Crisis Management

Doug Nolan


The current global backdrop remains alarming and, especially on bad days, darn right frightening. Yet as a macro analyst of Credit, money and the markets, I’m the proverbial kid in a candy store.

De-risking/de-leveraging and attendant market tumult (once again) reached the point of provoking concerted global crisis management measures (see “Global Bubble Watch”). Japanese stocks surged 6.8% this week, with Chinese shares up 3.5%. The Mexican peso rallied 3.6%.

This week saw the People’s Bank of China revalue the yuan currency higher (“biggest one-day advance” in more than a decade), a surprise move clearly meant to inflict pain upon the speculator community. One of China’s internationally respected officials reemerged in the public stoplight, with PBOC “Governor Zhou Xiaochuan breaking his long silence to argue there’s no basis for continued yuan depreciation” (Bloomberg). And what would Crisis Management be without talk of boosting government stimulus: “China is stepping up support for the economy by ramping up spending and considering new measures to boost bank lending” (Bloomberg).

With their economy apparently slipping back into recession in the face of ongoing massive QE, Japanese officials are keen to jump on the concerted global crisis management bandwagon. “Bank of Japan Gov. Haruhiko Kuroda… called on finance chiefs from the world’s major economies to find ways to stabilize global financial markets…” (WSJ). And a Thursday headline from the Financial Times: “Japan will have to double down on stimulus to save Abenomics.”

After witnessing a distressing bank stock collapse, European officials are desperate to (again) do “whatever it takes.” “The European Central Bank won't hesitate to boost its stimulus in March if it believes recent financial-market turmoil or lower oil prices could weigh further on stubbornly low inflation, ECB President Mario Draghi said” (Dow Jones). The ECB “is calling for European Union banking law to change to allow supervisors the option of permitting banks to make discretionary payments to investors… rules currently block payments of dividends, bonuses or coupons on contingent convertible bonds, known as CoCos, if a lender posts losses…” (Bloomberg).

The Chinese were not alone in seeking to ambush currency speculators. Mexico’s central bank stunned the markets by boosting rates 50 bps to 3.75%, while the Finance Ministry at the same time announced spending cuts. The peso surged almost 4%, “best daily gain since 2008.”

Here at home, as Federal Reserve officials advance dovish rhetoric, “one and done” looks closer to winning the day. Most notably, “Hawkish Bullard Moves Into Dove Camp,” stating that it’s now “unwise” to follow through with additional hikes. “Two important pillars of the 2015 case for U.S. monetary policy normalization have changed. These data-dependent changes likely give the FMOC more leeway in its normalization program.”

February 17 – Wall Street Journal (Paul Hannon): “Governments in the U.S., Europe and elsewhere should take ‘urgent’ and ‘collective’ steps to raise their investment spending and deliver a fresh boost to flagging economic growth, the Organization for Economic Growth and Development said… In its most forceful call to action since the financial crisis, the OECD said the global economy is suffering from a weakness of demand that can’t be remedied through stimulus from central banks alone.”
Inflationism was never going to work. And here we are after seven years of ongoing monetary stimulus and deficit spending – and the calls for more grow only louder. QE had no chance of success. Here we are in 2016 and inflated global securities and derivatives markets are more dangerous than ever. Inflating away debt problems was destined for failure. The world has added tens of Trillions of additional debt since 2008 and global Credit is more fragile than ever.

The precarious nature of “Terminal Phase” Credit Bubble excess is a fundamental CBB tenet. At this point, China is putting the historic U.S. mortgage finance Bubble to shame. The “Terminal Phase” sees underlying systemic risk expand exponentially. Not only does the quantity of Credit expand rapidly. The underlying quality of this Credit suffers progressive late-cycle deterioration. Think of 2006’s Trillion dollars of subprime mortgage derivatives. There’s just no escaping Credit Bubble reality: the more protracted the Terminal Phase, the more disastrous the consequences.

