Fanning the Flames

Doug Nolan


The Federal Reserve abandoned “data dependent” - at least for next week’s FOMC meeting. December futures imply a 1.78% Fed funds rate, up six bps for the week but still 62 bps below today’s 2.40% effective rate. Unless the Federal Reserve has completely caved to the markets, the Committee statement and Chairman Powell’s press conference should emphasize its commitment to “data dependent” and the possibility of a second-half recovery in growth momentum. By the reaction to Draghi’s marginally less than super-duper dovishness, markets will not be overjoyed if the Fed attempts walking back its “an ounce of prevention…” “insurance” rate cut cycle.

For posterity, I’ll document the data backdrop heading into what is widely believed to be the beginning of a series of cuts. Second quarter GDP was reported at a stronger-than-expected 2.1% rate, down from Q1’s 3.1% but ahead of the 1.8% consensus forecast. Personal Consumption bounced back strongly, jumping to a 4.3% annual rate from Q1’s 0.9%. It’s worth noting there have been only four stronger quarters of Personal Consumption growth over the past 13 years.

Personal Income increased 5.4% annualized, down from Q1’s 6.1% - but strong nonetheless. Employee Compensation expanded 4.7% annualized. Receipts on Assets (Interest Income and Dividend Income) increased 9.0% annualized, more than reversing Q1’s 6.1% annualized contraction. Overall Disposable Income increased an annualized 4.9%, up from Q1’s 4.8% and Q4 ‘18’s 4.2%.

Government Spending jumped to a 5.0% annualized growth rate (Q1 2.9%), led by a 7.9% annualized expansion in federal government expenditures (strongest reading since Q2 ’09).

With federal deficit spending near 4.5% of GDP, fiscal stimulus has become a powerful force in the real economy.

Dropping 5.2%, Exports were a drag on growth. Reversing Q1’s 6.2% growth rate, Gross Private Investment declined 5.5% annualized. Non-Residential Fixed Investment declined 0.6%, with Residential Investment down 1.5%.

At 2.3%, Q2’s GDP Price Index recovered strongly from Q1’s 1.1%. Q2 PCE (Personal Consumption Expenditures) rose to 2.3%, the strongest reading since Q1 ’18. Core PCE rose 1.8%, the largest price gain since Q1 18’s 2.1%. It’s worth mentioning Q2’s increase in Core PCE was above the 1.7% quarterly average going all the way back to 2004.

June Durable Goods Orders were up a stronger-than-expected 1.9% (estimates 0.7%), with the 1.9% rise in Non-Defense Capital Goods way ahead of the 0.2% consensus forecast. Weekly Jobless Claims declined to the lowest level in eight weeks.

And while the 50 reading for the Markit U.S. Manufacturing PMI missed the 51 estimate, Markit’s Services PMI was reported at 52.2 – besting estimates (51.8) and ahead of June’s 51.5.

Global manufacturing is weak, and the U.S. manufacturing sector has weakened. Google’s Q2 revenues were up 19% y-o-y to $38.94 billion. Microsoft saw revenues jump 12% y-o-y to $33.7 billion, while Facebook’s quarterly revenues surged 28% y-o-y to $16.89 billion. Combined, these three posted 18% y-o-y revenue growth. My point: the nature of economic output has changed momentously, and each year manufacturing accounts for a smaller piece of the greater U.S. economy.

The Fed made a mistake by pre-committing to a cut next week. Despite the obvious risks associated with weak global manufacturing, trade war frictions and China fragilities, U.S. financial conditions have been extraordinarily loose for months now. Investment-grade Credit default swap (CDS) priced dropped this week to the lowest level since the multi-year lows in February 2018. Junk bond spreads narrowed this week to near November lows. Corporate debt issuance is running at record pace.

And, of course, stock prices have surged to all-time highs. The Semiconductors ended the week with a y-t-d gain of 38.0%. The Nasdaq100’s 2.3% advance this week pushed y-t-d gains to 26.7%. It will be some weeks before we have Fed Q2 Z.1 data, but Household Net Worth and Net Worth to GDP likely jumped to all-time highs. Equities and Total (equities and bonds) Securities as a percentage of GDP will both be near record levels.

July 25 – Wall Street Journal (Jessica Menton): “Investors are piling into safe-haven bonds at a record pace, a sign that caution remains despite stocks pushing toward records. Mutual funds and exchange-traded funds tracking bonds posted $12.1 billion of inflows for the week ended July 17, the 28th consecutive week of inflows. That brings the total so far this year to $254 billion, on pace for a record $455 billion on an annualized basis in 2019, according to a Bank of America Merrill Lynch analysis of EPFR Global data. That compares with $1.7 trillion in bond inflows over the past 10 years…”

The Fed is about to lower rates in the throes of manic securities markets activity. They will surely cite global risks and below-target inflation. FT: “Powell Seeks a Cure for the Disease of Low Inflation.” “Jay Powell this month stressed the Fed’s determination to fight the sluggish inflation numbers dogging the US economy, warning Congress that downbeat prices could lead to an ‘unhealthy dynamic’ of lower interest rates and less room to act in a downturn. ‘We’ve seen it in Japan. We’re now seeing it in Europe,’ Mr Powell said in his testimony. ‘And that’s why we think it’s so important that we defend our 2% inflation goal here in the United States and we’re committed to doing that’.”

The issue is not some “disease of low inflation.” There’s plenty of inflation, it’s just neither uniform nor necessarily in all the avenues central bankers prefer. There has been strong inflation in securities prices, with the term “hyperinflation” fitting for some global bond markets (i.e. Italy, Greece, Portugal, Spain, Slovenia, etc.). Global stock prices are locked in a powerful late-cycle (speculative) inflation dynamic. Global real estate markets remain in a strong inflationary environment, along with asset prices more generally. The price dynamic for high-end collectables is hyperinflationary.

The world has changed profoundly in 30 years – the nature of economic output, economic structure, finance, monetary policy and “globalization”, to name broad categories that have profoundly altered inflation dynamics. Individual country inflation dynamics are no longer dominated by domestic Credit growth, financial conditions and monetary policy.

Today, the impact of a central bank’s monetary stimulus would work through various channels, perhaps stimulating asset prices, spending, imports and even investment – with a very unpredictable effect on an aggregate measure of consumer prices. As much as the Fed – and other central banks – rue the loss of influence over consumer prices, momentous changes in financial and economic structures ensure the system has been fundamentally and irreversibly altered.

With individual central banks having lost command over consumer price inflation, there has been gravitation to concerted global monetary stimulus. “If we all stimulate together, then we can spur a more systemic boost of inflation globally.” Such an approach is doomed to fail.

There is today a strong inflationary bias in securities and asset prices. At the same time, the legacy from the historic Chinese and EM booms is unprecedented overcapacity throughout manufacturing. The disinflationary dynamic in many goods markets ensures that monetary stimulus will spur powerful flows to speculative Bubbles with muted impact on aggregate consumer price indices. Finance will flow in force to – and exacerbate – areas with strong inflationary biases (i.e. assets markets).

