How Hong Kong Can Save Itself

Maintaining the city’s position as a global financial powerhouse requires a resolution to the political stalemate and an economic overhaul

By Nathaniel Taplin


Hong Kong is the most free economy in the world—in theory. In reality, most residents struggle to get by, and have little say in their political or economic future. Photo: isaac lawrence/Agence France-Presse/Getty Images 


Hong Kong is in the midst of its worst political violence since the semiautonomous city’s handover to China in 1997. Defusing the crisis—and maintaining its status as a global financial powerhouse and conduit for capital into China—requires urgent action not only on grievances including police accountability and stalled electoral reforms but also on deep, festering problems with the city’s economic model.

That means curbing the power of Hong Kong’s property tycoons and monopolies, finding a government-revenue model that doesn’t depend on sky-high property prices, and spending far more state resources immediately on public housing and public assistance. By some measures, Hong Kong is already among the most unequal societies in the world.



Most of Hong Kong’s most urgent economic problems relate to land. Median income growth has been modest over the past decade, but residential property prices nearly doubled in real terms from 2010 to 2018, according to the Bank for International Settlements. That far outpaces increases even in other notoriously bubbly markets such as Canada, where prices are up about 40%. Hong Kongers live in tinier apartments and pay more for them than nearly anywhere else.

Part of the issue is Hong Kong’s hilly geography, which means new space for building is limited. But an arguably much bigger problem is the vested interests of the government and big property developers in keeping prices high.

Hong Kong’s low tax rate and big fiscal surplus—the government over the past three years earned on average close to 20% more than it spent—is in fact funded largely by government land sales, which were 27% of total revenues in fiscal year 2017/2018. To make matters worse, the proceeds of land sales go into the Capital Works Reserve Fund, which is slated for infrastructure development. Hong Kong already has exemplary infrastructure. Residents watch in frustration as the authorities splurge on Beijing-backed political white-elephant projects like the multibillion-dollar sea bridge to Macau and high-speed rail link to Shenzhen, all while they can’t afford basic housing.



High property prices also make it hard to start small businesses—particularly since antimonopoly enforcement is already weak. Hong Kong, unlike most of its global peers, didn’t even have a comprehensive competition law in substantive effect until 2015. That has enabled property tycoons to fortify their empires with near-monopolies in areas such as utilities, transport and grocery stores, raising prices and stifling growth.

The government’s main solution to exorbitant property prices is the Lantau Tomorrow Vision, a proposed land-reclamation project near the territory’s largest island with an estimated cost of about $80 billion. New apartments, however, wouldn’t be available until the early 2030s—meaning a whole generation of young people could essentially remain priced out of the market even if the plan works. Critics say land supply could be boosted much more rapidly and cheaply by redeveloping existing brownfield commercial and agricultural sites as housing.

Mainland China’s political model works to the extent it does because citizens sacrifice a direct say in their future with the understanding that things will continue to improve. Denying people a say while simultaneously offering no real hope that things can improve is a far tougher sell.


US yield curve sends strongest recession warning since 2007

Bond market indicator worsens as questions swirl about Federal Reserve’s next move

Colby Smith in New York and Brendan Greeley in Washington


© AFP


A widely watched bond market indicator sent its strongest recession warning in more than a decade on Wednesday, as the global growth outlook dimmed and questions swirled about the Federal Reserve’s commitment to cut interest rates in light of rising US-China trade tensions.

The yield on three-month US Treasury traded as much as 41.23 basis points above that on the benchmark 10-year government bond — the widest gap since March 2007. Such an inversion of the yield curve — in which short-term yields are higher than longer-term ones — has preceded every recession of the last half century.

The difference narrowed by about 10bp later in the day as US stock prices gained ground and a government bond market rally lost steam, but the persistence of the yield curve inversion underscored the anxieties in global financial markets.

Analysts said fears about global growth were exacerbated by interest rate cuts by New Zealand, India and Thailand, a dismal industrial production report in Germany and the growing likelihood that the UK will leave the EU without a deal in October.

“The next recession couldn’t have been better telegraphed,” said Mark Holman at TwentyFour Asset Management. “There is a trade war between the two global superpowers with both sides digging in their heels and the clock is ticking towards a hard Brexit, so it really does make sense to take risk off the table.”

Michael de Pass, the global head of US Treasury trading at Citadel Securities, said the deeper inversion of the yield curve traced back to concerns the Fed is moving too slowly to lower rates.





“The message that the market appears to be sending is that the Fed is behind the curve and is at risk of a policy error,” he said. “It is too early to say whether it actually is behind the curve but that line of thinking has certainly been a key driver of price action over the last few sessions.”

Comments by James Bullard, St Louis Fed president, on Tuesday, deepened these concerns, according to John Briggs, the head of strategy for the Americas at NatWest Markets. At an event for the National Economic Club in Washington, Mr Bullard said it was unrealistic to expect the Fed to react to trade rhetoric.

“If you tried to respond every time there’s a threat or counter-threat in a tit-for-tat trade war, you would destabilise monetary policy,” he said.

Mr Bullard said the Fed had already responded in July to what he called “trade uncertainty.” July’s rate cut, he said, was “insurance” against what was not known about the trade situation.

Chicago Fed President Charles Evans toed a more dovish line on Wednesday, signalling to Reuters his support for further rate cuts given that inflation remains persistently below the Fed’s 2 per cent target.

But investors are still worried that the Fed will deliver when it comes to easing monetary policy in line with market expectations.

“Until we get some sort of indication that the Fed is open to additional action, the yield curve will continue to invert,” Mr Briggs said.

Traders are pricing in a more than 60 per cent chance the Fed slashes its benchmark interest rate by 25bp in September, with nearly 40 per cent betting on a more aggressive 50bp cut.


Powell, Tariffs And Trump: A Friday Tragicomedy

by: The Heisenberg


Summary
 
- On Friday morning, China retaliated against forthcoming tariffs from the Trump administration, throwing equities and risk assets for a loop.

- Jerome Powell's Jackson Hole speech was acceptable, and briefly stabilized things.

- Then, President Trump weighed in on Twitter, chancing a conflagration in "tinderbox" markets.



Here's a quick take, including a brief recap of why this is a dangerous setup.
 
On Thursday afternoon, in a somewhat cautious post for this platform, I gently suggested that one of the major risks headed into Jerome Powell's closely-watched speech at Jackson Hole was that the Fed Chair wouldn't come across as dovish enough to satisfy President Trump, setting the stage for a scenario in which the White House refuses to accept the implicit pushback, instead opting to escalate the trade war further in a bid to test Powell's mettle.
 
As I write these lines, we're still hours away from the closing bell on Wall Street, but it's been an eventful day. China announced retaliatory tariffs on $75 billion in US goods, including new 5% levies on soybeans and oil from September 1, and the reinstatement of 25% duties on autos starting on December 15.
 
