food prices rolls through.

The research departments of major asset managers are currently putting out their expectations for what to expect in 2020. There is a great deal of commonality in what is being predicted. The reality is many investors went to cash a year ago and were slow to reinvest. They continue to feel shy about being fully committed and still feel a great deal of uncertainty. That it being reflected in the views being espoused in predictions for 2020.

The cost of dollar funding for non-American banks can change rapidly because it’s sensitive to monetary conditions in the U.S. and abroad. September’s repo turmoil showed the speed with which a spillover could occur between dollar funding and currency markets. Within a day of the sudden surge in the overnight rate on Treasury repurchase agreements that began Sept. 16, the cost to borrow greenbacks while lending euros for a week almost doubled.

For DoubleLine’s Campbell, “the analysis of currency mismatches and asset/liability funding mismatches is an integral part of our investment process as we evaluate these risks on a country-by-country and security-by-security basis.”

At issue is what might happen when foreign banks get caught in a liquidity squeeze, and their sources of dollar funding dry up quickly, he added.

“When we go through the next downturn, a lot of activities are going to be exposed as being problematic,” he said. “The risk is that it could contribute to an even bigger fall in economic activity.”

The IMF first started worrying about the mismatch in Dollar funding requirements and supply back in June. The freezing up of the repo market in October vindicated the view that supply of Dollars was inadequate for the needs of the global economy. The willingness of the Fed to step in and provide $300 billion, to date, is a clear indication they are aware of the problem this condition represents and will act accordingly.

Linking his trade agenda with his Fed criticism in an early morning tweet, he said the two South American countries “have been presiding over a massive devaluation of their currencies, which is not good for our farmers.”

The president’s action amounts to retaliation against two nations that have become alternative suppliers of soybeans and other agricultural products to China, grabbing market share away from the U.S. Rural voters, including farmers, are a key constituency for Trump as he heads into the 2020 presidential elections.

While the steel tariffs could crimp trade, the Latin American countries gain much more shipping crops to Chinese buyers. In the first 10 months of the year, Brazil has shipped $25.5 billion in farm products including soybeans and pork to China. That’s more than 10 times the value of steel and iron product sold to the U.S.

This action is as much about the persistent strength of the Dollar as it is about pandering to farm voters in swing states. The US Dollar has been trending higher against the vast majority of international currencies for the last few years. The growth differential the USA has enjoyed has been one factor in that strength but the Fed’s policy of balance sheet contraction and hiking interest rates was more important.

With the latest sale, China will have dollar securities outstanding with maturity dates ranging from 2022 to 2096 (the result of a small century bond sold in the 1990s). There will be an increasing variety of maturities off which Chinese corporate debt can price, with sovereign benchmarks at maturities from 2022 to 2048 of at least half a billion dollars each.

The total Chinese dollar bond market now tops $740 billion, according to data compiled by Bloomberg, and issuance so far this year has run at a record pace. On a single day in early November, some six property developers were selling dollar securities.

Earlier this month, China also sold euro debt, the first time since 2004 that it issued in that currency. That deal saw blowout demand, with a majority orders coming from European funds in a region that’s been beset by negative-yielding securities.

The rapid growth of the China Dollar bond market was one of the primary reasons the Chinese central bank expressed worry about local government funding mechanisms in 2018. They quickly moved into a curtail the practice but that effort now appears to be over with demand for overseas debt increasing once more. 

The clearest difference between the parties is on how far their messages are spread by people sharing content voluntarily -- known as “organic” reach. Labour currently leads on this across the three most important social media platforms: Facebook, Twitter and Instagram.

Posts from the Facebook pages of Labour and Corbyn -- largely focused on issues such as the National Health Service and criticizing the government’s austerity program -- have been shared more than twice as many times as those from the Conservatives and from Johnson himself, according to data from CrowdTangle, a social media analytics tool owned by Facebook.

Labour and Corbyn have also garnered about 100% more views of their videos on Facebook and Twitter than the Tories, according to CrowdTangle and a Bloomberg analysis.

Knocking on doors has in many respects been replaced by tapping on phone screens and is arguably more effective considering the willingness of people to spend hours on their phones while being reluctant to open the door to anyone let alone politicians. Google and Twitter have been clear they do not see the risk of being accused of election interference as being worth the revenue from political parties. Facebook seems more willing to engage with politics. 

Today’s art-backed loans have gotten larger and riskier for collectors as the art market has started to shrink. U.S. collectors staked their art to borrow up to $24 billion this year, more than double the level a decade earlier, according to the latest data compiled by the Deloitte accounting firm and ArtTactic, an auction-database company. Some affluent borrowers tap their art like a piggy bank to fund living expenses. Others use the loans to buy more art.

But after a four-year rise, the global art market has started to retrench, with the value of sales down 22% at Christie’s auctions in the first six months of 2019 compared with the same period a year earlier. Last week’s $1.4 billion major fall auctions in New York were a third smaller.

If art values plummet, experts say, collectors may need to sell works for less than they are valued to pay down their loans—or add more pieces to their collateral pool to keep their loans square. If not, they could default on loans and forfeit their art altogether.

“If everyone is taking the same art as collateral—same artists, same bodies of work—and there’s a crisis, everyone may need to sell and you have a big problem,” said Adriano Picinati di Torcello, who issued the Deloitte-ArtTactic report last month.

Borrowing against hard assets has been a major investment theme over the last decade. A friend of mine is even involved in assisting art owners to collateralise their wealth via cryptocurrencies which in summary leverage on leverage. I haven’t heard the term collateralised crypto obligation (CCO) yet but it is certainly a growing field.

Private credit. Private credit fundraising softened in 2018 (down 15 percent versus 2017), but its long-term growth trend remains intact. In fact, 2018 was the second-highest fundraising year in history for the asset class (Exhibit 5). Seven-year trailing fundraising has grown at an average of 9 percent per annum since 2013, outpacing both PE and closed-end real estate growth, on the back of sustained low interest rates and a long economic expansion. Annual returns for private debt have averaged around 10 percent since 2008, with higher yields than are available in public debt. This has been an attractive proposition to more and more investors. A good indication is high-yield spreads, which reached ten-year lows in 2018 before widening again in the fourth quarter.

Private credit funds (and hedge funds, which are not included in our data) are now filling a financing void for many middle-market and sponsor-owned companies, helping sectors and providing security structures avoided by banks. Private credit has also increasingly returned to covenant-light lending as the market has grown hotter: in a recent survey by the Alternative Credit Council, 38 percent of North American private credit lenders reported lower financial covenants in the past year, versus just 8 percent reporting higher covenants.

There are obvious merits to investing in privately held companies. For one thing the reporting requirements are considerably less onerous but there is also cashflow and the ability to invest in growth at an earlier stage; thereby catching more of the base effect as businesses expand. The flip side is these advantages are well understood and the desire to capture yield has reduced returns and driven up prices.

In some ways, the Netherlands has one of Europe's most generous retirement systems: at its core, it represents a basic pay-as-you-go state pension as well as employer-run pension scheme which together provide workers with about 80% of their average lifetime wages when they retire. The US and UK have similar systems, but Dutch pension funds are more generous and must use a lower risk-free rate to value their liabilities, forcing them to hold more assets.

Unfortunately, the lower Dutch risk-free rate is not low enough, and as a result about 70 employer-run pension funds with 12.1m members had funding ratios below the statutory minimum at the end of September, according to the Dutch central bank. And here lies the rub: if funds have ratios below the legal minimum for five consecutive years or have no prospect of recovering to a more healthy level, they must cut their payouts. Interest rates have rebounded slightly in recent weeks, but many funds are still facing cuts.

In other words, in making a select handful of European stockholders rich courtesy of NIRP and QE, Mario Draghi is threatening the pensions of hundreds of millions of retired European workers.

So what, if any, is the solution?

Last week, Rabobank reported that the Minister of Social Affairs is supposedly willing to prevent a large part of the pension benefit cuts of 2020, as the government is reportedly willing to lower the minimum coverage ratio from 100% to 90% for one year. This temporary measure can be seen as a pause button, which buys time for:

Pension funds to hopefully recover over the next year. For pension funds, a rise in their risk-free rate term structure which is used to discount their liabilities (EUR 6m swap rates) would be most helpful
Continuing to work out the details of the Pension Reforms announced in June 2019. Unions, employer representatives and the opposition parties were against pension cuts because this would undermine the goals set out in the Pension Reforms.