There’s actually a strong case to be made that further stimulating asset Bubbles at this stage of the cycle only exacerbates disinflationary dynamics at work in goods and some services. There is today in the U.S. and globally a proliferation of new companies and products. The flood of finance into new technologies and startups ensures an even greater supply of goods and services (with many tech, cloud and web-based products/services enjoying essentially unlimited supply). The extreme financing backdrop creates aggressive companies flush cash and under no pressure to achieve profitability. It’s great for consumers, but it’s also an unsustainable Bubble that creates escalating risk to a deteriorating financing environment.

Playing a dangerous game, the Fed is now moving from accommodating this Bubble to actively stimulating it – from pushing back against a tightening of financial conditions to pushing forward already extraordinarily loose conditions. I often think these days of Joseph Schumpeter’s “Creative Destruction.” Today’s policy and financing backdrops ensure an extraordinary amount of “creative” along with extraordinarily little “destruction.”

The combination of bountiful new technologies, financial innovation, loose finance, speculative Bubbles and an accommodative central bank are reminiscent of the “Roaring Twenties.” The Federal Reserve in the late-twenties became increasingly concerned with waning consumer prices and worsening global fragilities. The primary focus should have been speculative market Bubbles and egregious financial excess, more generally.

Why are central bankers so fixated on somewhat below-target (an arbitrary target at that) consumer price inflation? Sure, they fear expectations of deflationary conditions could be self-fulfilling. But it goes beyond that. The entire contemporary doctrine of tolerating Credit excess and asset inflation – even directly using both for post-Bubble reflation – rests upon the notion that the consequences of financial excesses (i.e. debt and speculative Bubbles) can be remedied by inflating the general price level.

Excessive debt can always be reduced through inflation – merely inflated away. Excessive asset prices can be at least partially mitigated by inflating consumer prices and corporate earnings.

Understandably, central bankers are terrified at the thought of markets losing confidence in their capacity to manage a steadily inflating consumer price index. A world where central bank reflationary measures are viewed as ineffective is a world with suddenly elevated fear of unsustainable debt levels and asset Bubbles. Deficits do Matter.

Maintaining the pretense of effectively orchestrating higher inflation has become paramount to contemporary central banking doctrine. Central bankers pay lip service to ever widening wealth disparities. They surely recognize their activist reflationary policy measures are a primary contributor. Loose monetary policy fuels robust asset inflation, much to the benefit of the wealthy.

At the same time, average workers with bank deposits receive essentially no return on their savings. Worsening wealth disparities then only work to exacerbate the extreme dispersion of inflationary effects, with more “money” flowing into assets markets relative to the extra purchasing power available to drive aggregate consumer price inflation. Focused on below target CPI – while ignoring assets inflation and Bubbles – monetary stimulus only intensifies inequalities and attendant social and geopolitical tensions.

It’s somewhat difficult for me to believe the Fed will reduce already low rates in the current market environment. Alan Greenspan weighed in.

July 24 – Bloomberg (Alister Bull): “Former Federal Reserve Chairman Alan Greenspan endorsed the idea that the U.S. central bank should be open to an insurance interest-rate cut, to counter risks to the economic outlook, even if the probability of the worst happening was relatively low. ‘Forecasting is very tricky. Certain forecast outcomes have far more negative affects than others,’ he told David Westin in an interview… ‘It pays to act to see if you could fend it off.’”

Whatever happened to William McChesney Martin’s, the job of the Fed is to “take away the punch bowl just as the party gets going.” Or even the imperative for the Federal Reserve to “lean against the wind.” Wednesday the Fed will be spiking the punch – again – after one of the longest parties ever. Instead of “leaning against the wind”, they’ll be Fanning the Flames.

Real estate: post-crisis boom draws to a close

After several years of cheap money and soaring prices, there are growing signs of problems in property markets

Judith Evans in London







When China’s Greenland Group launched its Spire project near Canary Wharf in east London in 2016, it promised the 67-storey residential skyscraper would be “a new iconic landmark on the London skyline”.

The £800m curved glass tower was set to include almost 800 luxury apartments, a 35th-floor spa, a cocktail bar, dancing fountains and lifts that would travel at six metres a second. But after piling works were completed a year ago, the Spire building site fell silent.

The project is undergoing a “review” after “the residential sector in London . . . changed significantly since Spire London was conceived in 2014”, the developer said. The changes in prime London real estate have indeed been stark: prices have since fallen more than 20 per cent.

The developer insists the building will go ahead, though possibly in an altered form. But the stalled site has brought back memories of the financial crisis, when from Ireland to Dubai, half-finished construction projects conceived at the peak were stopped in their tracks by collapsing markets, a lack of funding or insolvent developers.

Property chart

The development is one of many signs that the global real estate boom is drawing to a close after a decade of cheap money that followed the financial crisis. Stores are shutting on New York’s Fifth Avenue as the retail sector suffers in the face of the relentless rise of ecommerce.

In China, a frenzy of real estate speculation has led to millions of empty new-build apartments and to street protests over price drops. Listed real estate securities worldwide are trading at steep discounts to the book value of their assets, a phenomenon that in the past has heralded downturns.

Other parts of the market, such as offices in major cities, have remained healthy. But some respected figures are preparing for a broader fall. Sam Zell, the Chicago-based real estate billionaire known for his sell-off of a $36bn office portfolio on the eve of the financial crisis, has been selling again: he has disposed of almost all the properties within Equity Commonwealth, a $3.9bn real estate investment trust.

That process, he says, has brought home the market shift. “Four and a half years ago, when we put a property on the market, we had 17 bids, and 15 of them were real. Last year when we put one on the market, we had three bidders, and we hoped one was real,” he said. “It’s clear that in the commercial real estate world, no one is clear about what values are.”



Sam Zell, the Chicago-based real estate billionaire, says 'there is too much capital chasing too few opportunities' in the real estate market © Peter Wynn Thompson/FT



Eleven years have passed since the financial meltdown in which real estate played a starring role. Portfolios of toxic residential mortgages paralysed credit markets, while some $40bn of risky commercial real estate exposure helped to bring down Lehman Brothers.

Real estate markets around the world now look very different from those before the crisis. Debt levels are lower, mortgage regulation tighter and speculative building more modest. A huge influx of institutional capital has entered real estate, as quantitative easing bloated markets and narrowed bond yields, forcing investors to look elsewhere for income. With interest rates set to remain lower for longer than was thought likely a year ago — economists expect the US Federal Reserve to actually cut rates this year — that search for yield is set to continue.

But that flow of cash has given rise to fears of a bubble. Real estate prices in global cities have soared to new highs: they are 45 per cent higher than at their previous peak in 2007, according to Real Capital Analytics. Yet vast sums are still pushing into the sector. Closed-ended real estate funds had raised a record $342bn of still-undeployed capital worldwide at the beginning of April, according to data from Preqin, of which $62bn was committed to debt funds — also a record. 