That news sent equity futures tumbling, but fortunately, Powell's Jackson Hole speech was replete with references to the darkening global growth outlook and allusions to geopolitical turmoil. He specifically mentioned weakness in the data out of China and the worsening situation in Germany, and he checked all the boxes when it comes to letting the market know he's apprised of the potential for political frictions to boil over, with negative ramifications for investors. To wit, from the speech:
We have seen further evidence of a global slowdown, notably in Germany and China. Geopolitical events have been much in the news, including the growing possibility of a hard Brexit, rising tensions in Hong Kong, and the dissolution of the Italian government.

Crucially, Powell said the Fed's "assessment of the implications of these developments" will inform the effort to sustain the expansion. Although not overtly "dovish", per se, that was most assuredly a sign that the Fed will assign a heavier weight than they otherwise might to international developments when deciding how best to ensure that the longest US expansion on record gets even longer.
US equities (and risk assets in general) recovered most of their morning swoon as traders digested Powell's remarks.
 
And then the president started tweeting. I don't think I have to quote directly from Trump's tweets (nor do I want to), but suffice to say he took his irritation with China's retaliatory measures out on Powell, who he explicitly called an "enemy" on par with "Chairman Xi". The President also said he would "respond" soon to China's retaliatory tariffs.
 
Irrespective of what form that response ends up taking, the fact of the matter is that Powell delivered what could reasonably be expected of him, especially in light of the hawkish setup from regional Fed presidents as discussed in the linked post above.

That is, there was every indication that Powell's remarks in Jackson Hole would lean overtly hawkish, betraying a desire for the Fed to stick to the "mid-cycle adjustment" script, but instead, we got a Fed chair who emphasized the myriad international developments weighing on growth and investor sentiment. That market-friendly lean was reflected in the bounce off the morning lows.
 
Have a look at this chart:
 
  (Heisenberg)
 
 
Powell did his job. He stabilized both equities and the yuan. Trump wanted more, although as I noted elsewhere, it's not entirely clear what the President expected. It's not as though Powell could re-write his speech an hour ahead of the public release and he certainly can't just cut rates from the podium in Wyoming.
 
In any event, that chart says it all, and the only saving grace as of lunchtime on Friday in New York is that the curve bull steepened a bit as the market still seems to think that trade escalations will be enough to force a Fed relent, especially in light of Powell's internationally-focused comments.

The dollar came off pretty sharply as well, and all else equal, that's a positive development for risk assets, but right now it doesn't matter - markets are spooked.
 
Barring a turnaround (which is possible depending on what the President says later), this will be the fourth consecutive week of losses for US equities. The last time that happened was, of course, in May, when Trump's decision to break the Buenos Aires trade truce threw stocks for a loop after Powell engineered a mammoth four-month rally.
 
(Heisenberg)
 
 
Far be it from me to question the White House's trade policies, but I would suggest that the administration is wading into dangerous waters with markets. As Nomura's Charlie McElligott wrote on Friday morning, we'll be dealing with "still-weak post-summer holiday volumes [and] depth of book" along with "tight liquidity and VaR constraints from dealers" for weeks to come. Market depth has dried up in both rates and equities at various intervals in August, exacerbating the price action.
 
Dealers' gamma profile now looks to have flipped negative again (see visual below) and on some models, we're back near de-leveraging levels for some trend-following strats.
 
(Nomura)
 
 
If the White House doesn't exercise some restraint, we good see equities careen through key levels and strikes, triggering systematic flows (both from trend-follower de-leveraging and dealer hedging) into a thin, August market.

At the same time, any further rally in bonds could bring more hedging flow, catalyzing another forced duration grab, which could push long-end yields even lower, sending a further risk-off signal to the market and, if the short-end can't keep up, inverting the 2s10s again, only this time sustainably.
 
This is something of a tragicomedy. China's retaliation was expected and, as alluded to above, Powell's speech in Jackson Hole was generally fine. Friday's drama was wholly unnecessary, and entirely dangerous when markets are, as I described them here a few days ago, a "tinderbox."

Legality is not the problem with parallel currencies

Critics of Italy’s mini-BOT identify the threat in the wrong place

Izabella Kaminska


Claudio Borghi, economics spokesman for Italy's League party. The government wants to use mini-BOTs to help deal with its debt © Getty


For a while now the Italian government has been toying with the idea of introducing mini bills of treasury — so-called mini-BOTs — to help it pay debts to private sector businesses. A parliamentary vote in May which endorsed the proposal helped give the idea further credence.

But there are many who have not taken the idea seriously. This is an error. Some wrongly believe that because the securities would be considered a parallel currency they would be deemed illegal in the eurozone.

This is because European Central Bank members are obliged to hold the euro as legal tender in their respective sovereign states. Thus, the scheme would be impossible to implement unless Italy was prepared to leave the euro. It is rightly assumed that Italy is not prepared to do that.

When asked about the mini-BOT plan, ECB president Mario Draghi did not hold back. He noted: “They are either money and then they are illegal, or they are debt and then that stock goes up.”

But this view overlooks the fact that parallel currencies can circulate without legal tender status. It also fails to acknowledge that parallel currencies have always been with us, and that in most western economies there is no prohibition on settling commercial debts in other forms of mutually agreed securities or assets. Not even in the eurozone.

Legal tender status helps in establishing and popularising a currency, but it is not essential. The system as it stands features a plethora of parallel currencies, none of which are legal tender, but which all seamlessly interact with each other without any legal contradiction.

As the Bank of England points out, cheques, debit cards and contactless payments don’t constitute legal tender. They too are a form of parallel currency.

The reason we have possibly forgotten the extent and breadth of the pre-existing parallel currency network — which features everything from store-issued points, bank money to the eurodollar market — is because in recent years it has been overshadowed by the emergence of cryptocurrencies. These differ from traditional parallel currencies in that they have no overt issuer or guarantor.

But it is this wider context that makes Mr Draghi’s stance on mini-BOTs disingenuous. He should recognise that in being issued by a national treasury and capable of being accepted as payment for taxes, mini-BOTs have a better chance of succeeding as a highly liquid currency than most other rival parallel systems (certainly more so than Facebook’s proposed cryptocurrency, Libra).

As the economist Willem Buiter noted last month in a research note, if mini-BOTs do acquire the property of moneyness, they have the potential to make a real difference by transforming illiquid government liabilities (arrears) into liquid ones. Indeed, once the private sector becomes willing to hold zero interest mini-BOTs, despite there being other risk-free assets with positive interest rates, the market begins to view them as “fiscal money”.

This in turn allows the state to use that liquidity to raise public spending on real goods and services. According to Mr Buiter, in an economy with slack, output and employment could rise leading to an increase in tax receipts.

There are certainly other examples where such fiscal monetary exercises have paid dividends.

Consider the IOUs California began issuing in 2009. These helped to inject enough liquidity to spare the state from bankruptcy. Those IOUs were a form of debt, which also worked like a currency with very positive impact.

Clearly, the eurozone is far more fragile than the dollar system ever was. So the analogy with California is not perfect. Another possible parallel is with the other famous state that used monetary fragmentation to tackle growing imbalances: the Soviet Union.