The logical result of negative yields is the holders of these assets eventually take a loss. Since pensions generally run a ladder of maturities in an attempt to match cashflows with liabilities the proverbial buck stops with them as the yield-to-worst loss is priced in.

What is CECL?: CECL is a new accounting standard that modifies how companies estimate loan and lease losses, and affects all periods starting after December 15, 2019 (i.e., begins 1Q20). In the midst of the financial crisis in 2008, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) established the Financial Crisis Advisory Group (FCAG). FCAG believes it has identified a “weakness in current GAAP being the delayed recognition of credit losses that results in the potential overstatements of assets,” which ultimately led to its recommendation for this new standard. The new standard requires financial institutions to use a combination of historical information, current conditions and reasonable forecasts to estimate the expected losses over the life of a loan. This is a significant shift from the current methodology, which relies on incurred losses. We note on day one of implementation, there will be a balance sheet adjustment, creating additional general reserves for expected credit losses and negatively impacting capital levels, but implying limited income statement impacts.

Conclusion: We walked away with more questions than answers, and anticipate a significant amount of variability in disclosures amongst the banks given the latitude FASB has provided in the standards. While many questions remain, FASB officials, consultants and management teams alike continue to work through the issues and are refining models as overall understanding of the standards improves. Fortunately, we anticipate regulatory capital relief for the banks as necessary, since capital levels remain elevated and the intent of the new standards was not to increase capital levels at the banks. However, we believe there could be some unintended consequences and potential ripple effects that will create further disruption in the space, potentially shifting assets out of the banking space and into the non-bank space, which has continued to gain share. Ultimately, we remain concerned with the uncertainty around CECL, anticipated volatility around disclosures and capital impacts, as well as potential negative implications on industry demand will serve to provide one more reason for investors to not own the space.

The Current Expected Credit Loss (CECL) regime is another piece of regulation imposed on the banking sector which serves to ensure the overleverage and inappropriate risk management that characterised the industry ahead of the financial crisis is not repeated. One of the primary results of successive waves of regulation has been to pile compliance costs onto the banks but it has also reduced their ability to leverage their balance sheets which has unintended consequences.

The investment data shows how cautious private companies have become, with their spending in the first 10 months of the year at the lowest level since 2016. The continued stability in spending by state-owned firms’ is preventing an even stronger drop in the headline data.

Investment in the property market is one bright spot, with spending by the manufacturing sector barely above the record low recorded in September. Infrastructure investment growth continued to bounce along around 4% as it has all year.

“I’m quite concerned with property investment, the only stable element in fixed-asset investment now,” according to Xue Zhou, analyst at Mizuho Securities Asia Ltd in Hong Kong. “Monetary policy needs to be more supportive on economic growth and there should be more cuts to banks’ reserve ratios to help smaller banks.”

The first couple of months of the year are when the Chinese financial system gets its annual quota for lending and generally makes its full allocation by around Chinese New Year. That sends a surge of liquidity into the market in January and February but the broader question is how much of that is already priced in considering it is so predictable.

“If China, U.S. reach a phase-one deal, both sides should roll back existing additional tariffs in the same proportion simultaneously based on the content of the agreement, which is an important condition for reaching the agreement,” Gao said.

Such an understanding could help provide a road-map to a deal de-escalating the trade war that’s cast a shadow over the world economy. China’s key demand since the start of negotiations has been the removal of punitive tariffs imposed by Trump, which by now apply to the majority of its exports to the U.S.

The US Presidential election is less than a year away. The time to prime the pump so growth is humming by the time people vote is now. China might have suffered more from the tariffs, because it has more to lose, but it is also well aware of the electoral timing the Trump administration is pressured by. That suggests a deal is likely to be signed and it is likely to be valid for at least a year.

The company warned there is doubt about its ability to continue operating. Its shares and bonds have plunged since reporting earnings Nov. 5.

*Based on price assumptions of $55 per barrel for oil and $2.50 per million British thermal units for natural gas as well as no debt reduction, Chesapeake is likely to trip its leverage covenant by the third quarter of next year, if not sooner, CreditSights analysts Jake Leiby and Michael Mistras wrote in
the report.

**They predict Chesapeake will have a free cash flow shortfall of about $50 million in 2020 and finish the year with gross leverage of 4.6 times debt to a measure of earnings, above the 4.25 ratio in its covenant.

Chesapeake dropped significantly over the last couple of days and is now dependent on the kindness of strangers to ease debt covenants if it is to survive. The problem for the company is it is not viable at a shale industry average of $55. Its breakeven might be closer to $70. Meanwhile natural gas prices remain volatile, even after the rebound over the last week which took the price back above $2.50.
 

Federal Reserve officials reduced interest rates by a quarter-percentage point for the third time this year and hinted they may be done loosening monetary policy, at least for one meeting.

The Federal Open Market Committee altered language in its statement following the two-day meeting Wednesday, dropping its pledge to “act as appropriate to sustain the expansion,” while adding a promise to monitor data as it “assesses the appropriate path of the target range for the federal funds rate.”

As with the September statement, the FOMC cited the implications of global developments in deciding to lower the target range for the central bank’s benchmark rate to 1.5% to 1.75%.

Treasuries weakened on the Fed’s announcement, pushing the 10-year yield up briefly to 1.81% from 1.80%. Stocks were little changed and the U.S. dollar gained. Traders also pared wagers on a fourth consecutive rate cut in December.

The Fed has been of the opinion we are in the midst of a mid-cycle slowdown. I think we can think of that as a best-case scenario which is why there is so much uncertainty about the outlook for rates amid the surge in bond prices. Let’s see what the charts tell us.

The wild card is how Treasury may address the elephant in the room. Dealers expect comment on last month’s turmoil in funding markets. And to some extent, the Treasury’s borrowing plans this fiscal year will be viewed, and traded, in light of the Fed’s T-bill purchases to replenish bank reserves. The central bank embarked on the program this month, saying it will run “at least into the second quarter” of 2020 at an initial monthly pace of about $60 billion.

 “They’re taking about half of net issuance next year,” said Gennadiy Goldberg, senior U.S. rates strategist at TD Securities.

Some say the Treasury’s relentless debt sales have contributed to a shortage of reserves in the financial system, which last month forced the Fed to resort to a money-market operation it hadn’t deployed since the financial crisis.

Treasury Secretary Steven Mnuchin has rejected that notion, saying this month that the September upheaval had “nothing to do with our issuance.” But the department is clearly curious about how dealers are coping with growing supply. It sought comment in this month’s survey on “the interaction between primary dealer positions, auction participation, and recent repo market variability.”

The lack of liquidity in the repo market is an anomaly. Whether it is because banks no longer have the liquidity to take advantage of arbitrage opportunities, or because the Treasury’s voracious appetite for funds is soaking up available liquidity, the fact remains there are not enough funds to meet the requirements of the market. That pretty much forces the Fed to step in and provide as much liquidity as required to ensure orderly markets.

The pound weakened after U.K. lawmakers rejected Prime Minister Boris Johnson’s plan to fast-track his Brexit accord through parliament.

Britain’s currency dropped against all of its major counterparts, but the losses were contained after the government won an initial vote on the deal. Johnson opened the door to a short extension to his Oct. 31 deadline, saying he would pause legislation and go back to the European Union, after earlier threatening to throw out the deal if lawmakers rejected his plans.

“For now it seems the market is still generally expecting this is a setback, but not a fatal setback, to a negotiated Brexit,” said Jeremy Stretch, head of G-10 currency strategy at Canadian Imperial Bank of Commerce. “There hasn’t been a rapid uptick in no-deal pricing at this point,” he said, referring to a scenario where the U.K. would leave the EU with no divorce deal.

The U.K. currency had rallied more than 8% from September’s low as Johnson secured an agreement with the EU and then lawmakers then forced him to request an extension to the Oct. 31 deadline, reducing that no-deal risk.

Sterling dropped as much as 0.7% after the votes to $1.2869, after rallying Monday to touch $1.3013, the strongest level since May. Against the euro, it fell 0.4% to 86.39 pence.

Parliament today supported the deal which, as expected, excises Northern Ireland economically from the UK. That is not going to be received well by loyalist communities in North Ireland. However, it is likely to be positive for the region’s economy since it will have a toe hold between the UK and the EU and subject to corporate taxes could attract inward investment.