Glass empty: work on the Spire, a 67-storey luxury block near Canary Wharf, London has stalled © Charlie Bibby/FT




Glass full: Billionaires’ Row, the set of ultra-luxury residential skyscrapers in Manhattan © Cynthia Van Elk/FT


“The real estate market has been ahead of itself. It’s been very much impacted by the fact that there is too much liquidity . . . There is too much capital chasing too few opportunities,” says Mr Zell.

Few observers believe the market faces an immediate crash. Chad Tredway, co-head of real estate banking in JPMorgan Chase’s commercial bank, says: “Everyone has been calling for a correction since 2014 or 2015 but nothing has really happened . . . I’m not feeling like from a pricing standpoint there are flashing red lights. I would tell you there definitely are yellow lights.”

But institutions’ exposure to real estate is on regulators’ radar. In its first financial stability report in November last year, the US Federal Reserve raised high commercial real estate prices as a key vulnerability.

Property chart


“We are in the more mature part of this cycle, particularly in the US, and pricing is high in many places,” says Lauren Hochfelder Silverman, managing director in Morgan Stanley’s real estate investment division. “We are finding interesting things to do but we are very disciplined and selective. We are very focused on downside protection.”

Mr Zell is one of a class of self-made real estate investors who drove much of the industry in the second half of the 20th and early 21st centuries. But they are becoming a rare breed. Property markets once dominated by maverick individuals are now home to trillions in pension and insurance capital, often managed by investment groups such as Blackstone and Brookfield. In 2007, Blackstone had real estate assets under management of $19.5bn; now it has more than seven times that.

The inexorable rise of economies in Asia, meanwhile, has meant that sovereign wealth funds, pension funds and insurers from China, Singapore and elsewhere have been equally hungry for global real estate assets, snapping up huge portfolios such as Blackstone’s Logicor warehouse group, bought for €12.25bn by China Investment Corporation in 2017.

The Spire project was part of a surge of Chinese investment into western cities. At $90bn, global cross-border real estate investment from Asia exceeded that originating from North America or Europe for the first time in 2017, according to property agency Knight Frank. “The world has become smaller. It used to be much more parochial in terms of where people would invest equity and deploy debt,” says Jim McCaffrey, managing director at Eastdil, a US-based real estate investment bank.

Property chart


Doug Harmon, chairman of capital markets at UK property agency Cushman & Wakefield, says the “institutionalisation” of real estate means that “the game has changed”. He adds: “It has become a much more boring, disciplined sector, but the foundations are stronger.”

But the influx of capital has also led to a desperation to deploy it. This has pushed up prices in unlikely corners of the market, from rented homes in Wilmington, Delaware to warehouses in the Czech Republic. Cash has flooded into “alternative” forms of real estate such as student housing, elderly accommodation and healthcare buildings.

Some in the market suggest that investors have used over-optimistic projections of future rental growth to justify paying higher and higher prices. They may not be taking into account more efficient use of office and retail space, which means that even where economic growth is strong, some businesses are shrinking their footprints.

Mike Prew, an analyst at Jefferies in London, says: “Real estate assets have been pricing in a very high, above-trend rental growth rate in many sectors, especially offices.”

One US banker says they are shocked by prices on assets such as Shanghai office buildings, where rental yields — which compress as prices rise — are narrowing to levels similar to those found in London or New York, despite the city’s far younger and more volatile market.

“I’m saying for the first time maybe since before the [crisis], maybe the market is sending me a signal . . . it’s the first time in a while I’ve taken a few steps back and said ‘I’m finding it hard to make sense of this’,” says the banker.




Lord & Taylor's century-old flagship store closes on Fifth Avenue, Manhattan © AP




WeWork and Rhone Capital bought the Lord & Taylor building for $850m © Cynthia Van Elk/FT


When Lord & Taylor’s century-old flagship store on Fifth Avenue was designated a New York landmark in 2007, the city’s landmark preservation commission called it “a recognised innovator in the history of department stores”.

But the store was unable to innovate fast enough for the 21st century. In 2017, Hudson’s Bay, the owner of Lord & Taylor, announced it had agreed a deal to sell the Italian Renaissance-style building to the serviced office provider WeWork and its investment partner Rhone Capital for $850m, to help pay off Lord & Taylor’s debt. Instead of selling suits and jewellery, the building will soon be filled with casually-dressed millennials working on sofas, drinking beer and eating vegetarian food.

The largely debt-funded acquisition closed earlier this year, becoming a prime example of how the use of buildings is changing. Jeff DiModica, president of Starwood Property Trust, one of the lenders, called it “a really smart trade on a really beautiful building”.

But there are sceptics — including Mr Zell, who believes WeWork and its rivals are among some sections of the market that have attracted more cash than hard-headed scrutiny. “With the exception of retail there is pretty significant [tenant] demand but there is a question of whether that demand is as good as it looks,” he says. “WeWork would be an example . . . and it has spawned a lot of me-too competitors. They are taking space that previously was occupied by a tenant with credit.”


WeWork, which is working towards a public listing and has been heavily backed by Japan’s SoftBank, has transformed the market for office space by leasing smaller companies, and departments of large ones, fashionably decorated shared space on all-inclusive contracts. But these deals, and those offered by competitors such as Knotel, are short-term, raising questions over the stability of their sites.

In an April report on the impact of flexible offices on commercial mortgage-backed securities, the rating agency Standard & Poor’s said: “Our overall credit view of co-working tenants, all else equal, is negative relative to traditional ones.”

WeWork and its rivals disagree. The company argues that more relationships with big corporates are strengthening its tenant base and a downturn could actually cause more firms to turn to its short-term deals. Advocates of the WeWork model point to shifts taking place across real estate: leases are shortening and tenants becoming more demanding of their landlords.

Still, a reversal of fortunes for the sector could sour sentiment in major office markets like London and Manhattan. In Manhattan, flexible office groups accounted for 18 per cent of new leasing in 2018, according to CBRE.


Property chart


Mr Zell is not the only market player suggesting the capital influx has created bubbles with the potential to burst. Others see risks building in private debt, where lightly regulated and opaque debt funds have partially filled a vacuum left by banks’ post-crisis retreat from real estate lending.

Debt funds are often backed by institutional investors or by credit lines from banks, who do not have to account for such lending as real estate loans. Lending by these funds helped to propel a boom in high-end residential construction, creating what many analysts now describe as an oversupply.

Josh Zegen, co-founder of the US real estate private equity firm Madison Realty Capital, says: “There may be a bubble in credit, and it’s not with the banks, but with the debt funds . . . We are already seeing cracks in the system, with loans not hitting their business plans.”

Matt Borstein, global head of commercial real estate at Deutsche Bank, says debt markets feel “frothy”. “Loan-to-value ratios have been really disciplined but there has been an aggressiveness in loan pricing which seems to know no bounds right now,” he adds.

Some analysts argue that despite market risks, buildings like the Lord & Taylor flagship will hold their value for some time. The past three years have rewarded braver real estate investors: those who prepared for a steep downturn in 2016, when the market slackened, are now falling behind bolder rivals, since no crash materialised.

Yolande Barnes, chair of the Bartlett Real Estate Institute at University College London, says real estate markets are on a “high plateau” but low interest rates may lead to gentler cycles, and lower price inflation, in the future.