The original goal there was to create a system that transferred value so seamlessly that money itself would, in theory, no longer be needed. Except, as imbalances built up, the state was forced to issue three different types of money, with varying usability profiles. Unfortunately, the managed nature of these currencies, plus the lack of slack in the system, inhibited growth. A system-wide economic collapse with inflationary consequences followed.

With precedents like that, it is unsurprising that Mr Draghi was inclined to talk down the mini-BOT plan: it could genuinely undermine the euro. The legality question, however, is a distraction — something that Mr Draghi’s successor Christine Lagarde, a former lawyer, will be aware of.


Fed’s Warning: We Can’t Solve Everything

As China tensions mount and President Trump fumes, Fed chairman reminds world of limits to monetary policy

By Justin Lahart



Federal Reserve Chairman Jerome  Powell probably wishes his job was as easy as not talking about the elephant in the room.

Elephants, while large, aren’t vocal critics of Fed policy. One could reasonably talk about the natural rate of unemployment while a staffer quietly handed the elephant peanuts.

But the Fed chairman has to contend with PresidentTrump,who has been berating the central bank and calling for lower interest rates for over a year. And who clearly wants the Fed to clean up any damage to the economy from trade tensions, which escalated Friday as China said it would impose tariffs on $75 billion worth of U.S. goods.



The Fed’s shift from tightening to easing has been a balm for a stock market that might otherwise be a lot lower as a result of the trade fight. And Mr. Powell, in his remarks in Jackson Hole, Wyo., on Friday made it clear that the Fed is ready to respond with more cuts if trade tensions worsen the economic Outlook.

But Mr. Powell also said that when it comes to trade, there are limits to what the Fed can accomplish, and investors should be mindful of that. President Trump didn’t seem to take that well, wondering publicly on Twitter whether Mr. Powell is a greater threat to the U.S. than Chinese President Xi Jinping.

Part of the problem is that the Fed has no real sense of how it should proceed, Mr. Powell noted. So far this year, for example, employment and consumer spending have continued to do well even as business confidence has eroded, making it unclear how much easing the economy actually needs. For the Fed to keep cutting rates beyond next month, it might need a clearer indication that the job market and consumer spending are at risk.

Moreover, if trade uncertainty does spill over into the broader economy, the Fed’s ability to counteract the damage may be limited. First, there is the simple matter that with rates already low, the Fed only has so many rate cuts to give. But there may also be limits to what monetary policy can do to offset trade troubles.

The Fed’s safety net might be flimsier than investors believe.

America Needs an Independent Fed

The economy functions best when the central bank is free of short-term political pressures.

This article is signed by Paul Volcker, Alan Greenspan, Ben Bernanke and Janet Yellen.



As former chairs of the board of governors of the Federal Reserve System, we are united in the conviction that the Fed and its chair must be permitted to act independently and in the best interests of the economy, free of short-term political pressures and, in particular, without the threat of removal or demotion of Fed leaders for political reasons.

Collectively, we served our nation across nearly 40 years and were appointed and reappointed by six presidents, both Republican and Democratic. Each of us had to make difficult decisions to help guide the economy toward the Fed’s legislated goals of maximum employment and stable prices. In retrospect, not all our choices were perfect. But we believe those decisions were better for being the product of nonpartisan, nonpolitical assessments based on analysis of the longer-run economic interests of U.S. citizens rather than being motivated by short-term political advantage.





Photo: Getty Images/iStockphoto


The Fed’s nonpartisan status doesn’t mean it is unaccountable. Congress sets the Fed’s powers and charges it with maximizing employment and promoting stable prices. The chair and other Fed leaders testify before Congress and speak regularly in public, explaining their views of the economy and how they plan to meet their mandates. Presidents, members of Congress, financial-market participants, pundits and many private citizens advocate that the Federal Reserve make particular monetary policy decisions. In our system of government, that is the right and privilege of every person, one we don’t question. The Fed welcomes open dialogue, as evinced by the “Fed Listens” program, in which Fed leaders have engaged with the public about possible changes to the Fed’s policy framework. A robust public debate helps make monetary policy better.

History, both here and abroad, has shown repeatedly, however, that an economy is strongest and functions best when the central bank acts independently of short-term political pressures and relies solely on sound economic principles and data. Examples abound of political leaders calling for the central bank to implement a monetary policy that provides a short-term boost to the economy around election time. But research has shown that monetary policy based on the political (rather than economic) needs of the moment leads to worse economic performance in the long run, including higher inflation and slower growth. Even the perception that monetary-policy decisions are politically motivated, or influenced by threats that policy makers won’t be able to serve out their terms of office, can undermine public confidence that the central bank is acting in the best interest of the economy. That can lead to unstable financial markets and worse economic outcomes.

Because nonpartisan, independent monetary policy is so important, Congress wisely established the Federal Reserve as an independent agency with regional participation and safeguards against political manipulation. Among these safeguards are 14-year terms for Federal Reserve Board members (four years for the chair and vice chairs) and the provision that Fed governors, including the chair and vice chairs, may be removed only for a cause related to violations of law or similar misbehavior, and not for policy differences with political leaders. This system of fixed terms is designed to ensure that the Fed makes decisions that best serve the economy—and all of us—regardless of short-term political considerations.

Elections have consequences. That certainly applies to the Federal Reserve as well as to other government agencies. When the current chair’s four-year term ends, the president will have the opportunity to reappoint him or choose someone new. That nomination will have to be ratified by the Senate. We hope that when that decision is made, the choice will be based on the prospective nominee’s competence and integrity, not on political allegiance or activism. It is critical to preserve the Federal Reserve’s ability to make decisions based on the best interests of the nation, not the interests of a small group of politicians.

The Race Card in America

Donald Trump has racialized American politics more than any US president in living memory, and many are blaming him for acts of racist violence, like the recent mass shooting in El Paso. But, given that what makes politics in the United States so complicated is the conflation of race, class, and culture, his opponents should not follow his example.

Ian Buruma


buruma150_MARKRALSTONAFPGettyImages_elpasovigilwomancandle


LONDON – The recent mass shooting in El Paso, Texas, carried out by a young white man who had posted a hate-filled anti-immigrant screed shortly beforehand, has called attention to US President Donald Trump’s own rhetorical affinity for white supremacy. Trump has consistently insulted Mexicans, African Americans, and other people of color. He referred to Haitian and African immigrants as coming from “shithole countries.”

Last month, he told four new members of Congress, Alexandria Ocasio-Cortez, Rashida Tlaib, Ayanna Pressley, and Ilhan Omar, to “go back” to where they came from. All four Congresswomen are, of course, American citizens. All but one (Omar) were born in the United States.

Trump’s Republican supporters deny that he is a racist. Who knows? But he is clearly appealing to his followers’ darkest instincts, which are angry, vengeful, bigoted, and prejudiced in ways that can only be described as racist. By stirring up hatred, Trump hopes to mobilize enough voters to be reelected next year.