The more that markets internalize this shifting monetary policy sentiment inside central banks, the more that they will unwind the policy expectations that fueled several forces acting to invert the U.S. yield curve, including indirect ones such as the enormous pressure on foreign investors to flee negative yields in Europe and Japan and go into longer-dated U.S. bonds. Look for this phenomenon to also maintain the yield spread between German and U.S. bonds at its current lower range despite what will continue to be relative economic outperformance by the U.S.

Just as I argued in March that it was unwise to react to the inversion of the Treasury yield curve with extreme anxiety about a U.S. recession, it would be premature to celebrate the recent partial reversion as an indicator of significant strengthening of U.S. economic prospects. Instead, both are reminders of the extent to which traditional economic signals have been distorted by a prolonged period of extraordinary central bank policies. And they should also been seen as just one of the unusual consequences of a monetary stance that, imposed for several years on central banks by the lack of proper policy action elsewhere, will now see the hoped-for benefits give way to a broadening and deepening recognition of the unintended consequences and collateral risks.  

An inverted yield curve has been one of the most readily available lead indicators for a US recession for decades. There is always an argument that this time is different and that it only works for the USA’s economy. It is also worth remembering that no US recession has occurred without an inverted yield curve first but is a very small number of false positives. When considering the history of the measure anyone who is willing to buck the historical trend is betting on the signal giving a false positive.

I have to admit I don’t look at the internals of the market all that often because it is the trend rather than the day to day moves which lend some insight into the health of the market. I thought it might be useful to look at some of the most common measures to discern if any clues to market direction are evident.

The Total Number of New 52 Week Highs on the NYSE Index is coming back down towards the lows December 2018 and towards the end of 2015. The significant spike on the upside in late 2017 was an anomaly suggesting a period of underperformance ahead, but generally lows are better predictors of market bottoms than spikes are of tops.

Rather than purchase longer-dated securities, Mr. Powell said officials are now contemplating buying shorter-dated Treasury bills. Officials believe holding long-term securities boosts the economy and financial markets by lowering long-term rates and driving investors into stocks and bonds. They think a portfolio weighted toward shorter-term securities provides less or no stimulus.

The Fed’s plan hasn’t been finalized, but Mr. Powell suggested would be ready by or before officials’ Oct. 29-30 policy meeting. The goal would be to rebuild the level of reserves in the system sufficiently above the low point of less than $1.4 trillion reached last month.

The demise of institutional prop trading and the requirement on banks to hold “Tier 1 capital”/government bonds mean there is no additional liquidity to contain spikes beyond the upper setting for repo rates. The Fed has no choice but to supply that liquidity.

The unusual nature of the forces at play -- and the fact that many of them are geopolitical and emanate from abroad -- makes it more difficult for policy makers to decide how far to go in easing credit.

There’s even a question of how effective rate cuts will be in an economy where business executives fear such dire developments as the breakup of global supply chains.

Powell is expected to deliver his latest thinking on the outlook when he speaks to the National Association for Business Economics in Denver at 2:30 p.m. U.S. East Coast time on Tuesday. He said last week that despite some risks, the U.S. economy is in a “good place,’’ and that the Fed’s job is “to keep it there.’’

Mrs. Treacy’s containers arrived from China over the last few days and I spent most of this morning at Los Angeles port. I have been going to down to the customs warehouses twice a year for four years to help out in the business but also to get a feel for what activity is like at one of the country’s busiest ports of entry.

Multiple surveys show that traders and investors see the U.S.-China trade war as the biggest risk facing markets. Bank of America Merrill Lynch’s latest monthly poll of global fund managers, released in mid-September, revealed that the number of respondents who said trade tensions were the biggest danger outstripped by far those who cited ineffective monetary policy and the potential bursting of the bond bubble. In her first major address as head of the International Monetary Fund, Kristalina Georgieva said Tuesday that the global economy is in a synchronized slowdown, in part due to trade uncertainty. Also on Tuesday, the National Federation of Independent Business said its small-business sentiment index fell to near the lowest level of Donald Trump’s presidency. Even more notable was that the part of the index measuring “uncertainty” plunged to its lowest since February 2016.  “More owners are unable to make a statement confidently, good or bad, about the future of economic conditions,” the group said, with 30% of respondents reporting “negative effects” from tariffs. To cut to the chase, if businesses can’t forecast with any confidence, how can investors or strategists?

U.S. and China trade negotiators are scheduled to meet on Thursday to resume talks. What’s discouraging is that instead of making conciliatory comments, each side seems to be hardening their stances. Chinese officials said Monday that what isn’t on the table from China’s perspective — and never will be — are changes to its laws to protect foreign intellectual property. Later that day, the U.S. placed eight of China’s technology giants on a blacklist over alleged human rights violations against Muslim minorities. In response, China hinted that it might retaliate. Then the news broke that the Trump administration is moving ahead with discussions around possible restrictions on portfolio flows into China. None of this sounds like either side is ready to make a deal.

Political rhetoric amplifying ahead of the start of negotiations have been a trend that has evolved over the last year. Each of the other occasions has ended in disappointment and the market is now pricing in a similar conclusion to the upcoming talks.

On a global level, bonds with a value of about $15 trillion currently trade with a negative yield. What’s going on here?

For every investor today, the starting point must be the bond market. Just a few weeks ago, we had $17 trillion of negative yielding debt. We’re now down to about 15, but even that is way too much. This is investment money that is guaranteed to produce a loss of capital. These extreme levels in today’s bond market can only have three possible explanations. One, the world faces an economic meltdown of epic proportions. Two, the bond market is the biggest bubble we have ever witnessed, and three, we have just experienced a massive buying panic in bonds.

I agree with all three of these points so we then need to address the question of what will happen to deflate the bubble. The answer is inflation which is like kryptonite for the bond market. The only way anyone can justify buying bonds with a negative yield is if they believe the deflationary argument is self-fulfilling. 

A link to the full report is posted in the Subscriber's Area.

The one thing we know is the consensus’ in markets seldom reach the worst or best predictions of investors. The rationale for MMT is compelling. The US government is already running a $1 trillion deficit in a boom and needs to pay for that with a large issuance of bonds. Since this is occurring before a crisis, investors logically conclude that trend has to continue in a linear manner. However, we have ample evidence of outcomes eventually working out much differently in reality.

The government considers it’s still not clear whether Germany will plunge into a full-blown recession and, as a result, the full array of remedies may not need to be deployed.

Germany’s five leading research institutes slashed their forecasts for economic growth this year and next, citing trade tensions and Brexit weighing on German industry. GDP is to grow 1.1% in 2020 from a previous forecast of 1.8%, and 0.5% this year from an earlier prediction of 0.8%.

Traditionally, Germany shifts to high alert whenever the global economy looks to be slowing -- the country’s dependence on exports means that it tends to head south with the rest of the world. But with the domestic market still relatively robust and the ECB renewing monetary stimulus, Merkel’s economic team judges that this time the path toward recession is less certain.

On the down side, a prolonged trade war could eventually lead to a much bigger fallout than expected, according to another scenario being considered. That spurred the government to gradually increase investments and bolster the labor market as a preemptive and precautionary measure.

Finance Minister Scholz told ARD TV on Wednesday that economic forecasts are pointing toward a recovery and that there is currently no need for a stimulus program.

“We are well prepared because we have good financial resources and can react, should it really come to an economic crisis but so far it’s just slower growth,” Scholz said.

The bond market has been signallng for a while that all is not well in the global economy. The fact that just about all of Germany’s sovereign debt is trading with a negative yield is as much about the outlook for global growth as it is about the ECB’s negative interest rate policy. The Eurozone has been relying on the strength of the export sector to pull growth higher but the slowdown is exposing the absence of a clear domestic demand story to offset the slowdown in demand.

While clear signalling for the end of the austerity program remains unlikely, there is evidence of fiscal laxity creeping in all over the continent. Italy, France and Spain are already engaged in fiscal stimulus and it is only a matter of time before Germany deploys its balance sheet to support the economy.

A link to the full report is posted in the Subscriber's Area. 

Germany failed to sell a 2 billion zero coupon bond in August which was a precursor to the reversionary move seen in bond prices. However, the economy is recession and there is no prospect of the ECB raising rates. Instead quantitative easing will further increase the ECB’s holdings of regional sovereigns.