Still, Mr Zell continues to reduce his real estate exposure. Equity Commonwealth, for example, was sitting on more than $3bn of cash at the end of March, according to S&P Capital IQ.

“Any day you’re not selling, you’re buying,” Mr Zell says. “And I’ve got to face up to whatever position I take.”

The ECB Needs New Inflation Rules

The European Central Bank has consistently undershot its inflation objective of “close to, but below 2%” for over a decade, potentially threatening its credibility. To maintain credibility, the ECB should adopt a two-pronged strategy focusing on a medium-term inflation target and systematically smoothing financial cycles.

Michael Heise

heise15_GettyImages_eurocoinontwolinegraph


MUNICH – The upcoming change of leadership at the European Central Bank represents an opportunity – if not an obligation – to review the Bank’s policy framework. The ECB can take credit for major achievements during Mario Draghi’s presidency – most importantly, stabilizing the eurozone during the 2007-08 global financial crisis and ending speculation about the possible breakup of the single currency during the sovereign-debt crisis in 2012. But the ECB’s strategy of steering consumer-price inflation has been much less successful.

The ECB’s policies regarding inflation have had some powerful side effects – including increased risk-taking, skewed capital allocation, rising inequality, and growing pension gaps. Yet annual inflation has undershot the bank’s objective of “close to, but below 2%” for over a decade, and has averaged only 1.2% since the financial crisis. To bolster its credibility on inflation in today’s uncertain policymaking environment, the ECB should adjust its rules and adopt a more flexible approach.

The impact of monetary policy on economic activity and inflation has been hotly debated ever since John Maynard Keynes published The General Theory of Employment, Interest and Money in 1936. Although there have always been cracks in the transmission of such policies to the real economy and prices, the financial crisis and its aftermath exposed major ruptures.

Even the ECB’s drastic interest-rate cuts and practically unlimited long-term refinancing operations failed to trigger additional lending for years following the crisis. Banks, companies, and households were in deleveraging mode, repairing their balance sheets and rebuilding savings. As a result, eurozone inflation fell toward zero in 2014 and 2015.

The ECB responded with even more monetary stimulus, and introduced large-scale asset-purchase programs. These measures further depressed eurozone government bond yields and boosted asset prices. But despite the ensuing wealth effects, people did not spend more, owing to persistent policy uncertainties and a realization that near-zero interest rates required them to save more for retirement.

Of course, we cannot know with any certainty how the economy would have performed had ECB policies been less accommodative. But even if we assume that monetary policy did manage to increase capacity utilization and reduce unemployment, the expected higher inflation did not materialize.

The traditional inverse relationship between unemployment and inflation, as posited by the Phillips curve, seems to have broken down or at least become much weaker. Moreover, persistently low inflation – or “lowflation” – is not unique to the eurozone and likely reflects broader economic trends, such as changing wage and price dynamics, owing to the globalization of labor and product markets. Hundreds of millions of Asian and Eastern European workers have joined the global labor force in recent decades, while advances in digital technology and artificial intelligence continue to disrupt existing business models. Economists do not yet fully understand how such trends affect wages and prices, and the ECB’s policy framework should reflect these increased uncertainties.

Early adopters of inflation targets, notably the Bank of New Zealand and the Bank of Canada, have set a range of 1-3% for medium-term inflation. Such an approach seems to make sense for the ECB as well in today’s climate. The Bank could combine a medium-term inflation target with a broader definition that might include core consumer prices (excluding energy), along with its preferred measures of inflationary expectations. ECB policymakers would thus have more flexibility to accept above- or below-target inflation, should conditions warrant (for example, in the event of commodity-price shocks).

Greater flexibility would also help the ECB to accommodate policy trade-offs between inflation and financial stability. Central banks should attempt to smooth the financial cycle by leaning against the wind during booms and loosening policy in periods of volatility and fear. History has repeatedly shown that debt-fueled financial bubbles result in economic and social misery once they burst. While taking away the metaphorical punch bowl while the party is in progress is never popular, there is plenty of evidence that, by preventing nasty debt hangovers, smoothing the financial cycle is conducive to long-term growth. The “Greenspan doctrine” of mopping up after a bubble has burst has fallen out of favor since the global financial crisis eliminated millions of jobs and wiped out billions in savings.

For now, the ECB faces a manageable build-up of financial risks in the eurozone. True, investors’ search for yield is compressing risk premia for corporate bonds, loans, and, to some extent, equities. Real-estate prices have increased significantly, too. But greater risk-taking has not yet been accompanied by a large increase in private debt. Moreover, prices of financial assets have repeatedly been hit by political uncertainties related to trade wars or the risk of a hard Brexit.

Although these developments suggest that the ECB does not urgently need to tighten monetary policy, the bank should be wary of loosening it further in an attempt to raise inflation, which currently stands at 1.7 %. Measures to accelerate credit expansion – via negative interest rates or targeted refinancing operations, for example – would almost certainly lead to new financial-market bubbles in the future. The ECB should thus consider adopting a two-pronged strategy focusing on consumer prices and systematically smoothing financial cycles.

A central bank that consistently misses its inflation target over a long period risks losing credibility, and may feel compelled to adopt aggressive policies and “do whatever it takes” to regain market confidence. To reduce the need for drastic measures, the ECB’s next president should push to replace the bank’s relatively narrow inflation objective with a broader target range.


Michael Heise is Chief Economist of Allianz SE and the author of Emerging From the Euro Debt Crisis: Making the Single Currency Work.

How China Cuts Rates Without Cutting Rates

By Nathaniel Taplin





The Federal Reserve looks almost certain to cut U.S. interest rates on Wednesday. The People’s Bank of China doesn’t need to follow suit to make its own stance looser.

Chinese monetary policy can seem bewildering. The central bank’s huge tool kit spans numerous short- and medium-term lending rates, plus other tools such as banks’ reserve requirements. On top of that, political pressure often forces it to pursue seemingly contradictory goals—like simultaneously controlling leverage and reducing corporate borrowing costs.

The two issues are intertwined: In fact, the array of instruments probably provides some political cover for the bank to act without antagonizing different bureaucratic factions or setting off unwanted, frenzied speculation in markets.

Right now, the economy still needs more help: Producer price inflation is flirting with zero, small banks are struggling, and the labor market is in trouble. But there are also very strong voices within the government calling for a hard line on debt control.


The People's Bank of China’s tool kit spans numerous short- and medium-term lending rates, plus other tools. Photo: Qilai Shen/Bloomberg News


In this situation, a new toy looks particularly useful. After relying heavily on its one-year medium-term lending facility—currently pegged at 3.3%—to fund banks in recent years, the central bank has debuted a new tool. This is dubbed the targeted medium-term lending facility, and has a one-year rate of 3.15%. In theory, only banks that “provide strong support to the real economy” can use the facility, which is meant to boost small- and private-sector lending, but the central bank has discretion. These loans can be rolled over twice to last three years, meaning they are both cheaper and longer-lasting than their predecessors.