The president is careful not to incite people openly to commit violence. But many violent people feel licensed by his words to do so. This makes Trump’s behavior dangerous and contemptible, and he must be held to account for it. He deserves to be called a racist. Some of his critics go further than that. They argue that race should be the central issue of the 2020 elections.

Because Trump relies on angry white voters, diversity, anti-racism, and the elevation of people of color should be the counterstrategy.

This course would be morally justified. The question is whether it would be the most effective way to vote the scoundrel out, which should be the main aim of anyone who sees Trump as a danger to the republic, let alone to people who are targeted by angry racists. There is room for doubt.

Some people don’t actually mind being called racists. At a rally of the French National Front in 2018, Trump’s former advisor Steve Bannon told the crowd to wear the word “racist” as a badge of honor. But many Trump supporters don’t think of themselves as racists and resent the allegation. Quite a number of these people, often from the white working class, voted twice for Barack Obama. The Democrats need to get some of these voters back into their fold, especially in pivotal Midwestern states.

But fear of offending Trump supporters who don’t regard themselves as bigots is not the only reason to be careful about racializing politics even more than it already is. The fact that Trump plays that game is no reason for his opponents to follow his example. What makes politics in the US so complicated is the conflation of race, class, and culture.

Senator Lindsey Graham of South Carolina criticized Trump for getting too personal in his hostile comments about the four congresswomen. But it was all too typical of a particular way of thinking to call them “a bunch of communists,” as Graham did. The women are left-wing by most American standards, but certainly not communists. Communism, or even socialism, is regarded in certain right-wing circles as “un-American” by definition. That was the thinking in the early 1950s, when Senator Joe McCarthy was on the prowl for un-American “communists” – often ruining the lives of people who were merely on the left.

By the same token, writers, professors, or lawyers who favor reproductive freedom, or who don’t believe in God, or argue in favor of equal rights for people of all genders and sexual orientations, or support universal health care for all, are often accused of being more like namby-pamby godless Europeans.

Leftist or secular views cannot be associated with any particular race. If anything, highly educated white people are likely to espouse them. And those who believe that a coalition of non-white minorities is best placed to oppose Trump’s white chauvinism should be wary. A significant number of African Americans and Latinos are religious and socially conservative.

Of course, race plays an important part in the American culture wars. And the concept of “white privilege” is not invalid. But to see the country’s political, social, and cultural fissures in terms of a racial divide is, well, too black and white. To make opposition to white privilege the main platform in the fight against Trump not only risks alienating people the Democrats need on their side, but could also set Democrats against one another.

Former Vice President Joe Biden is far from an ideal candidate for the Democrats. He is too old and not quick enough on his feet. But to attack him, and even demand an apology from him, because he said he was once able to work with colleagues whose racial prejudices he clearly didn’t share, is a mistake. Working with people with whom you disagree, or actually abhor, is the stuff of politics.

Trump has managed to push the Democratic Party further to the left than it was under Obama. This suits him well. He would like to make the four congresswomen into the face of his political enemies.

Biden, who is proud to associate himself with the Obama years, is criticized by his younger rivals for being out of step with our more racially sensitive times. The second night of last week’s Democratic debates was marked by a spirit of antagonism toward the Obama administration. Biden found this “bizarre.”

He had a point. Obama managed to be successful precisely because he minimized race in his politics. He didn’t ignore it. Some of his best speeches were about it. But he carefully avoided making race into the main issue. He didn’t have to. His election made the point for him. And he is still more popular than any other politician alive.

Biden, alas, is no Obama. But the fact that he has more support among black voters than any of his competitors, even those who are black, should tell us something. If the Democrats want to beat Trump, they attack his flawed but infinitely better predecessor at their peril.

Ian Buruma is the author of numerous books, including Murder in Amsterdam: The Death of Theo Van Gogh and the Limits of Tolerance, Year Zero: A History of 1945, and, most recently, A Tokyo Romance: A Memoir.

Why the China-U.S. Trade Conflict Won’t Become a Currency War

The U.S. trade war with China reached a new phase on Aug. 5 after the U.S. labeled China a currency manipulator. That followed a surprise move by the Chinese government to let the yuan break through the long-standing 7-to-1 exchange rate for the first time in 11 years. Tensions eased slightly when China’s central bank fixed the exchange rate a bit higher than the lowest point the yuan hit, but global financial markets remained rattled.

Recent events in the trade dispute have been fast-moving. On Aug. 1 President Trump announced new tariffs on China – 10% on an additional $300 billion in goods — saying China had not bought large amounts of U.S. farm products as promised. Four days later, China devalued the yuan, and the U.S. currency manipulation charge followed. Then on Aug. 6, China said it may increase tariffs on U.S. farm products. But Wharton Dean Geoffrey Garrett explains why U.S.-China dispute is unlikely to become a full-on currency war, in this opinion piece.


Global markets were spooked yesterday by the Chinese Renminbi crossing the psychologically important barrier of 7 RMB to the greenback—sparking speculation that the current trade war will metastasize into a currency war between the world’s two biggest economies. The fact that the Trump administration responded immediately by officially labeling China a “currency manipulator,” for the first time in 25 years, is only grist for the mill.

The logic is straightforward. A weaker Chinese currency cushions the blow to Chinese exports of American tariffs. But greater Chinese exports to America would increase America’s trade deficit within China, creating incentives for the Trump administration to retaliate with a tit-for-tat weakening of the dollar.

Despite this logic, there are three powerful reasons why the trade war won’t become a currency war. In increasing order of importance they are:

1. Donald Trump loves showing America’s strength—and to many, there is no better signal of strength than a strong U.S. dollar.

What’s more, when the global economy wobbles, investors turn to the U.S. dollar as a port in the storm. 

2. The Trump administration cannot unilaterally manipulate the dollar, even if it wants to.

This is true on multiple levels. The dollar floats on global foreign exchange markets without the capital controls that allow a country like China to manage the value of its currency. The single most direct way to weaken the currency is for the central bank to lower interest rates. In the U.S. that is the domain of the Federal Reserve. To Trump’s chagrin, the Fed remains independent of the White House, and its charter asks it to balance the risks of unemployment and inflation, not the exchange rate. And the Fed told the financial markets just last week not to expect further cuts to interest rates.

3. The Chinese government cannot afford the risk of an RMB in free fall.

All the charges by America in the past decade that China is a currency manipulator belie the fact that for more than a decade after 2005, the Chinese currency actually appreciated considerably against the U.S. dollar. This no doubt reduced China’s exports to America, but to China it was worth the price. The specter of mass capital flight has been an existential fear of the Chinese government since the Asian financial crisis in the late 1990s. China then saw the devastating effects of capital flight and vowed that it would never happen in China. With the slowdown of the Chinese economy giving itchy feet to holders of RMB, the last thing China’s government wants is to turn market nervousness into a full-on rush for the exits.

There is no doubt that allowing the RMB to cross 7:1 against the dollar was Xi Jinping’s shot-across-the-bow response to Trump’s threat of imposing tariffs on all Chinese imports on September 1. Just don’t expect the single shot to become an ongoing fusillade.