Richard Russell used to say “print or die” and that is exactly what the central banks of the world are going to do. What I find particularly interesting is the comparison with debt levels only being approximating current levels during wartime. That must mean we are in a war but this time it is with ourselves and the contention is about the ability to pay unfunded liabilities.

One would be forgiven for concluding that algorithms have been programed with round numbers in mind. Roundophobia has been a topic of conversation at The Chart Seminar for decades but it is particularly relevant now because so many instruments have paused in the region of big round numbers. I’m greatly looking forward to the next event which will be in London on October 3rd and 4th.

A link to the full report is posted in the Subscriber's Area. 

The Credit Suisse short-term interest rates (STIR) team have been way out in front of the Fed’s dilemma in needing to support the repo market while also being reluctant to expend its balance sheet. The clear risk is the Fed will have to settle for lower quality assets in order to control the size of its balance sheet.

The typical U.S. home now sells for more than four times the median U.S. income, according to the Joint Center for Housing Studies at Harvard University. Between 1980 and 1999, home prices were closer to three times household income.

• Given the savings rates of the millennial generation born between 1981 and 1996, rental-listing company Apartment List estimates that two-thirds of millennial renters would require at least two decades to save enough for a 20% down payment on a median-priced condo in their market. Just 11% would be able to amass a 20% down payment within the next five years.

• The upshot: Millennial households had an average net worth of about $92,000 in 2016, nearly 40% less than Gen X households (people born between 1965 and 1980) had in 2001, adjusted for inflation, and about 20% less than baby boomer households (born from 1946 to 1964) had in 1989, according to data from the Federal Reserve.

So it’s time to kill the idea that student-loan debt is always “good debt,” to admit that buying a house isn’t always the right move, and to refashion these old expectations. It’s time for a new playbook.

Student debt and the promise of progressive candidates to cancel it are potential election winners as the millennial demographic becomes more influential in US elections.

Futures traders still see about another quarter-point of easing from the Federal Reserve this year, after the central bank cut rates on Wednesday and said it will “act as appropriate” to sustain the economic expansion.

The rate on the January 2020 fed funds futures contract was about 1.63% after the central bank’s announcement. The dot plot accompanying the statement shows policy makers’ median projections are for interest rates to remain on hold this year and next, but the balance of views has shifted more dovishly.

Judging by this level, traders still expect one more cut in either of the Fed’s two remaining decisions this year -- on Oct. 30 and Dec. 11. This estimate of the market’s pricing assumes that the effective funds rate moves toward the middle of the Fed’s new target range of 1.75% to 2%.

The Fed’s balance sheet is belatedly started to expand once more as the liquidity demands of the economy and Treasury market pressure the central bank to provide the funds necessary to ensure an orderly market. That is the most basic requirement for central banks, but the requirement has been exaggerated by the shrinking of investment and commercial bank balance sheets over the last decade. That suggests even without quantitative easing there is a clear need for the Fed to expand its balance sheet.
 

“There’s been a sea change in markets, and it’s one the Fed needed to respond to,” said Lou Crandall of Wrightson ICAP. “In the current market environment, there is just not enough elasticity in the repo market to handle the big seasonal swings of the banking system. The Fed needed to come in now and alleviate the immediate problem, while it is also working on long-term solutions.”

The Fed has considered introducing a new tool, an overnight repo facility, that could be utilized when needed to reduce pressure on key money market rates, but no decisions have been announced.

The New York Fed declined to comment on the events of this week.

Actions like the Fed took Tuesday were once commonplace, but stopped being so when the central bank expanded its balance sheet and started using a range of rates to implement its policy in the aftermath of Lehman Brothers’ 2008 collapse.

Securities eligible for collateral in the Fed operation include Treasuries, agency debt and mortgage-backed securities. In an overnight system repo, the Fed lends cash to primary dealers against Treasury securities or other collateral.

Bank balance sheets are not what they used to be. One of the primary results of the heavier regulations imposed on the sector since the financial crisis has been to cut the primary investment banks out of risk taking. That is impeding their ability to provide liquidity when the market needs it and is likely to result in the Federal Reserve intervening more often to assist.

“I think that they were just very impatient in this round of negotiations,” said Marick Masters, a management professor and the director of Wayne State University’s labor studies program.

But there’s a flurry of complicating factors in ongoing negotiations. Union leadership is under increased scrutiny as federal prosecutors continue to unravel a sprawling culture of corruption among former UAW leaders and negotiators.

There also was a strong sense inside and outside the union that a strike was likely, Masters said. Such an outlook could have contributed to the speed with which the strike was called, according to the professor.

“It’s hard to say how far apart they are,” Masters said of the UAW and GM. “But I get the feeling that they are pretty far apart. So you hope that they come to their senses pretty soon. But it certainly has the makings to go on for a very long time with the caveat that when reality sets in, they’re probably going to want to sit down and see what they can do to bring things back together.”

Workers are increasingly agitating for a bigger piece of the pie as stocks close in on all-time new highs and the cost of living increases. That is contributing to the potential for inflationary pressures to reappear despite the widespread fear of deflation that has pervaded sovereign bond markets this year.

The unprecedented revolt took place during a fractious meeting where Bank of France Governor Francois Villeroy de Galhau joined more traditional hawks including his Dutch colleague Klaas Knot and Bundesbank President Jens Weidmann in pressing against an immediate resumption of bond purchases, the people said. They spoke on condition of anonymity, because such discussions are confidential.

Those three governors alone represent roughly half of the euro region as measured by economic output and population. Other dissenters included, but weren’t limited, to their colleagues from Austria and Estonia, as well as members on the ECB’s Executive Board including Sabine Lautenschlaeger and the markets chief, Benoit Coeure, the officials said.

The competition to influence the replacement of Mario Draghi as head of the ECB is heating up. Verbal opposition to the policies announced today came from a number of the countries who were contenders in the race for the top job. Proving your verbal commitment to monetary prudence is almost a pre-requisite in some countries, regardless of the reality once in office. 

The likelihood of U.S. recession before the 2020 election has grown, based on changes in the Treasury yield curve, according to Jeffrey Gundlach, the billionaire money manager and chief executive officer of DoubleLine Capital.

“We should be on recession watch before the 2020 election,” Gundlach said Thursday in London. “We’re getting closer but we’re not there yet.”

The odds of a U.S. recession before the election are 75%, said Gundlach, whose Los Angeles-based firm oversees more than $140 billion, reiterating a prediction he made in August.

The best signal of a recession is not an inverted yield curve, the money manager said. “It’s the inversion occurring and then going away.”

Yields on 2-year Treasuries exceeded those on 10-years in August, forming an inversion, before flipping back this month.

In other comments, Gundlach said:

* He’s turned “neutral” on gold, one of his previously recommended investments. “It’s had a big run.”

* The U.S. and China are unlikely to reach a long-term trade pact before the presidential election.

* It’s a “terrible time” to bet on U.S. housing and homebuilder stocks because of high inventory and weak demand.

The US yield curve spread inverted in August and is now mildly positive. The peculiarity of the spread is it is a reliable lead indicator for US recessions, but the corresponding spread does not provide a reliable lead indicator for other markets even though the rationale for why it should lead is the same.

A link to the full report and a section from it are posted in the Subscriber's Area. 

The Federal Reserve in particular has stated it is aware of the risks to the economic expansion and is willing to do what is necessary to ensure it persists. This is quite different from what Alan Greenspan was saying in 1998 when he made his irrational exuberance speech.

You wouldn’t know it from benchmarks, but beneath a tranquil surface violent swings are lashing traders along obscure fault lines. Companies like real-estate firms that rose the most in 2019 are plunging, and some that have trailed are being pushed out front. It’s been a mild reckoning for hedge funds and others who have bet on the status quo persisting.

Amid all the churn has been a renewed focus on a quantitative concept known as factor investing, which groups companies not by industry but traits such as how fast their prices move or profits rise. A question gaining currency in the past few days is whether these categories are just handy descriptions of twists in the market -- or are at some level guiding them.

“It seems very mechanical right now,” said John Swarr, investment specialist at Penn Mutual Asset Management, which has $27 billion under management. “If you look within some of these stocks that are being hit the hardest, some are in much better shape than others and yet they’re all being affected similarly,” he said. “It does feel like it’s a rules-based rotation.”