Replacing some maturing medium-term loans with funds under the new facility helps lower longer-term borrowing costs without making big headlines, or flooding money markets with liquidity, like cuts to reserve ratios typically do. This is exactly what the PBOC has been doing, most recently on July 23.

News coverage Wednesday will probably focus on whether Beijing’s central bankers will cut their benchmark one-year lending rate—a possible, but unlikely move. The real action is taking place in another compartment of China’s cavernous monetary-policy tool kit.

10 Ways to Lower the Cancer Risk of Grilling

If you plan to grill often experts suggest taking some small steps to make a big difference in lowering your exposure to compounds that are tied to cáncer.

By Sophie Egan




























Credit Michael Graydon & Nikole Herriott for The New York Times



As with most lifestyle choices related to dialing up or down one’s cancer risk, the dose makes the poison. Which means if you’re grilling once or twice a year, don’t sweat it. But if you plan to grill often — once or twice a week throughout the summer, say — experts suggest taking some small steps to make a big difference in lowering your exposure to these compounds.

1. Think outside the burger

Grill fish, seafood, poultry or plant-based foods rather than red meat and especially processed meats like hot dogs; the World Health Organization considers processed meats a carcinogen and red meat a probable carcinogen. While HCAs are still formed while grilling fish and seafood, Ms. Doyle pointed out that you typically don’t have to cook seafood as long as beef and chicken, which reduces the accumulation of the compounds.

2. Marinate first

Research suggests that marinating for at least 30 minutes can reduce the formation of HCAs on meat, poultry and fish. The reason for this is not entirely clear to researchers, but one possibility is a kind of shield effect. “If you put a barrier of basically sugar and oil between the meat and the heat, then that is what becomes seared instead of the meat,” said Nigel Brockton, vice president of research at the American Institute for Cancer Research. It also makes your meat more flavorful.

3. Make produce the star

Many kinds of fruits and vegetables are actually protective as far as cancer risk, and they don’t form HCAs when grilled. Several experts recommend using meat as a condiment. Think of alternating cubes of chicken with peppers and onions or peaches and pineapple on a skewer, for instance. This trick, which also works when pan frying, reduces the surface area of meat exposed to the hot surface, Dr. Brockton explained, since the meat is also touching other ingredients throughout the cooking process.

4. Leverage herbs and spices

According to Dr. Brockton, cooking your meat with herbs, spices, tea, chili peppers and the like — ingredients with phenolic compounds — can be a helpful approach because “it seems they quench the formation of the potentially carcinogenic compounds because of the antioxidant properties of those ingredients.”

5. Be mindful of the smoke itself

Try to minimize how much smoke you’re breathing in, the Harvard T.H. Chan School of Public Health recommends as part of a helpful resource on healthy summer picnic practices.

6. Avoid char

The black, crispy crust that you often see on the bony edges of ribs or steak is more likely to contain a higher concentration of potentially carcinogenic compounds. Ms. Doyle also recommends cleaning the grill grates ahead of time, to remove any previously generated char.

7. Cut time on the grill

“The longer you cook something, the longer the chemical reaction is happening, the higher the amount of HCAs are formed,” Dr. Brockton said. If you partially precook your meat, such as by baking or cooking in the microwave, the layer of HCAs that gets formed won’t be as thick. The same goes for meat cut into smaller pieces, such as with kabobs, because it cooks faster. Grilling in foil can also help protect the food from smoke and speed up the cooking time, according to the Harvard resource on healthy picnics.

8. Select hardwoods instead of soft woods

“Types of wood can influence HCA formation,” Ms. Doyle said. “Hardwoods, such as hickory and maple, and charcoal all burn at lower temperatures than soft woods, such as pine. Cooking with wood that burns at a lower temperature is desirable.”

9. Reduce fuel for the fire

To minimize your exposure to polycyclic aromatic hydrocarbons, experts recommend selecting leaner cuts of meat or trimming any visible fat, which can lower the amount that drips down through the grates and comes back up in the smoke. To minimize dripping, Ms. Doyle suggests not piercing your meats while they’re on the grill.

10. Flip often

According to guidance from the National Cancer Institute, fewer HCAs are formed if you turn meat over frequently while cooking it on high heat.


Sophie Egan is the author of the book “Devoured: How What We Eat Defines Who We Are.” Based in San Francisco, she has written about food and health for Time, The Wall Street Journal, Bon Appétit, WIRED, Forbes and more. @SophieEganM

Can Facebook’s Libra Avoid Regulators? History Suggests Not

Facebook’s cryptocurrency looks a lot like a money-market fund, a vehicle that has come under intensifying scrutiny from regulators

By Jon Sindreu

The history lesson for Facebook is that just a few impediments to the redemption of a cash-like instrument are enough to stop many people from using it. Photo: Andre M. Chang/Zuma Press 



For all its crypto styling, Facebook ’s FB 1.13%▲ Libra looks less like bitcoin and more like a 50-year-old type of investment fund that has attracted intense regulatory scrutiny since the 2008 financial crisis. Investors should be skeptical of claims it can escape the same kind of attention.

This is a familiar question raised by sharing-economy disrupters like ride-service firm Uber and hospitality platform Airbnb. How much of what they offer is a new source of value? Or are they just jumping—temporarily—ahead of outdated laws? Libra seems, in large part, a case of the latter.

The so-called currency isn’t really like bitcoin, which allows everyone to record and validate transactions. With Libra, Facebook will—at least for now—decide which organizations get to do that. Also, Libra’s value won’t fluctuate wildly because it will be backed by a multicurrency fund of liquid assets, allowing holders to get actual money back.
The setup looks very similar to the money-market funds that many companies and investors have used to manage their cash since the early 1970s. On top of traditionally fixing the value of their shares at $1 to give them the appearance of actual cash, these funds invest clients’ money in very short-term debt that can easily be redeemed, but still provides some extra return.

With Libra, Facebook will be earning all of that income. Users of the digital currency benefit only from the ease of transfer. The company believes it could be popular in countries where access to banks remains difficult. This week, however, regulators in Japan joined those in the U.S. and the U.K. in expressing concerns about Libra.

Money-market funds only managed to fly under the radar for so long.

In the run-up to 2008, they became an integral part of the shadow-banking system, loading up on paper that was ultimately backed by subprime mortgages. When the value of that paper was called into question and clients started demanding their money, the $1 value per share couldn’t be sustained.

French bank BNP Paribaswas the first to freeze redemptions in its money-market funds in 2007. In 2008, the behemoth Reserve Primary Fund became the first retail money-market fund to admit its assets were worth less than $1 a share. Short-term funding collapsed across the global financial system.

Or take China, where online money has long been extremely popular. Libra seems to have drawn some inspiration from Ant Financial, which runs the payments platform Alipay—akin to PayPal .Users can store money in an online vehicle that has become the world’s biggest money-market fund. When officials started to panic about its systemic importance, the fund tried to control its size through investment caps.

In the U.S. and Europe, regulators have spent a decade tightening the screws on such funds.

Many can no longer fix their shares at $1 and have to impose gates and fees in times of turmoil.