The Anatomy of the Coming Recession

Unlike the 2008 global financial crisis, which was mostly a large negative aggregate demand shock, the next recession is likely to be caused by permanent negative supply shocks from the Sino-American trade and technology war. And trying to undo the damage through never-ending monetary and fiscal stimulus will not be an option.

Nouriel Roubini

roubini131_GettyImages_globelinegraphdown

NEW YORK – There are three negative supply shocks that could trigger a global recession by 2020. All of them reflect political factors affecting international relations, two involve China, and the United States is at the center of each. Moreover, none of them is amenable to the traditional tools of countercyclical macroeconomic policy.

The first potential shock stems from the Sino-American trade and currency war, which escalated earlier this month when US President Donald Trump’s administration threatened additional tariffs on Chinese exports, and formally labeled China a currency manipulator.

The second concerns the slow-brewing cold war between the US and China over technology. In a rivalry that has all the hallmarks of a “Thucydides Trap,” China and America are vying for dominance over the industries of the future: artificial intelligence (AI), robotics, 5G, and so forth. The US has placed the Chinese telecom giant Huawei on an “entity list” reserved for foreign companies deemed to pose a national-security threat. And although Huawei has received temporary exemptions allowing it to continue using US components, the Trump administration this week announced that it was adding an additional 46 Huawei affiliates to the list.

The third major risk concerns oil supplies. Although oil prices have fallen in recent weeks, and a recession triggered by a trade, currency, and tech war would depress energy demand and drive prices lower, America’s confrontation with Iran could have the opposite effect. Should that conflict escalate into a military conflict, global oil prices could spike and bring on a recession, as happened during previous Middle East conflagrations in 1973, 1979, and 1990.

All three of these potential shocks would have a stagflationary effect, increasing the price of imported consumer goods, intermediate inputs, technological components, and energy, while reducing output by disrupting global supply chains.

Worse, the Sino-American conflict is already fueling a broader process of deglobalization, because countries and firms can no longer count on the long-term stability of these integrated value chains. As trade in goods, services, capital, labor, information, data, and technology becomes increasingly balkanized, global production costs will rise across all industries.

Moreover, the trade and currency war and the competition over technology will amplify one another. Consider the case of Huawei, which is currently a global leader in 5G equipment. This technology will soon be the standard form of connectivity for most critical civilian and military infrastructure, not to mention basic consumer goods that are connected through the emerging Internet of Things. The presence of a 5G chip implies that anything from a toaster to a coffee maker could become a listening device. This means that if Huawei is widely perceived as a national-security threat, so would thousands of Chinese consumer-goods exports.

It is easy to imagine how today’s situation could lead to a full-scale implosion of the open global trading system. The question, then, is whether monetary and fiscal policymakers are prepared for a sustained – or even permanent – negative supply shock.

Following the stagflationary shocks of the 1970s, monetary policymakers responded by tightening monetary policy. Today, however, major central banks such as the US Federal Reserve are already pursuing monetary-policy easing, because inflation and inflation expectations remain low. Any inflationary pressure from an oil shock will be perceived by central banks as merely a price-level effect, rather than as a persistent increase in inflation.

Over time, negative supply shocks tend also to become temporary negative demand shocks that reduce both growth and inflation, by depressing consumption and capital expenditures. Indeed, under current conditions, US and global corporate capital spending is severely depressed, owing to uncertainties about the likelihood, severity, and persistence of the three potential shocks.

In fact, with firms in the US, Europe, China, and other parts of Asia having reined in capital expenditures, the global tech, manufacturing, and industrial sector is already in a recession.

The only reason why that hasn’t yet translated into a global slump is that private consumption has remained strong. Should the price of imported goods rise further as a result of any of these negative supply shocks, real (inflation-adjusted) disposable household income growth would take a hit, as would consumer confidence, likely tipping the global economy into a recession.

Given the potential for a negative aggregate demand shock in the short run, central banks are right to ease policy rates. But fiscal policymakers should also be preparing a similar short-term response. A sharp decline in growth and aggregate demand would call for countercyclical fiscal easing to prevent the recession from becoming too severe.

In the medium term, though, the optimal response would not be to accommodate the negative supply shocks, but rather to adjust to them without further easing. After all, the negative supply shocks from a trade and technology war would be more or less permanent, as would the reduction in potential growth. The same applies to Brexit: leaving the European Union will saddle the United Kingdom with a permanent negative supply shock, and thus permanently lower potential growth.

Such shocks cannot be reversed through monetary or fiscal policymaking. Although they can be managed in the short term, attempts to accommodate them permanently would eventually lead to both inflation and inflation expectations rising well above central banks’ targets. In the 1970s, central banks accommodated two major oil shocks. The result was persistently rising inflation and inflation expectations, unsustainable fiscal deficits, and public-debt accumulation.

Finally, there is an important difference between the 2008 global financial crisis and the negative supply shocks that could hit the global economy today. Because the former was mostly a large negative aggregate demand shock that depressed growth and inflation, it was appropriately met with monetary and fiscal stimulus.

But this time, the world would be confronting sustained negative supply shocks that would require a very different kind of policy response over the medium term.

Trying to undo the damage through never-ending monetary and fiscal stimulus will not be a sensible option.


Nouriel Roubini, a professor at NYU’s Stern School of Business and CEO of Roubini Macro Associates, was Senior Economist for International Affairs in the White House’s Council of Economic Advisers during the Clinton Administration. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank.

Daily chart

America has half a million fewer jobs than previously thought

As central bankers meet in Jackson Hole, the Fed ponders its next move



IT IS NOT easy being a central banker these days. Jerome Powell, the chairman of the Federal Reserve, has come under particular scrutiny in recent months. Some commentators believe he has been too hawkish, even though he cut the Fed’s main interest rate by 25 basis points last month, and should cut rates more aggressively. President Donald Trump, who appointed Mr Powell, is now his most vocal critic, and recently tweeted that the Fed should cut its benchmark rate by “at least 100 basis points”.

Lowering interest rates would be a natural response to an economic downturn, but optimists have taken comfort from labour-market figures, which suggest that America’s economy is still humming along. The country’s unemployment rate currently sits at just 3.7%, its lowest level in five decades. The labour-force participation rate of “prime-age” workers aged between 25 and 54, although still below where it was before the financial crisis, has been rising steadily since 2015.

Still, investors are anxious. America’s trade war with China shows no signs of abating. The country’s manufacturing sector is growing at its slowest pace in nearly three years; and business investment contracted in the second quarter. Meanwhile Germany, Europe’s economic powerhouse, appears to be tipping into recession. Recent news from America’s Bureau of Labour Statistics has not helped matters. On August 21st the agency revised its figures, saying that employers added half a million fewer jobs in the year ending March 2019 than previously reported (see chart). The 0.3% downward revision to total non-farm employment was the biggest in a decade.