The total of negative yields bonds was at $17 trillion for a brief time at the end of August and has since contracted to $14.3 trillion. That’s a big more in a little less than two weeks.

The failure of the German government to sell a full allocation of bonds and failed auctions at the US Treasury in August were probably the catalysts for sapping investor demand for bonds globally. The unwinding of leveraged long positions now has the scope for meaningfully move bond yields higher with clear upward dynamics evident across multiple markets.

Negative yielding debt is a concept that could only be considered rational by an academic. Given 4,000 years of human history, I’ll bet this is as faulty an idea as there ever has been and that it will be proven to be 100% hokum. Negative yields distort the entire capital asset pricing model. They undermine financial company profit models, pension fund liability assumptions, and seriously work to reduce the attractiveness of lending money and financial liquidity by eliminating the ability to do repo finance. But don’t worry, since the central banks will save the day by buying corporate debt. Isn’t that what the Japan’s central bank did, as well as the ECB? And what have these policies achieved in terms of real economic growth? Very little! And now we have members of the Fed actually discussing and agreeing that a negative rate can be effective and appropriate. In other words, penetrating the zero-rate boundary will broaden their policy options. Again, the Fed is clueless and is working with inadequate and ineffectual sets of econometric models.

Negative rate policies distort the economic and financial market systems. The unintended consequences from these policies will be significant and harmful. To deploy capital successfully, the potential list of companies is most likely very limited. At the very minimum, potential target companies should have extremely strong balance sheets to weather the oncoming economic and financial market tsunami. They should also have strong market positions. My guess few companies, with this limited set of criteria, would be attractively priced. Thus, a high level of liquidity is necessary. Finally, escaping to long-term bonds is similar to investing in equites, since their effective durations have volatility characteristics like those of equities.

Stock markets are waiting with baited breath to hear what the ECB has planned on Thursday. The bond markets have priced in a flotilla of policy easing tools such as negative short-term interest rates, deeper negative deposit rates, a tiered deposit rate to aid the banking sector and a fresh round of quantitative easing. The strong momentum push in bonds to a record total of negative yields priced in all of these initiatives.

He makes $21 an hour, but his wages have not risen in five years. He hopes a new contract will help him and his co-workers keep pace with California's cost of living increases. Prices in California are rising nearly twice as fast as the rest of the country, according to the Labor Department.

"We're on the front lines. We work in the stores. We're pulling in the money," Escarcega said. "We're not being taken care of so that's why we're here."

Escarcega said that going on a strike would be a "last resort" for employees, but that "everybody wants to speak up and get what we deserve."

Grocery workers often have more leverage in negotiations with employers than other retail workers because groceries are perishable and companies can ill-afford work slowdowns, experts say.

Minimum wages in California were $10 in 2016 and have risen increments over the last few years. They are due to hit $15 an hour in July next year. The predictable result of those increases is to cause people who were previously making above minimum wage to demand more money for the same job. It comes down to basic human psychology. No one wants to think of themselves as a minimum wage worker so when the lowest rate rises everyone wants to sustain their buffer to enhance their own feeling of self-worth. That might be considered the push side of the argument.

Concerns about ECB underdelivering keeps the pressure on bunds. A wide range of possible outcomes from Thursday’s meeting slants towards near-term profit taking of very rich valuations.

ECB speakers have been trying to dial back the extreme easing expectations priced by markets to give Draghi some room to surprise, but the hurdle still remains high

Policy makers will need to be aggressive on rates and keep the future path suppressed otherwise a modest depo rate cut risks seeing EUR rates continue to sell off in the near-term given the impact of the lower bound on the curve

From a macro valuation perspective there is room to sell off (with fair value of -0.43%)

Setting the path to go deeply negative on rates and lifting the buying limits on any QE announcement to make it scalable is key to seeing bunds extend the rally in the short term; however, positioning for a disappointment via options is still worth looking at given the difficulty for Draghi to engineer a dovish surprise

The ECB has quite a dilemma in front of it. The short end of the yield curve is sporting negative yields for just about all sovereigns. However, when we look at the shape of the yield curve for individual countries, compared to the Eurozone as a whole, we get two very different pictures.

U.S. stocks edged higher, and Treasuries inched lower after a mixed jobs report fueled bets the Federal Reserve will cut rates in two weeks. The dollar declined.

The S&P 500 headed for its second weekly gain as investors keyed on underlying strength in the report that signaled a solid labor market that isn’t too strong to deter further central bank easing. Megacap technology stocks weighed on benchmarks after New York opened an antitrust probe into Facebook Inc.

The 10-year Treasury yield erased most of its earlier gains, while the dollar headed for its fourth straight fall following the payroll numbers. Chairman Jerome Powell is set to make public remarks Friday. Crude sank toward $55 a barrel in New York.

The bond market has already priced in at least a 25-basis point cut so the soft jobs report confirms the need for additional easier policy. China also cut its bank reserve requirements today in an effort to extend credit. The ECB is expected to announce some form of easing when it meets next week and the region’s bond markets have been busy pricing in a negative short-term interest rate. All of these measures contribute to stimulative measures.

The outlook for the public debut of WeWork, which has racked up billions of dollars in losses in recent years as the company funds grand ambitions, is cooling after the disappointments of other major IPOs this year such as Lyft Inc. and Uber Technologies Inc. That could put pressure on WeWork, which has a mammoth credit line tied to the success of the IPO, as well as SoftBank Group Corp., which invested at a $47 billion valuation earlier this year.

“They would probably price this thing at the more conservative end, maybe in the $20 billion range, given that the company is trying to raise more money,” said Phil Haslett, co-founder of EquityZen, a marketplace for private stock sales.

Potential terms for the share sale are still being discussed, and the eventual valuation could change depending on investor demand, said the people, asking not to be identified because the information is private. A representative for WeWork, whose parent is The We Co., declined to comment.

One of the most memorable moments from a Marcus Evans conference I attended earlier this year was the conversation I had with one of the other delegates at dinner. He was a long/short equity manager at Pimco, but had been recruited by one of his clients to run a venture fund which would be seeded with about $200 million. He was at the conference to make contacts because he hadn’t the foggiest idea how to invest in private companies. His client was being attracted by stories of instant wealth and almost risk-free returns in what has the “no brainer” investment of the last decade.

Apple Inc. on Wednesday joined U.S. companies including Deere & Co. and Walt Disney Co. in a recent sprint to issue new bonds, taking advantage of the steep decline in benchmark interest rates and a surge in investor demand.

Apple launched its first bond deal since 2017, selling $7 billion of debt. All three companies issued 30-year bonds with yields below 3%, a first for the corporate debt market.

Twenty-one companies with investment-grade credit ratings issued bonds totaling about $27 billion on Tuesday, said Andrew Karp, head of investment-grade capital markets at Bank of America Corp. “That’s equivalent to a busy week for us—in one day,” he said. About 20 more companies were expected to issue investment-grade bonds Wednesday.

The issuance boom is one consequence of a rally in debt that has driven down Treasury yields, which fall as bond prices rise, to near-record lows. Spurred by concerns that slowing growth and a mounting trade conflict will end the decadelong global economic expansion, investors have swept up government bonds around the world, pulling yields in many countries into negative territory. Bonds issued by name-brand corporations give investors a relatively safe alternative that still pays more than government bonds.

Anyone with any sense is either refinancing or issuing debt at these levels. There is a cacophony of people talking about the US following Europe and Japan into negative rates. That is a possibility but the bigger question is when? It does not look likely before the end of the year and in the meantime, there is a wave of corporate and sovereign bond issuance for the market to digest.

London, Seattle, Manchester and, um, Xiamen. Some of the world’s priciest housing markets aren’t where you might think. A four-year property boom in China has elevated a collection of little-known cities and turned them into real estate gold.

While that’s been great news for speculators, it’s raising concern about whether China’s educated middle-class is quickly being priced out of these so-called second-tier cities, undermining Beijing’s goal of making them home to the millions moving from rural areas. Another risk is increasingly stretched family budgets: The average household debt-to-income ratio in China soared to a record 92% last year from just 30% a decade ago.

“A property bubble is foaming up in many places in China,” said Chen Gong, the chief researcher at independent strategic think tank Anbound Consulting. “Prices are starting to look
abnormal when compared to residents’ income.”