Right before the new rules came into effect in 2016, $1 trillion rushed out of standard “prime” funds and into those that invest only in government debt, which remain more lightly regulated.

The history lesson for Facebook is that just a few impediments to the redemption of a cash-like instrument are enough to stop many people from using it. A related takeaway is that regulators will eventually come up with such impediments when large amounts of money are involved.

And that doesn’t even cover other potential regulatory pitfalls, like anti money-laundering protocols.

If consumers find a use for Libra—which remains to be seen—Facebook will need to grapple with many new problems. Investors shouldn’t be fooled by temporary regulatory loopholes.

Want a Job in the Future? Be a Student for Life

Infosys president Ravi Kumar discusses the future of work in the digital age.



New digital technologies are expected to take away many jobs. They will also create several new ones. However, to grasp these new opportunities, everyone must continuously learn new skills. “We will now have to move to a continuum of lifelong learning, which essentially means we have to be lifelong learners,” says Ravi Kumar, president at Infosys, the digital services firm.

Kumar sees two big shifts on the jobs front. The first, he says, will be from repetitive tasks to non-repetitive tasks. And the second will be from problem-solving to problem-finding. In a conversation with Knowledge@Wharton in the company’s New York City offices, Kumar discusses how the emerging world of technology will shape the jobs of the future and what it means for individuals, industries and countries.

An edited transcript of the conversation follows.



Knowledge@Wharton: At a recent conference, you said that 75 million old jobs will go away by 2022, and 135 million new jobs will be created because of new technologies. How will the jobs of the future be different from the jobs that are being eliminated? What are the main factors driving this change?

Ravi Kumar: Every large enterprise and every large government ecosystem is thinking about this – about automation, AI, machine learning and new age digital technologies taking away jobs of the past and creating jobs for the future. That has happened in most tech revolutions of the past. But the sheer scale and accelerated pace of this, sets it apart. It’s a tectonic shift in the way businesses and operating models have evolved in the last few years.

I think there will be two big shifts. First, a lot of repetitive tasks at the workplace will be automated with machines and AI. When that happens, humans will do the cognitive, non-repetitive tasks. Humans have to start looking at using machines as a way to amplify their own abilities. This shift from repetitive to non-repetitive tasks is a big one.

Second — and this fascinates me – institutions and enterprises will move from a people-only workplace to a people-plus-machine workplace. If I extend that thought, they will move to people-plus-gig-plus-machines. Machines will do the problem solving. The gig economy will bring variability and agility to our workforce, along with scale. And the private human capital we now have – scaled with public human capital made accessible to us in the gig economy — will switch to the creative job of problem-finding. So, one shift will be from repetitive tasks to non-repetitive tasks. And the second shift will be from problem-solving to problem-finding. Human beings will transition to creative jobs.

Knowledge@Wharton: What are some of the opportunities and challenges in implementing this vision that you just described?

Kumar: The fundamental shift that must be made is to lifelong learning. All of us — when we were growing up — made a linear progression from learning at schools to working. We will now have to move to a continuum of lifelong learning, which means we have to be lifelong learners. You have to learn to learn, learn to unlearn, and learn to re-learn. For an individual to imbibe that culture of being on that learning curve for a lifetime is a big switch.
The second aspect is about nurturing curiosity and learning problem-finding. The lines between industries are being blurred and therefore one has to start thinking in a more diverse and cross-functional way. In fact, even when it comes to gaining expertise in a particular discipline, just that alone won’t work anymore. In the digital age, applying technologies to businesses will be a more valued virtue than learning the technology itself. On one side of the spectrum, we need deep programmers. On the other side, we need individuals who can contextualize that skill to a specific business and apply it meaningfully, which means we need people who can find problems, and then apply technology to solve those problems across businesses. That means one needs a much more diverse workforce coming from liberal arts, coming from design, coming from humanities, coming from anthropology and disciplines of almost every kind. That’s a big shift from the previous era where the tech revolution embraced only technologists. In fact, technologists, seem to have created the ‘digital divide.’ We have the opportunity to bridge that divide today.

Knowledge@Wharton: Which industries do you think are best prepared for this shift? And which countries are best prepared for these changes in the future of work and jobs?

Kumar: Industries with a legacy of adopting core technologies or traditional technologies often find it much more difficult to repurpose themselves for the digital future. This is because they have their legacy to deal with. An industry that did not deeply adopt traditional technologies can now leapfrog and get ahead of the curve.
Another way of seeing this is that industry lines are blurring. Every time I meet CXOs from across enterprises, I see they are not worried about peers from their own industry. It’s what other industries are doing that gives them sleepless nights, because they don’t know which other industry will spawn their next competition. If I meet a CXO of a bank, most times I hear, “Tell us what you are doing with retail clients. We want to know about them.” It’s the same with other industries.

Regarding countries, emerging economies like India and China — which were far slower than their Western counterparts in traditional technology adoption — are leapfrogging and creating digital platforms that are distinctly superior. It’s easier for them because they do not have as many legacy systems and legacy processes to deal with. The Western world, in contrast, must tackle the challenge of repurposing legacy capital and legacy skills for their digital future. Emerging economies, on the other hand, can leapfrog into a completely new digital paradigm without having to bear the baggage of legacy.

An intriguing question is who’ll win the race? For instance, China, traditionally has provided labor arbitrage to create massive manufacturing ecosystems. Today, advancing technology has brought us to an inflection point where automation can take away that leverage of labor arbitrage. Human labor on the manufacturing shop floor is clearly on the decline. This could well make developed nations, which now find little labor advantage in the developing world, bring their manufacturing back home. This is a complicated paradox for economies to deal with.

Knowledge@Wharton: Do you see the model that you described earlier of people plus machines plus gig economy playing out in China? And how is it different from the way it plays out, say, in a place like the U.S.?
Kumar: If you look at the density of robots on a shop floor, China doesn’t rank number one. Korea ranks higher. So does Taiwan.

Knowledge@Wharton: You mean in the manufacturing space?

Kumar: Yes, in the manufacturing space. Germany is doing pretty well. In fact, a lot of manufacturing is going back home [to the developed countries]. So China really has to rethink their game plan. This just brings home the lesson that being an incumbent is not necessarily a competitive advantage in an era where every day brings with it the opportunity to imagine and build a completely new operating model.

Knowledge@Wharton: As you look to the future of work in a sector like banking and financial services, what kinds of jobs do you think are likely to go away, and what kinds of new jobs will come into being as a result of these technology shifts?

Kumar: The traditional way of banking – going to a bank to complete a transaction — has all but vanished as banks now come to us (on an app) so we might get our work done. This is true in almost every country in the world. In fact, in the emerging markets, financial transactions – both in volume and scope – are executed digitally to a greater extent than in the developed nations. This has taken the whole banking revolution into a new orbit. In underdeveloped nations, the unbanked population — a significant segment — accesses banking services through the mobile phone. Nearly all of Africa, for example, banks on the mobile phone and mobile service providers are emerging as the ‘new bankers.’ Clearly, the lines between industries are blurring, which means practically any entity with imagination and initiative has a chance to be the bank of the future in these nations.