The bond market is also sending worrying signals. The yield on America’s short-term government bonds currently exceeds that of its longer-term debt. Such “inversions” have preceded each of the past seven recessions. A forecast from the Federal Reserve Bank of New York issued on August 2nd, based on historical data from the government-bond market, estimated that there was a 31% chance of a recession within the next twelve months. Up-to-date data would yield an even scarier forecast. Mr Trump was at one point so concerned that he floated the idea of issuing a new wave of tax cuts, though he appears to have since reconsidered.

All eyes are now on Mr Powell, who is due to speak tomorrow at an annual gathering of central bankers in Jackson Hole, Wyoming. Financial markets currently suggest the Fed has a 98% chance of cutting its benchmark rate by at least 25 basis points by September. Whether such a cut will be enough for Mr Powell to stave off a recession and placate his critics remains to be seen.

The Asian strategic order is dying

Forty years of prosperity in the region are now under threat

Gideon Rachman




When somebody is reaching the end of their life, they often suffer from lots of apparently unrelated ailments — fevers, aches-and-pains, unlucky falls. Something similar may happen when a strategic order is dying. Across east Asia, the past month has seen a rash of diplomatic and security incidents that are symptoms of a wider sickness.

In late July, the Chinese and Russian air forces staged their first ever joint aerial patrol in the region, causing South Korean warplanes to fire hundreds of warning shots at Russian intruders. The South Koreans are also facing the most serious deterioration in their relations with Japan in decades — with the Japanese imposing trade restrictions last week in a dispute that has its origins in the second world war. North Korea has also just restarted missile tests, endangering US-led peace efforts.

All of the other east Asian flashpoints — Taiwan, the South China Sea, Hong Kong and the US-China trade war — are also looking more combustible. Protests and strikes in Hong Kong are still gathering momentum. Chinese officials are now openly discussing military intervention and last week a White House official drew attention to a massing of Chinese troops, just across the border from Hong Kong. For the Trump administration, however, the major preoccupation remains its trade dispute with China, which also intensified last week, with the US imposing a new set of tariffs.

July also saw a Chinese oil exploration vessel enter waters claimed by Vietnam, leading to a stand-off between heavily armed Chinese and Vietnamese ships. The government of the Philippines too sounded the alarm about Chinese naval incursions and called for American assistance. China’s growing assertiveness was underlined by the news that Beijing is developing a military base in Cambodia, its first in south-east Asia.

Tensions over Taiwan continue to rise. In late July a US warship sailed through the Taiwan Strait and China released a defence white paper, accusing the Taiwanese government of pursuing independence and threatening a military response. The US meanwhile is talking of soon deploying intermediate-range missiles in east Asia, following its pullout from the Intermediate-Range Nuclear Forces Treaty last week.

On the surface, many of these incidents seem unconnected. But collectively they point to a regional security order that is coming apart. America’s military pre-eminence and diplomatic predictability can no longer be taken for granted. And China is no longer willing to accept a secondary role in east Asia’s security system. In these new circumstances, other countries — including Russia, Japan and North Korea — are testing the rules.

The past 40 years have been a period of unprecedented growth and prosperity across east Asia, which has also transformed the global economy. But Asia’s economic miracle relied on peace and stability. Those conditions were established in the mid-1970s, with the end of the Vietnam war and America’s rapprochement with China.

Since then, America has tolerated and even facilitated the rise of China. In return, China has tacitly accepted that America would remain the dominant military power in the Asia-Pacific region. You could label these arrangements the “Kissinger order” in east Asia, after Henry Kissinger, the US secretary of state who helped broker the new relationship between America and China in the early 1970s.

But both President Xi Jinping of China and President Donald Trump of the US have rejected basic elements of the Kissinger order. Mr Trump has abandoned the idea that US-Chinese ties are mutually beneficial, by launching his trade war, while Mr Xi has set about challenging America’s strategic pre-eminence.

China’s challenge to American power has raised the question of how long the US’s strategic dominance in Asia will last. Rather than offering reassurance, Mr Trump has added to the uncertainty by openly questioning the value of US alliances with Japan and South Korea. As one Asian foreign minister put it recently: “The damage that Trump has done will outlive Trump.”

The loss of the US’s regional authority is evident in Washington’s inability to control the feud between Japan and South Korea, its two most important regional allies. Even the Australians are beginning to doubt American leadership, with one senior Australian diplomat telling me recently that, with the trade war intensifying, “there will come a point when America and Australia will part company on policy towards China”.

But doubts about American leadership are not matched by any desire to embrace a China-dominated region. On the contrary, from Tokyo to Taipei and from Canberra to Hanoi, there is growing anxiety about Beijing’s behaviour. That anxiety is only increased by the growing closeness between China and Russia. From Moscow’s point of view, the recent joint air patrol underlined Russia’s return as a Pacific power — just as military intervention in Syria signalled its re-emergence as a power in the Middle East.

The Kissinger order in east Asia did not resolve most of the historic disputes and rivalries in the region. But it helped to freeze regional conflicts in place, buying time for peaceful development. Now the geopolitical climate has changed so frozen conflicts are moving again. As the ice melts, things can move fast in dangerous and unpredictable ways.


Officials See Few Options if Slowdown Hits

Amid debate over whether the U.S. is going into an economic downturn, there are few good options to deal with one if it happens

By Rebecca Ballhaus and Nick Timiraos


Policy makers have limited options to boost the U.S. economy amid signs it is slowing. Above, a Mercedes-Benz assembly plant in Vance, Ala. Photo: andrew caballero-reynolds/Agence France-Presse/Getty Images


After debating for days whether the U.S. is going into an economic downturn, Washington policy makers and Wall Street investors on Wednesday barreled into an even more difficult problem: There are few good options to deal with one if it happens.

With short-term interest rates already low, the Federal Reserve has little room to cut borrowing costs to spur spending and investment as it usually does in a slowdown. Meantime, the federal debt is exploding, which could hamstring any efforts to boost growth with tax cuts or spending increases.

Further complicating matters, Democrats and Republicans strongly disagree about how best to rev up the economy, with Democrats favoring higher spending and the GOP wanting lower taxes. Even within their own ranks there are disagreements about what course to take.

President Trump on Wednesday backed away from pursuing new tax cuts, a sharp reversal from a day earlier, when he described several such measures the White House was contemplating. Mr. Trump is in the awkward position of calling for economic stimulus at the same time he says the economy is strong.

“I just don’t see any reason to,” Mr. Trump told reporters at the White House when asked if he was contemplating tax cuts. “We don’t need it. We have a strong economy.”

He dismissed an idea he floated Tuesday: lowering capital-gains taxes by indexing investment gains to inflation. “I’m not looking to do indexing,” he said. “I think it will be perceived, if I do it, as somewhat elitist…I want tax cuts for the middle class, the workers.” He added that it was an option, but “not something I love.”

On Tuesday, speaking to reporters in the Oval Office, the president said he had been “thinking about payroll taxes for a long time” and that indexing was “something I’m thinking about.” He added, “I would love to do something on capital gains.”