When something sounds crazy, that’s usually because it is. Xiamen is a smallish city, by Chinese standards, in Fujian. It’s a long way from any of the other coastal metropolis’ stature so its rise as one of the most expensive places in the world to buy property is further evidence of another bubble inflating in financial assets, this time in China.

At the end of last year, a return of inflation was assumed to be inevitable with the 10-year Treasury yield trading comfortably above 3%, commodity prices recovering, wages marching higher, full employment and high capacity utilisation. The perspective could not be more different today.

Interminable deflation has been priced in to Treasury yields as they test the lows of the last eight years. Commodity prices are under pressure, the trade war has resulted in a number of export dependent nations flirting with recessions, purchasing managers indices suggest contracting manufacturing activity and an inverted yield curve has started the clock on the next recession. Meanwhile gold has exploded on the upside to complete a six-year base formation.

What is likely to happen to the price of precious metals if a bubble in equities arises for all the reasons that you have stated. Precious metals appear to fall each day that equities perform well. Which sectors/countries are the likely leaders If there is an equities bubble or will we need to wait for the charts to tell us?

Gold has rallied impressively to complete a six-year base. The catalyst for that move was the perception the ECB is about to move interest rates below zero. That spurred a massive move in bonds that has created a situation where $17 trillion in nominal bonds are trading with negative yields in Europe and Japan.

Reserve Bank of Australia comments in 2019/20 corporate plan released on website Friday.

“Over 2019/20 to 2022/23, the structure of the Australian economy will continue to evolve and economic shocks -- which, by definition, are not forecastable -- will occur. Movements in asset values and leverage may be more important for economic developments than in the past given the already high levels of debt on household balance sheets”

“Especially in the context of weak growth in household income, high debt levels could complicate future monetary policy decisions by making the economy less resilient to shocks”

“The flexible medium-term inflation target is the centerpiece of the monetary policy framework in Australia and has been well established for more than two decades. Since the early 1990s, it has provided the foundation for the bank to achieve its monetary policy objectives by providing an anchor for inflation expectations. The bank will remain alert to new developments that may have a bearing on the framework for monetary policy”

The Australian Dollar remains in a medium-term downtrend, moving to a new closing low today. With energy and iron-ore prices declining and the domestic housing market in a parlous condition the RBA may be required to embark on the same counter deflationary measures other developed markets have endured over the last decade.

For the first time since 2009, S&P 500′s dividend is yielding more than 30-year Treasury bonds.

The only other similar inversion in the past four decades came in March 2009 — a low point of the financial crisis, according to data from Bespoke Investment Group. But it might bode well for stocks as investors have few other options to find yields.

“For an investor looking to hold something for the long term, it makes equities relatively attractive,” says Bespoke’s Paul Hickey. 

The contraction in government bond yields, globally, have driven demand for higher yielding assets. It has been one of the primary factors in containing risk in the high yield sector and it is also likely to continue to represent a major factor in the ability of the primary indices to continue to hold in the region of their peaks.

Since then, we have had a mirror-like symmetrical reversal (a dis/deflationary blow-off). Look at the current inflation rates at the current cyclical peaks (i.e. not much inflation despite the world economy and financial markets being near a peak and despite all the central banks’ money printing) and imagine what they will be at the next cyclical lows. That is because there are strong deflationary forces at work as productive capacity has increased greatly. These forces are creating the need for extremely loose monetary policies that are forcing central banks to drive interest rates to such low levels and will lead to enormous deficits that are monetized, which is creating the blow-off in bonds that is the reciprocal of the 1980-82 blow-off in gold. The charts below show the 30-year T-bond returns from that 1980-82 period until now, which highlight the blow-off in bonds.

Today’s 7-year auction of Treasuries came in well below expectations suggesting at least some reticence to participate at decade-low yields. The effect on yields was minimal but we did see a pause in the run-up in gold.

With just over two months until Johnson’s self-imposed deadline to leave the European Union with or without a deal on Oct. 31, every day is going to count. And since Johnson wants a new Queen’s Speech to set out his government’s legislative agenda, which is usually followed by five days of debate, it will be more like two weeks of parliamentary time lost.

While suspensions of as much as two months were common in the 19th century, most prorogations of Parliament in recent decades have lasted for less than a week. Johnson’s suspension for 35 days will be the longest since the 1970s, according to the House of Commons library.

The U.K. doesn’t have a written constitution and, within reason, governments can do whatever they like as long as they have a parliamentary majority. But given that a number of ex-ministers -- including former Chancellor of the Exchequer Philip Hammond and Theresa May’s Justice Secretary David Gauke, have already attacked his move, that is far from guaranteed.

Exiting the EU and retaking the ability to set its own rules and regulations is a once in a generation opportunity to recast the UK’s economy as a pro-growth engine for innovation and trade. Grasping that opportunity is the only way the UK will make a success of Brexit, so it is imperative that the raft of measures proposed in September is not simply a commitment to double down on spending without a plan to grow.

So-called tappable equity grew by more than $335 billion during the quarter. The total is 26% more than the mid-2006 peak of $5 trillion. Roughly 45 million mortgage holders have excess equity, and half of them have mortgage rates higher than 4.25%, making a refinance not only possible but attractive. The average rate on the 30-year fixed is now around 3.6%. The majority of these borrowers also have top credit scores.

Falling mortgage rates over the past several months have caused a surge in overall refinance activity, but despite the record housing wealth, homeowners have been highly conservative about taking cash out. In 2006, 89% of refinances were cash-out, according to Freddie Mac. In 2012, when home prices crashed, that share dropped to 12%. But even now, with prices back above their previous peak and mortgage rates much lower, cash-out refinances are just 61% of the total pool of refinances.

“I think you’re seeing a little bit of reluctance both on the side of lenders and on the side of borrowers,” said Andy Walden, director of market research at Black Knight. “If you look at lending, guidelines are a little bit tighter than they were back in 2006, but even given those lending restrictions, I think you’re seeing more conservative behavior on behalf of homeowners as well, as folks have the remembrance of the financial crisis in the rearview mirror.”

I was at an end-of-summer party on Saturday night and conversation turned to mortgage refinancing. About half of the people I was talking with had used low rates over the last 18 months to refinance at about 3.5% while the rest had not done so yet. Mortgage rates have done a round trip from 3.5% to 5% and back again over the last year and there is still scope for the rate to move lower. That is going to put additional cash in the pockets of the people most likely to invest in the stock market.

Gold and silver futures rose on Tuesday (http://www.marketwatch.com/story/gold-higher-but-silver-sets-the-pace-2019-08- 7), with gold settling at a level not seen since 2013, and silver scoring its highest finish in more than two years. Prices for the precious metals got a boost from losses in the U.S. stock market, a drop in Treasury bond yields and a weaker dollar--all of which helped lift the metals' investment appeal. December gold climbed by $14.60, or 1%, to settle at $1,551.80 on Comex. That was the highest most-active contract settlement since April 2013, according to FactSet data. September silver added 51.2 cents, or 2.9%, to end at $18.153 an ounce, the highest since April 2017

The continued compression of government bond yields is creating significant demand for gold as a hedge against competitive currency devaluation. That is now starting to be manifested in other precious metals with silver playing catch up and platinum beginning to garner attention.

Inflows into the foreign RRP facility are a case in point. Just as an inversion is forcing foreign central banks to latch on to the Fed for collateral, an inversion would force primary dealers and banks to latch on to the Fed for reserves, as weak demand for Treasuries from ultimate investors drives growing dealer inventories. The optics of what we just described are odd…

…as they imply the conflicted existence of two uncapped facilities: a foreign RRP facility that sterilizes reserves and adds to collateral supply and a standing repo facility or an asset purchase facility built to add reserves and absorb collateral. That makes no sense…

…it has to be one or the other. If the standing o/n repo facility or an asset purchase facility (or “mini-QEs”) are the future, an uncapped foreign RRP facility must be the past. Whether the Fed provides a technical fix with or without an uncapped foreign RRP facility, we don’t think a technical fix is the right solution for the problems caused by the inversion. All this brings us back to the rationale for more rate cuts – a series of rate cuts (see here).

A link to the full note is posted in the Subscriber's Area. 

The US Treasury has a substantial funding requirement this year with upwards of $600 billion in bonds maturing. Coupled with the increased demand for collateral from the reverse repo facility and the increased deficits agreed to as a way of avoiding a government shutdown that suggests significant bond issuance. Ensuring that issuance comes at as a low of yield as possible and with as long a maturity as possible is likely behind speculation on 50-year and 100-year bond issuance.