Knowledge@Wharton: How will jobs of the future need to balance between technical skills on the one hand and emotional and social skills on the other? What are some of the implications for blue-collar and white-collar work?

Kumar: That’s a fascinating question. Yes, technologies of the future are going to change the paradigm of workforces and workplaces and we will need deep programming skills to build these technologies. And yet that alone will not be enough. I think the skills that will be valued even more are the abilities we must develop to find the pressing problems of business and society and then find ways to apply these technologies to solve those problems. This will need an emotional quotient and an empathy quotient to use technology to make our lives better. Finally, that’s what technology is all about. It has to make lives better.

And for that to happen, my sense is that we will have to move from having only deep programming skills and nurturing only STEM talent to bringing to the mix skills from liberal arts, design, humanities and other backgrounds that are completely removed from the world of STEM. This did not happen before when the first waves of the technology revolution hit us. It is happening in the digital age, when diverse technologies are being embraced across industries. Now the emotional and the human aspect of technology will shine through.
I also believe that we are going to shift from nurturing T skills to developing Z skills. T skills means specializing in one area of expertise, along with a broad embrace of other disciplines.

This is typically advocated by our educational ecosystems. But we are going to have to move to building Z skills, which means one learns, unlearns and re-learns continuously. I call it the “anti-disciplinary” approach to education because there isn’t any one discipline that one is required to master. So, in this construct, the technology is important, but a bigger virtue is the ability to apply it in a human and empathetic way to solve a business problem. That’s the future.

Knowledge@Wharton: As you think about the future of work, what are some of the biggest risks that keep you up at night? What do you hear from the people you talk to in different companies and different industries? What are they most worried about? What can be done about those risks?

Kumar: Across the world, everybody now recognizes that reskilling is very important.

Repurposing talent is very important. But everybody is talking about reskilling for white-collar jobs. What happens to those working blue-collar jobs? What happens to the factory worker?

The technician? The bartender? In the past, there was this distinctive difference between blue- and white-collar jobs, and the clearly different skills these jobs demanded.

But the embrace of digital is so overarching and so pervasive today that we need to start thinking about reskilling for these blue-collar jobs as well. That line between white-collar and blue-collar jobs is blurring, creating ‘new-collar jobs.’ Very little reskilling infrastructure has been established for blue-collar jobs or jobs in the future. That’s a big risk and an uphill task, because so many of our people are not reskilled and not ready for the future. In fact, our own initiative in community colleges is a phenomenal example of how we are trying to remedy that.

The second aspect, of this reskilling is: Who owns it? Is it the employee or the enterprise, the government or the academic institutions? Governments are wired to invest in the first 15 to 20 years of citizens’ lives, and then once again in the last 20 years of citizens’ lives. But all the change happens in the middle. All the reskilling is needed in the middle. So how do governments re-architect their own infrastructure to deal with the middle? And how do educational ecosystems gear up to create lifelong learners? These are the things I would lose sleep on.

Knowledge@Wharton: What is Infosys doing to try to mitigate some of these risks?
Kumar: In our own small way, we are making an impact on all of these three areas. We have a learning platform called Wingspan that helps enterprises curate learning for their employees – including blue-collar workers. In fact, we leverage Wingspan for the learning transformation of our own employees.

We are also very actively pursuing collaboratively working with governments. Our hiring from schools in the U.S., for our six digital centers, is in partnership with state governments and local academic institutions to create net new future talent, which doesn’t already exist in the market.

When it comes to creating lifelong learners, we have the Infosys Foundation in the U.S. This is among the top three foundations for computer science education in K-12 schools. Our endeavor is to teach teachers so that they are, in turn, equipped to teach students. We also teach students of course. And we are doing this on a massive scale.

Knowledge@Wharton: What advice would you give to young people who are just about to enter the workforce? What can they do today so that they can have a meaningful career over the next 30 to 40 years?

Kumar: Being a lifelong learner is probably the most valued attribute in these times of digital.
At present, you complete your higher education, you start on a job, and you think you are done with learning. I think you need to change that in favor of nurturing the mindset of being a lifelong learner, because what you learn today will become obsolete in a few months or a year. And yet, you should be prepared to continue to grow on your career path. The only way to do this is to be on this constant learning journey. If you want to stay relevant, you have to be on top of all that’s new around you, all the change around you, and act accordingly.


The 2 Loops

by: The Heisenberg

 
 
Summary
 
- The ongoing global manufacturing slump continues to argue for Fed cuts and central bank easing despite the trade truce.

- As rate cut bets remain "sticky", one bank worries about a "perverse feedback loop."

- Meanwhile, another bank warns that the Fed may be stuck in a "hall of mirrors."

- The intersection of those two self-feeding dynamics is perilous, but fortunately, two of the three circuit breakers entail relatively benign market outcomes.


On the heels of the Osaka trade truce struck between Donald Trump and Xi Jinping over the weekend, investors got the relief rally they were looking for on Monday. Gains were especially pronounced in tech and chip stocks, which surged thanks to the Trump administration's softer approach to the Huawei ban.
 
Despite ostensible progress on trade, the narrative around the Fed (and central banks more generally) has not changed. If anything, the case for further monetary accommodation has grown in light of abysmal PMI data out Monday. Although manufacturing gauges held up ok in the US, the global picture was dark indeed, both in Asia and in Europe. As Bloomberg put it, the global manufacturing slump is a "reality check" for investors hanging their hats on trade progress.
 
Of course, existing tariffs on China remain in place and the "deal" between Trump and Xi included no timeline for lifting them. Throw in the USTR proposing tariffs on another $4 billion in European goods, and one is left to ponder whether the outlook has changed. Even if it has, the latest global PMI data underscores the notion that some of the damage from the trade war is already done.
 
All of this argues for dovish central banks and, indeed, the RBA cut rates for a second consecutive meeting on Tuesday. Although the statement suggested the Board will remain on hold going forward, Philip Lowe was quick to reiterate (in a subsequent speech), that the door for more cuts remains open.
 
News that the ECB isn't "in a rush" to cut rates this month hardly changes anything (another easing package is coming, perhaps in September) and Christine Lagarde's nomination to succeed Mario Draghi is probably a dovish development.

In light of still rampant expectations for central bank easing amid what is likely to remain an extremely fragile economic backdrop, I wanted to briefly draw readers' attention to a pair of self-referential dynamics or feedback loops, as it were.
 
Regular readers know I like to talk about self-fulfilling market prophecies, and while these types of posts have a tendency to run long, I'll make this one relatively short.
 
The first loop is between Fed policy, the economy, stocks and the trade war. This is something I've discussed in these pages before and written voluminously about on my own site. But, in a note dated Sunday, BofA captured it more concisely than I have in the past (which isn't hard to do considering my affection for verbosity).
 
Specifically, the bank warns that "the biggest risk going forward" (and those are their words, not mine) is that a "perverse feedback loop" develops between the Fed's efforts to buoy markets and the economy and the Trump administration's penchant for thinking about economic gains and stock market rallies as opportunities to "play with the house's money," so to speak.
 