Total Chinese New Credit (aggregate “social financing”) expanded $525 billion in January. This was more than 50% above estimates. It was also a record for Chinese Credit expansion and, surely, one of the biggest months of Credit growth in the history of mankind. There are important seasonal and special factors at play. Nonetheless, January Credit data support/confirm the view that China’s financial system has succumbed to a precarious self-destruction phase. Such egregious Credit creation may help meet 2016 growth goals. It will do anything but bolster flagging confidence in policymaking and China’s financial system.

February 19 – Washington Post (Didi Tang): “Chinese President Xi Jinping made a rare, high-profile tour of the country’s top three state-run media outlets Friday, telling editors and reporters they must pledge absolute loyalty to the party and closely follow its leadership in ‘thought, politics and action.’ The remarks by Xi… are the latest sign of the party’s increasingly tighter control over all media and Xi’s unceasing efforts to consolidate his powers… At CCTV, Xi was welcomed by a placard pledging loyalty to the party. ‘The central television’s family name is the party,’ the sign read… ‘The media run by the party and the government are the propaganda fronts and must have the party as their family name,’ Xi told the propaganda workers at the meeting…”Chinese officials have apparently settled on a strategy: hold economic crisis at bay by stimulating rampant system Credit growth, while stabilizing the yuan currency with currency controls and heavy-handed market intervention. The flaw in this plan can be traced back to a loss of faith in China’s financial and economic model, along with waning confidence in Chinese policies. “Money” wants out of China - and the more “money” created the more finance available to seek the exits. Chinese officials are determined to make life more challenging for those betting again the yuan. At the end of the day, however, massive “Terminal Phase” excess will ensure a highly destabilizing currency devaluation.

Policymakers retain the capacity to incite short squeezes. I don’t recall much official protest while the speculating community was positioned leveraged long global risk markets. But to place bets against China, Europe or on “risk off” more generally, well, these days such acts provoke aggressive responses. In the past, this competitive advantage afforded to “risk on” proved instrumental in prolonging the global Bubble.

It was a big squeeze week – stocks, corporate bonds, currencies and EM. The Morgan Stanley High Tech index jumped 6.3% and U.S. biotechs surged 4.4%. The small caps rose 3.9%. The broker/dealers recovered 5.1%. The German DAX rallied 4.7%. Brazilian stocks rallied 4.4% and Russian stocks were up 3.9%.

With the caveat that short squeezes do tend to take on lives of their own, the key question remains whether concerted policy measures and attendant squeeze dynamics have the capacity to resuscitate the global Bubble. I believe the Bubble has burst and reflationary measures at this point only work to further destabilize.

It was one of those “dogs that didn’t bark” weeks. It’s worth noting that Italian bank stocks completely missed out on this week’s global equities rally. For that matter, U.S. bank stocks were none too impressive. Treasuries gave up very little of recent strong gains. Commodities as well were in no hurry to price in a resurgent global economy. The Brazilian real slipped 0.5%, the Turkish lira declined 0.7% and the South Korean won dropped 1.9% - despite a decent squeeze in EM currencies. German bund yields fell another six bps. European periphery spreads reversed little of recent widening. Curiously, the yen added to recent strong gains, completely disregarding the rally in risk assets.

At this stage of the cycle, policy-induced squeezes and market volatility only work to further derail market stability. There is increased chatter of mounting losses at some of the prominent hedge fund complexes. The pressure to further de-risk/de-leverage has turned intense. The market, economic, policy and geopolitical backdrops are too uncertain. Correlations between markets are too disjointed and unpredictable to leverage various sectors, assets classes or global markets. I’m sticking with the analysis that leveraged currency “carry trade” liquidity evolved into a powerful source of global market and economic fuel over recent years.

It is as well my view that acute currency market volatility – certainly spurred by policy experimentation and confusion – is a serious detriment to saving this faltering Credit cycle. Global policies appear too gimmicky for my taste. In short, market participants still have a lot of confidence in official willingness and ability to punish those betting on – or hedging against – “risk off.” 
 
Much more importantly, confidence is waning in the capacity of policymakers to manage the unfolding global bust. Confidence is waning in the leveraged speculating community’s ability to provide attractive returns while accepting reasonable risk. In general, confidence in leverage has evaporated – which changes so many things. At the same time, confidence is waning in political processes around the globe. And confidence is beginning to wane in the ability to keep the peace.

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