“Trade policy uncertainty seems to be playing a role in the global slowdown and in weak manufacturing and capital spending in the United States,” Powell said in the text of his remarks Friday to central bankers gathered at the Kansas City Fed’s annual symposium in Jackson Hole, Wyoming. “We will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2% objective.”

It is looking like the learning curve for a newly installed Fed chair is about 18 months. Today’s measured statement from Jerome Powell did an excellent job of placating investor fears while leaving open the optionality of how much to cut by. The Fed has made clear they will cut rates if they need to but will not hurry. However, the simultaneous announcement by China that they are increasing tariffs on $75 billion of US goods is likely to be prove the catalyst for deeper cuts.

A link to the full report is posted in the Subscriber's Area. 

The massive move we have seen in European sovereign bonds is definitely representative of a buyer’s panic but the broader question is who is panicking? Pension funds and insurance companies spring to mind. What are they panicking about? There is a real prospect we are going to see the ECB announce negative short-term rates as well as a raft of additional measures which are clearly designed to boost liquidity but will come at the expense of savers. That suggests what we are seeing is potentially a buy the rumour and sell the news phenomenon.

“This shows that there is less demand for 30-year bonds at negative yields,” said Marco Meijer, a senior fixed-income strategist at BNP Paribas SA. Still, Meijer doesn’t “see yields rising a lot in Europe.”

The whole of Germany’s yield curve is now below zero -- the first major market exhibiting such a trait -- meaning the government is effectively being paid to borrow out to 30 years. That’s a reflection of dwindling expectations for inflation and growth over the coming years, while the European Central Bank is widely forecast to introduce a new wave of monetary stimulus next month.

The sale comes as Germany is priming the pumps for extra spending should an economic crisis hit. While the nation is confined to strict laws on running a fiscal deficit, Finance Minister Olaf Scholz suggested Germany could muster 50 billion euros ($55 billion) should a recession hit. The economy contracted in the second quarter.

 

Bond market investors are not quite yet willing to be the Turkeys that vote for Christmas. Even the most bullish of momentum traders can see that locking in a zero return, at best, for maturities out to 2049 does not make for sense for long-term investors. However, it is also worth remembering that this situation is occurring in a global slowdown where growth is still positive. It portends even lower yields during a contraction.

While Conte’s resignation adds to the uncertainty, bond investors welcomed the fact that an alternative coalition is still on the table, while the chance of snap elections in the fall diminished somewhat. Yields on 10-year Italian bonds touched 1.31%, the lowest level since 2016, while the spread over German bonds -- a key gauge of risk in the nation -- dropped to 200 basis points for the first time in nearly two weeks.

Salvini pulled his support from the governing alliance with the anti-establishment Five Star Movement this month, saying the coalition no longer has a working majority. The 46-year-old anti-immigration hardliner has been seeking to cash in on strong poll ratings and upended the political establishment with a mid-summer power grab while parliament was in recess.

At stake is whether Italy’s mountain of public debt -- a chronic concern for both European officials and international investors -- will be managed by a right-wing ideologue set on confrontation with Brussels. Salvini on Tuesday promised Italians 50 billion euros ($55 billion) of tax cuts and public spending if he can take control of the government.

There was a certain inevitability about the collapse of the merger between right and left-wing populists. In fact, some might reason it is amazing it lasted this long. Italian politics is not noted for the longevity of its administrations. Annual elections are the price to pay as the political establishment strains to come to terms with giving a voice a population at odds with the continued adherence to decades of fiscal austerity.

Frankly, there is a lot to like about the WeWork opportunity. Yes, a $47 billion valuation seems way too high, particularly given the fact the company is on pace to make only about $440 million in gross profit this year (i.e. excluding all buildout and corporate costs), and given the huge recession risk. At the same time, this is a real business that provides real benefits to companies of all sizes, and those benefits are only growing as the nature of work changes to favor more office work generally and more remote work specifically. And, critically, there is no real competition.

The problem is that the “unsavoriness” I referred to above is hardly limited to the fact that WeWork can stiff its landlords in an emergency. The tech industry generally speaking is hardly a model for good corporate governance, but WeWork takes the absurdity an entirely different level. For example:

WeWork paid its own CEO, Adam Neumann, $5.9 million for the “We” trademark when the company reorganized itself earlier this year.

That reorganization created a limited liability company to hold the assets; investors, however, will buy into a corporation that holds a share of the LLC, while other LLC partners hold the rest, reducing their tax burden.

WeWork previously gave Neumann loans to buy properties that WeWork then rented.
WeWork has hired several of Neumann’s relatives, and Neumann’s wife would be one of three members of a committee tasked to replace Neumann if he were to die or become permanently disabled over the next decade.

Neumann has three different types of shares that guarantee him majority voting power; those shares retain their rights if sold or given away, instead of converting to common shares.

WeWork by all accounts creates spaces where people might actually want to work. That’s no mean feat. It’s not cheap but it is laudable. I spent a couple of days a week popping in and out of the Luxembourg Regis office between 2000 and 2003 and it was a pretty grim experience despite the prime location on Boulevard Royal. I would never have volunteered to work there full time if there was a better alternative available.

See yield chart middle page 1.  How low (negative) can govt credit yields (-1%) go till the financial system freezes over?  Serious Q……………this negative yield stuff wasn’t taught in Economics 101.

There must be an absolute level of negative rates that destroys money velocity (V) as it means no one puts money in the bank anymore and lending gets restricted.  At -10% I wouldn’t lend to UBS.  What happens at say -5%?  Assuming a real rate of 3%, bank lending -after a margin of say 2%- would essentially be FREE (0%).  But what does that do to banking system integrity (banks make money but less of it as their margins collapse; their deposit base shrinks as they struggle to increase/ attract deposits………….not only do depositors go on strike but existing depos are decreased annually by negative yields!)….and what about regulatory oversight?….would CBs and regulators afraid of imprudent lending caused by needy borrowers at 0% step in to restrict the very process that they are trying to encourage via making money so cheap?  i.e. will they try to stop “BAD” lending.  How will they judge/enforce?

And where does inflation fit into this calculus?...without any inflation the interest rate structure/ yield curve that might restore banking margins is hard to normalize/ become positive again.

Or should governments everywhere borrow vast sums at negative rates for 50 years to finance a massive infrastructure spend (highways, 5G, clean energy, railways etc.) i.e. “GOOD” lending?  Wouldn’t this raise rates and restore normality?  Then what debt / GDP levels are prudent (see Italy)?  I recall Argentina’s 100-year bond issue in 2017 at 7.9%, 3x over-subscribed by famished yield scavengers.

Investment implications

• Negative bond yields unattractive versus investment in high quality equities paying well covered dividends, though it is certainly not a good world for poor quality companies who don’t
• How is any of this bad for gold, whose carry cost is collapsing?

 

Just sharing some thoughts, largely written out of confusion

I think we are all in a state of disbelief at the willingness of investors to pour trillions into bonds with a negative yield. I have long wondered at the absence of any discussion of bond market convexity over the last decade. After all, shouldn’t we all have an interest in the sensitivity of bonds to changes in interest rates?

Concho Resources Inc., long considered one of the Permian’s premier operators, was forced to scale back activity after drilling almost two dozen wells too closely together. That move by the Midland, Texas-based producer spooked investors across the industry, with Evercore ISI predicting the “carnage” would have a lasting impact.

Concho’s problem with well spacing highlights the challenges of fracking so-called child wells: Too close to the “parent,” and output is less prolific; too far apart, and companies risk leaving oil in the ground.

Exxon and Chevron say they aren’t as exposed to those problems. Because of their size relative to smaller independent producers, the oil giants are able to lock up acreage, giving them room to be more conservative in their well spacing.

The lower for longer nature of oil pricing over the last few years and probably for the foreseeable future suggests smaller independent oil drillers and producers need to concentrate a lot more on containing costs. That suggests there is scope for consolidation within the Permian where the larger better capitalised companies are likely to have an advantage.

Counting all kinds of debt, including mortgages, consumers aren’t nearly as debt-burdened as they once were. In the fourth quarter of 2007, the last year before the financial crisis struck, households devoted 13.2% of their disposable income to debt service. In the first quarter of 2019, that number was 9.9%, largely due to low interest rates.