The worry is that Trump is only deterred from tariffs when the economy looks set to roll over or when US equities are falling. Because Fed cuts are designed to deal with both of those issues (the former explicitly and the latter implicitly), successful monetary policy interventions that support the economy and bolster equity prices will tempt Trump to reengage on the trade war.
 
This could lead to a "collar" on the market.
 
Here's BofA to explain:

" In particular, suppose (1) the Fed is following a “risk management” approach, in which it tries to raise inflation by sustaining above-trend growth, and avoids disappointing the stock and bond markets, and (2) the Trump Administration only stops escalating the trade war if there are notable signs of pain in the economy or markets. If this “Powell Put” and “Trump Call” are strong enough, they could create an ever-escalating trade war matched by an ever lower funds rate. The stock market would be left in a range-bound “collar” trade, with its upside and downside capped by the trade war and the Fed, respectively. "



That is something investors should take seriously now that the Fed is set to start cutting rates.
 
Remember, the turning point for stocks following the May selloff came when Trump threatened tariffs on Mexico, prompting STIR traders to aggressively double down on Fed cut bets. Once market expectations for cuts went into hyperdrive, equities rebounded on the assumption that the Fed would be loath to disappoint market expectations.
 
I usually use eurodollar calendar spreads to illustrate this, but a reader on this platform
suggested that might not be the best way to communicate the point to readers, so instead I'll just use a simpler chart with 2-year yields and daily gains/losses on the S&P:

(Heisenberg)
 
 
See that dramatic plunge in the short rate that played out in the wake of the Mexico tariff threat?
 
That's a rough proxy for the market pricing in Fed cuts. Subsequently, stocks surged on the way to a blockbuster June.
 
Now, you could argue that the decision to call off the Mexico tariffs and, later, the truce with Xi, is evidence that Trump is moving forward with the "crazy like a fox" strategy, which entails striking trade deals and generally deescalating the tariff tension once the Fed has pre-committed to rate cuts.
 
The idea would be to pile a final trade relief rally atop Fed cuts in a bid to supercharge the market. I outlined that thesis in a post for this platform last month and, indeed, BofA includes it as one of three possible outcomes that could break the loop illustrated in the figure from the bank shown above.
 
But it's not likely Trump is there yet. That is, he doubtlessly realizes that striking a deal "too" quickly would, at the very least, prompt the seven Fed officials who, as of the June FOMC, saw 50bp worth of cuts as appropriate, to reconsider. The administration is still acutely focused on this issue. Trump brought up the Fed again in remarks delivered in South Korea on Sunday and on Tuesday, during an interview with CNBC, Peter Navarro cited Fed cuts as one of two things that "needs to happen to get the Dow to 30,000 or above."
The read-through is that the administration will likely keep trade tensions simmering just enough to ensure the Fed is vigilant and does in fact start to follow through on rate cuts. If the USTR's Monday evening proposal to add additional products to the list of EU goods subject to proposed tariffs is any indication, a standoff with Europe is likely even if the China dispute is resolved (and remember, the Monday evening jab at Europe relates to Airbus subsidies - the prospective auto tariffs are another issue entirely).
 
If the Fed starts to cut rates and that puts a floor under the US economy and stocks, Trump may well turn up the heat on China, Europe or both. That would put us squarely in BofA's "perverse feedback loop."
 
That's a perfect segue into the second self-fulfilling dynamic I promised to cover. If you recall, one of the main reasons the Fed had to be sure to deliver on dovish expectations for the June FOMC meeting was down to how crowded a variety of front-end trades (i.e., rate cut bets) had become. Similar crowding has taken place in duration, with US Treasurys seen as the most crowded trade on the planet in the most recent edition of BofA's Global Fund Manager survey. When market positioning gets that one-sided in rates, disappointing those expectations risks a disorderly unwind.
 
Contrary to simplistic "analysis" from those who might not understand how things work, it is not as simple as the Fed pushing back against "spoiled" markets. If you're the Fed and you're staring at lopsided positioning, leaning too hawkish in the face of that and knowingly triggering an unwind could easily lead to a tantrum-like scenario that tightens financial conditions via higher rates, a stronger dollar, a stock selloff and, with a lag, wider credit spreads. If that state of affairs persists for too long, it can dent business sentiment and even consumer spending in the event it carries on long enough for the "wealth effect" to go into reverse.
 
That's how market pricing "traps" the Fed. On Monday, Goldman was out with a kind of pseudo-lament for this "hall of mirrors" effect (the "hall of mirrors" is a nod to a quote from Bernanke).
 
Consider this excerpt:
To see what could go wrong if policymakers simply follow market pricing, imagine that the bond market begins to price a 25bp decline in interest rates and the Fed, interpreting this as a signal that the growth and inflation outlooks have deteriorated, responds with a 25bp cut. A positive feedback loop could ensue in either of two ways. First, the bond market might immediately price a higher probability of subsequent cuts, reflecting the assumption grounded in past experience that there is momentum in monetary policy decisions—the probability of cutting, for example, is higher conditional on having cut last time. As our interest rate strategist note, even when rate cuts appear fully priced, delivering them tends to lead to precisely this reinforcement. Quantitatively, these effects are large enough to tip market expectations toward expecting that the next 25bp move is more likely than not, an expectation that could be self-fulfilling if the Fed took it again as a signal about the outlook that it ought to respond to. Second, the bond market might interpret the cut as evidence that the Fed is worried about the growth outlook. If market participants view the Fed as having private information about the economy—either via privileged insights into the financial system or simply via better economic research—they might grow more pessimistic themselves.
 
 
Obviously, escalations on the trade front have the potential to prompt the bond market to price in worsening growth outcomes. If the Fed takes its cues from the bond market, triggering the positive feedback loop in Goldman's exhibit, the two self-fulfilling dynamics (that described by BofA and that illustrated by Goldman) can become entangled with one another.

Crucially, this is not merely an academic exercise or some kind of brain teaser. Rather, this is already happening and these loops will likely start spinning faster as the Fed actually begins to cut rates.
 
There are three ways out of this (call them circuit breakers) if you assume the Fed isn't likely to stop responding to what the bond market is "saying".
 
First, Trump could decide (say, in December) that two or three rate cuts is enough and that it's time to call an end to the trade disputes just as the calendar flips to an election year. The hope would be that between 75bps of Fed cuts and a deescalation of trade tensions, both the US economy and equities would be poised to soar in 2020.
 
Second, Trump could overestimate the power of the Fed to offset the potentially deleterious effects of the tariffs on the way to escalating things to the point where no amount of rate cuts are enough to rescue the economy and shore up market sentiment. At that point, the economy could fall into a recession, causing stocks to decline enough to convince Trump that the trade war is no longer worth it - at least not until the election is in the rearview.
 
Third, the tariff effects could show up in consumer prices and/or exert just enough of a drag on growth that public opposition to the trade war mounts, compelling the administration to back off before a recession actually materializes.
 
Obviously, the ideal scenario is some combination of circuit breaker number one and number three.
 
Two is no good for anyone - including and especially President Trump.