White House officials, meanwhile, said the administration has long been examining a range of tax cuts as part of what Republicans have termed “Tax Cuts 2.0,” though no proposals are expected imminently and such a measure is unlikely to go anywhere in Congress.

The president also has been pressuring the Federal Reserve to cut interest rates at a clip typically only seen when the economy is severely struggling. On Wednesday morning, Mr. Trump compared Fed ChairmanJerome Powell,his own choice for the post, to a “golfer who can’t putt.”

Though unemployment remains exceptionally low, economic growth and hiring have slowed in recent months and some warning signs are flashing in bond markets. Most notably, long-term interest rates at times have dipped below short-term rates, something that has telegraphed recessions in the past and spooked investors in recent weeks.

Wednesday’s economic reports included some troubling new signs. U.S. job growth was weaker in the year through March than previously thought, government economists said. The Labor Department lowered its estimate of total U.S. employment in March by 501,000, or 0.3%. That brought down the average monthly increase in payrolls over the period to about 168,000 from 210,000—still solid but not as robust as once thought.

Other government data revisions in recent weeks also pushed down estimates of growth and corporate profits.

But it wasn’t all bad news: Sales of previously owned homes picked up in July, the National Association of Realtors said Wednesday, a sign that lower mortgage rates may be driving sales after a weak spring selling season. Some retailers also reported good profit numbers, another sign that households remain a pillar of the economy.

The Dow Jones Industrial Average rose 240.29 points Wednesday, or 0.93%, to 26202.73. It had surpassed 27000 in July, when downturn worries started to concern investors.

Academic research cited by top Fed officials in the past says that the central bank should move quickly to cut short-term rates in moments when it has little room to maneuver and the economy might be heading for a slide.

The Fed’s target rate is just over 2%, leaving far less room to cut aggressively than in the past.

But officials at the central bank aren’t yet convinced that drastic action is needed. Moreover, the Fed’s ranks are divided about what steps to take.

Fed minutes from its July 30-31 meeting released Wednesday showed several officials favored holding rates steady because they judged “that the real economy continued to be in a good place.”

Two of those officials, Boston Fed President Eric Rosengren and Kansas City Fed PresidentEsther George,dissented from the decision to cut rates by a quarter percentage point.

But two other officials, not identified in the minutes, favored a more aggressive half-point cut, which they said would better address “stubbornly low” inflation.

The minutes also showed the officials believed uncertainty surrounding the Trump administration’s trade policy wasn’t likely to let up anytime soon, creating a “persistent headwind” for the U.S. economic outlook.

Many business executives have said the uncertain outlook for U.S. trade policy could be holding back the economy. With the U.S. locked in sharp disagreements with China over a range of issues, that might not get resolved soon.

Mr. Powell disappointed some investors—and the president—at his news conference after the July meeting when he pushed back against market expectations of a more vigorous series of rate cuts to follow.

“Now we know why Powell had a hard time at the press conference. There wasn’t a clear consensus,” saidDiane Swonk,chief economist at Grant Thornton.

Washington’s appetite for budget deficits could be tested by a slowdown or recession. Federal spending tends to rise in a recession because mandatory payments on programs like unemployment insurance goes up. Meantime, tax receipts tend to slow as household income growth and business profits slow or decline.

On top of all of that, cutting taxes or increasing spending to kick-start growth could be a challenge since both can boost deficits. Federal deficits are projected to grow much more than expected over the next decade thanks to the two-year budget agreement lawmakers and the White House struck last month, the Congressional Budget Office said Wednesday.

The agency boosted its forecast of cumulative deficits over the next decade by $809 billion, to $12.2 trillion. That means an additional $12 trillion of debt on top of the $22 trillion already outstanding.

The increase primarily reflects higher federal spending under the new budget deal, partly offset by lower projected interest rates.

The CBO said the new agreement, which increased spending roughly $320 billion over the next two years above previously enacted spending caps, will add roughly $1.7 trillion to deficits between 2020 and 2029. That reflects CBO’s assumption that federal spending will continue to grow at the rate of inflation after 2021.

Deficits as a share of gross domestic product are expected to average 4.7% over the next decade, up from the 4.3% average CBO projected in May, and a significant increase from the 2.9% average over the past 50 years.


—Kate Davidson, Josh Mitchell and Alex Leary contributed to this article.


Why Markets Have Been A Tinderbox In August

by: The Heisenberg

Summary
 
- New estimates show that most of the manic moves in stocks and bonds this month can be explained by many of the self-feeding loops I've spent years discussing.

- In rates, the recent plunge in yields was mostly down to convexity hedging.

- In stocks, gamma hedging and CTA de-leveraging played a prominent role last week.

- And it's all exacerbated by disappearing liquidity.
 

If you're looking to assign blame for the manic market moves that have, through Monday anyway, defined the month of August, you can point to systematic flows and technically-driven price action.

I've discussed this at length here and elsewhere over the past two weeks, effectively documenting it in real time, but I think it's worth fleshing out a bit further for the audience here in the interest of perhaps shedding a bit more light on something that still isn't well understood by retail investors.
 
Starting in rates, I talked quite a bit in a Friday post for this platform about receiving flows and convexity hedging and the extent to which that had almost certainly played an outsized role in the frantic rally at the long-end of the US curve. 10-year yields fell below 1.50% and 30-year yields below 2.00% at the height of the rally last week.
 
(Heisenberg)
 
 
We've seen the bottom fall out for yields on several occasions in 2019 and while some of that is down to growth concerns, collapsing inflation expectations, a flight-to-safety and the assumption of lower rates, a large percentage of this month's downdraft in yields is attributable to mortgage investors and banks chasing the rally.
 
That sprint created some $500 billion in demand, according to JPMorgan, whose rates strategists on Tuesday reminded clients that these flows are easy to see. "[It's] clear from the behavior of derivatives markets, since most of these hedging flows occur in interest rate swaps," the bank noted.
(JPMorgan)
 
 
As I wrote Friday on this platform, this sets in motion a self-fulfilling prophecy. The lower long-end yields go, the more convinced market participants become that everyone else is panicking about the outlook for global growth. Those jitters beget still more demand for duration, which pushes yields even lower, forcing more hedging, and around we go.
 
And then there's the psychological impact on equities. The exaggerated moves in rates described above are part of the reason the 2s10s inverted. That inversion, in turn, dealt a grievous blow to investor psychology last Wednesday, when the Dow suffered its worst one-day drop of 2019.
 
This is a maddeningly circular and exceptionally precarious dynamic. When fundamental, discretionary investors sell on recession jitters tied to what, as noted above, was an exaggerated move in the bond market, that can push equity benchmarks through key levels, which starts tipping dominoes for systematic deleveraging by the likes of CTAs.
 
JPMorgan's Marko Kolanovic underscored all of this in a note out Tuesday morning. "This is an important data point for equity investors, as moves in rates (e.g. yield curve inversion) significantly impact investment sentiment”, he wrote, on the way to quantifying how much selling in and around last Wednesday's rout was attributable to programmatic/systematic strats. That figure, according to Marko, was roughly $75 billion, with 20% of it coming from CTAs.
 