Partly because of widespread refinancing, mortgage payments since the start of 2017 have claimed the smallest slice of disposable personal income in decades, in the low 4% range, according to Fed data.

Lifestyle creep hits most families. As soon as incomes increase people eat out more, buy more clothes, spoil the kids or indulge in more after school activities, buy a better car and move to a better neighbourhood. That all works out as long as incomes keep up with expectations. It is also why the throwaway remark “a recession is when your neighbour loses his job, a depression is when you lose yours” rings so true. Of course in today’s economy it might be more correct to state it’s a recession when your spouse loses their job and a depression when you both do.

Latest reports have highlighted a distinct slowdown in growth in the housing sector since the start of the year. Despite a clear need for more houses this is not converting to actual sales. In fact, price drops have become commonplace in the second-hand market, and sales of properties over €500,000 have shown a 21 per cent drop since the start of the year.

All of this points to an affordability issue for buyers, and a gradual market realisation that prices need to be adjusted accordingly. Add to this fears over Brexit and Central Bank mortgage lending restrictions and the slow 2 per cent growth in number of mortgage drawdowns in the first quarter begins to make sense. Compare this with growth rates in 2018 of about 20 per cent.

Meanwhile, the throughput of housing stock for sale is strong. “June and July have been unseasonably strong with the flow of stock coming through,” said Angela Keegan, managing director of property website MyHome.ie. “It’s possible people are more confident about the market because, remember, if they are selling they are buying too. We know interest rates are not going up in the near term and there are excellent fixed-rate mortgages available too.”

Declining demand for higher priced homes suggests consumers and investors are trimming their expectations for continued economic strength. There is no country likely to do worse from a hard Brexit than Ireland.

It will be for historians to parse whether the backstop gambit was an historic mistake or a masterful stroke. Meanwhile the stock market is rolling over and the housing market is softening. That occurring against a background where interest rates are close to zero and the ECB is about to restart QE.

The move will add to fears that the region’s economic slowdown is being driven by more structural factors akin to Japan’s “lost decade.” Germany’s bond market is widely perceived as being one of the world’s safest, with investors lured in by the liquidity and credit quality offered. Funds still looking to extract a positive return from European sovereign assets have been forced further out the yield curve or into riskier debt markets such as Italy.

“It underlines that the hunt for yield, or rather hunt to avoid negative yields, is accelerating day by day,” said Arne Lohmann Rasmussen, head of fixed-income research at Danske Bank A/S. “It just makes things more complicated.”

Yields on 30-year bunds fell almost 10 basis points to -0.002%. Those on 10-year securities dropped five basis points to -0.50%, also a record low and below the European Central Bank’s -0.40% deposit rate.

Investors are paying the German and Swiss governments to take their money at every maturity and in Japan out to 15-year maturities. Bond investors have concluded the only possible way to manage the debts and unfunded liabilities that have built up over decades is with money printing. That will be facilitated by central banks buying the newly minted bonds and that contributes to the momentum move. The victims are currencies which is why gold is rallying.

President Donald Trump abruptly escalated his trade war with China, announcing that he would impose a 10% tariff on $300 billion in Chinese imports that aren’t yet subject to U.S. duties.

The new tariff will be imposed beginning Sept. 1, Trump said in a tweet Thursday that broke a tentative trade cease-fire between the world’s two biggest economies. The 25% tariff already imposed on $250 billion in Chinese goods will remain in place, he said.

A draft list of $300 billion worth of targets published by the Trump administration in May included a raft of consumer and technology goods, including most of Apple Inc.’s major products such the IPhone, along with toys, footwear and clothing. The final list hasn’t yet been released.

“These are the tariffs on many of the consumer goods that were spared in the previous tariff rounds,” said Neil Dutta, head of economics at Renaissance Macro Research in New York, in a note. “This is a small hit to growth but will likely be more obvious to consumers. Keep in mind that margins have come in somewhat already, not sure firms can simply eat the cost.”

Jay Powell’s statement yesterday that the cut to interest rates was more of a mid-cycle insurance cut than a response to the end of the credit cycle led to some unwinding of bets on a 50-basis point but. As the news was digested this morning the majority of markets were in positive territory and at one point has almost completely unwound yesterday’s decline. That was until President Trump announced additional tariffs. That is going to set off a scramble for inventory ahead of the busy fourth quarter retail period.

The fact that foreign money managers are delving into Canadian municipal bonds -- which account for just 1% of trading in the country’s C$2 trillion public sector fixed-income market -- is a testament to how hungry they’ve become for high quality, higher-paying assets in a world where at least $13.8 trillion of debt is now in negative-yield territory. Throw in the fact Canada has given little indication it will follow the global move toward easier monetary policy, and the market is fast becoming a magnet for sophisticated investors seeking to boost returns.

“If you’re sitting in the Middle East, Asia or Europe and you’ve got all this negative yielding debt, it makes a lot of sense to look for the hidden gems such as these excellent quality municipals,” said Avi Hooper, a portfolio manager at Invesco, which has $1.2 trillion under management, including bonds issued by the city of Montreal. “One has always to be careful with the liquidity of course. Big institutional investors are not going to get involved with $50 million deals.”

The paradox of the bond markets is the biggest debtors tend to have the most liquid bonds. Better credits don’t tend to borrow as much and therefore tend to have less liquid issues. Ahead of the credit crisis companies like General Motors and Hypovereinsbank had their own yield curves because they had outstanding debt at every maturity that was highly liquid. At the time no one seemed to pay much attention to the fact that they had so much debt it represented a threat to repayment of principal.

Samsung has since closed all but one of its smartphone plants in China. It now assembles around half of the handsets it sells worldwide in Vietnam. Samsung’s subsidiaries in the country, which employ around 100,000 people, accounted for nearly a third of the company’s $220 billion in sales last year.

A Samsung spokeswoman said about 90 percent of those sales involved goods shipped from Vietnam to other countries. That implies Samsung alone accounted for a quarter of Vietnam’s exports in 2018, although even that might not fully capture the company’s effect on the wider economy. Samsung’s success in Vietnam helped convince many of its South Korean suppliers that they needed to be here, too.

“When you are a big company and you move to a place, everything follows you,” said Filippo Bortoletti, the deputy manager in Hanoi at the business advisory firm Dezan Shira.

Some Vietnamese business owners say the blessings are mixed, though. Foreign giants, they say, come to Vietnam and work largely with vendors they already use elsewhere, leaving little room in their supply chains for local upstarts.

Samsung has 35 Vietnamese suppliers, the spokeswoman said. Apple declined to comment.

When Samsung first set up in the country, it bought some of the metal fixtures used on its assembly lines from a local firm, Vietnam Precision Mechanical Service & Trading, or VPMS. But then more of Samsung’s South Korean partners started coming into the country, and after a year, Samsung and VPMS stopped working together, said Nguyen Xuan Hoang, one of the Vietnamese company’s founders.

Price and quality were not the issue, Mr. Hoang said, over the hissing and clanging of machinery at his factory near Bac Ninh. The problem was scale: Samsung needed many more fixtures than VPMS could deliver.

The sheer scale of China’s manufacturing operations is not going to be easily repeated elsewhere. However, no one ever thought China would achieve the manufacturing might it now possesses either. The history of major manufacturing hubs is they evolve where labour, land, transportation and electricity are cheapest and where the tax and regulations are most lax.

Hope all is well.

 I had a question about the comment you made at the end of your video today. You mentioned that the indicator that we should focus on which will lead to this current cycle unwinding is Private equity and the success of their investments, plus on government debt and the deficits they are building.

Are you able to expand on what we can track (tangibly) for these 2 issues?

Thanks v much

Thank you for this question. I am very conscious of the temptation of generals to always be fighting the last war. In 2005 and 2006 there was some talk of a housing bubble in the USA but few people understood just how massive the liar loans problem was. Consumers had become extraordinarily overleveraged. As interest rates ground higher the first signs of trouble appeared in the underperformance of banks, rising credit card delinquencies and the collapse of leveraged hedge funds at major investment banks. The big question we need to ask is whether it will be these factors which are most relevant in this cycle?

Let’s think about the economy as made up of consumers, corporations and the government. After a decade of extraordinary monetary policy total debt has gone up but the US consumer has been de-levered while corporations and the government have seen their debt loads balloon.