Now, recall how, on August 11, I mentioned in a post for this platform that dealers' gamma positioning likely flipped negative after the FOMC, which meant that selling would beget more selling. Kolanovic on Tuesday underscored that assessment, noting that heading into last week, dealers' gamma positioning betrayed "a sizable short".

Try to appreciate how the dominoes fall. As yields move lower on what are, initially, fundamental concerns, convexity hedging flows turbocharge the bond rally. That has the potential to create a false optic, or to magnify recession concerns (I referred to it as a "Fata Morgana" earlier this year). Last week, that manifested itself in the inversion of the 2s10s, which led to selling in equities. Once stocks fell through key levels, it activated CTA de-leveraging and because dealers' gamma positioning was negative, their hedging exacerbated the situation.
 
Kolanovic on Tuesday said some 50% of the above-mentioned $75 billion in programmatic selling during or as a result of the August 14 selloff was attributable to index option delta and gamma hedging, which he calls "the single most important driver of price action during both the selloffs and rallies last week".
 
Mercifully, that positioning is back to neutral now, something Nomura's Charlie McElligott illustrated on Monday as follows:
 
(Nomura)
 
 
That, folks, is how modern markets can turn into tinderboxes.
 
If you're looking to explain why nine of the 14 sessions since the July FOMC have seen S&P moves of 1% or more (top pane in the figure), that's why.
 
 
(Heisenberg)
 
 
This is exacerbated materially by low liquidity. These flows are hitting during a month when liquidity is seasonally sparse, but this August has been particularly dry. More broadly, liquidity in S&P futures simply never recovered after the February 2018 vol. event.
(Deutsche Bank)
 
 
That's attributable to a variety of factors, but one of the issues is that HFT liquidity provision is volatility-dependent. That is, algos pull back when volatility rises.
 
Well, needless to say, the interaction of all the dynamics mentioned above has a tendency to push up volatility. If vol. spikes prompt HFTs to reduce liquidity provision, it can make a bad situation immeasurably worse. That goes for bonds too. As JPMorgan pointed out again on Tuesday, "fast market participants represent roughly 80% of the liquidity provision in the hot-run interdealer Treasury market."
 
Going forward, positioning has once again been washed out a bit, with hedge fund betas very low, for instance. As noted above, dealers' gamma positioning is (basically) neutral now, so that should serve to help tamp down volatility.
 
But, it is by no means clear that the impact of hedging flows in rates is behind us, and on top of that, the dollar is near YTD highs. Jerome Powell has the potential to exacerbate both the decline in bond yields and dollar strength on Friday if he doesn't strike the "right" tone in Jackson Hole.
 
Suffice to Boston Fed chief Eric Rosengren did not signal a willingness to back off his propensity to dissent against more rate cuts when he spoke to Bloomberg on Monday.
 
And President Trump did not signal a willingness to step back from his insistence on those same cuts when he spoke to Twitter.

Buttonwood

The LME is Europe’s only surviving “open outcry” venue

Traders still bark orders for copper as they have for more than a century




HER CLIENT’S huge order would cause prices to surge if the market got wind of it. She knew she needed to be crafty. “So I shouted as loud as I could, ‘I’ll sell at £795’.” The price sank. “By now I was pointing at everyone who had bid, but because they thought I was a heavy seller they backed off, only taking 25 tonnes at a time.” At the bell, the price fell to £780. That triggered automatic sell orders. At the next session she was able to buy back her stock—plus a few thousand tonnes for her client—on the cheap.

Every trader on the London Metal Exchange probably has a tale to tell of wrong-footed rivals. This story, told in “Ring of Truth”, a memoir by Geraldine Bridgewater, the LME’s first female trader, is from four decades ago. Little has changed. Traders still sit in a circle (the Ring) and yell orders for copper at each other, just as they have for more than a century. The LME is the only “open outcry” trading venue left in Europe. Its rituals seem as quaint as Morris dancing or the Trooping of the Colour.

Yet somehow the LME retains its relevance. It is now owned by Hong Kong Exchanges and Clearing (HKEX). Ms Bridgewater’s big trade was for the People’s Republic of China, a client she had shrewdly cultivated. China has since become the LME’s biggest source of custom. There is a rival exchange in Shanghai; China dislikes being a taker of prices set beyond its borders. Still, the LME is where the liquidity flows to. Its staying power owes a lot to incumbency—but also to transparency.

Metals-trading in London can be traced back as far as 1571. Back then, it happened alongside other kinds of merchant-trading on the Royal Exchange. A metals-only exchange that traded mostly copper and tin was formalised in 1877, at the peak of British industry’s global clout. In those days copper from Chile took three months to reach London. Merchants wanted to lock in the price of a shipment as it left port. That is how three-month futures became a standard. They are still the most traded LME contract today.

Other traditions are observed. Even on a brutally hot day in July everybody is dressed smartly, the men in jackets and ties. The noise rises a little as the bell signals the start of a new session.

Metals are traded in short, timed bursts to enhance liquidity. Traders sit on the red quarter-circle banquettes of the Ring. Account executives (in Ms Bridgewater’s day they were simply “clerks”) stand behind them straining to hear. They relay each quote, assisted by hand signals, to colleagues standing, with telephones cradled to each ear, in the brokers’ booths that make up an outer ring.

It looks chaotic. It certainly sounds it. But it is striking, given the noise, how calm the traders seem. It is essential for them to remain poker-faced. When they need to be heard, they lean forward. In between yells a trader might glance up at the main board, down at his dealing card or at his watch to see exactly how much time is left (the clock on the dealer board does not count seconds). Unlike in the trading pits of Chicago, most sessions are limited to one sort of commodity. And traders sit in the same spot every day.

Is all this fuss and noise strictly necessary? Only perhaps a tenth of trades that are cleared through the LME are agreed on in the Ring. Most are done over the phone or on the LME’s electronic trading platform. When HKEX acquired the LME in 2012, it must surely have thought it would soon be rid of the Ring. It is a costly pageant. Screen-based trading has lower overheads and is more profitable for the exchange. A lot of Ring trades are lending or borrowing between odd dates—from next Tuesday to Monday a fortnight hence, say. Only specialists want to make those kinds of bets.

Yet they are needed to underpin a system of daily contracts that extend out to the three-month contract. They are too complex to be carried out on-screen. Daily pricing matters to the miners, smelters and manufacturers who produce or consume the metals being traded. Long-term supply arrangements are based on LME prices. So the Ring survives. It is like a poker room—a loss-leader in a casino full of more profitable slot machines.

Some things have changed: daytime drinking is now banned. But the LME is still the place to find liquidity of the right sort. Trading could scarcely be more transparent (once you can speak the argot). Prices are trusted worldwide. Traders can feint, but must play fair. Tomorrow they will be face-to-face with the same people. You can’t help wishing that all financial markets were like this.