Issues 2019
Doug Nolan
When I began posting the CBB some twenty years ago, I made a commitment to readers: “I’ll call it as I see it - and let the chips fall where they will.” Over the years, I made a further commitment to myself: Don’t be concerned with reputation – stay diligently focused on analytical integrity.
I attach this odd intro to “Issues 2019” recognizing this is a year where I could look quite foolish. I believe Global Financial Crisis is the Paramount Issue 2019. Last year saw the bursting of a historic global Bubble, Crisis Dynamics commencing with the blow-up of “short vol” strategies and attendant market instabilities. Crisis Dynamics proceeded to engulf the global “Periphery” (Argentina, Turkey, EM, more generally, and China). Receiving a transitory liquidity boost courtesy of the faltering “Periphery,” speculative Bubbles at “Core” U.S. securities markets succumbed to blow-off excess. Crisis Dynamics finally engulfed a vulnerable “Core” during 2018’s tumultuous fourth quarter.
As we begin a new year, rallying risk markets engender optimism. The storm has passed, it is believed. Especially with the Fed’s early winding down of rate “normalization”, there’s no reason why the great bull market can’t be resuscitated and extended. The U.S. economy remains reasonably strong, while Beijing has China’s slowdown well under control. A trade deal would reduce uncertainty, creating a positive boost for markets and economies. With markets stabilized, the EM boom can get back on track. As always, upside volatility reenergizes market bullishness.
I titled Issues 2018 “Market Structure.” I fully anticipate Market Structure to remain a key Issue 2019. Trend-following strategies will continue to foment volatility and instability. U.S. securities markets rallied throughout the summer of 2018 in the face of a deteriorating fundamental backdrop. That rally, surely fueled by ETF flows and derivatives strategies, exacerbated fragilities. Speculative flows fueling the upside destabilization eventually reversed course - and market illiquidity soon followed. Yet short squeezes and the unwind of market hedges create the firepower for abrupt rallies and extreme shifts in market sentiment.
Market Illiquidity is a key Issue 2019. Its Wildness Lies in Wait. Rallying risk markets create their own liquidity, with speculative leverage and derivative strategies in particular generating self-reinforcing liquidity. Recovering stock prices ensure bouts of optimism, along with confidence that robust markets enjoy liquidity abundance. Problem arise with market downdrafts and De-Risking/Deleveraging Dynamics. Rally-induced optimism feeds unreasonable expectations and eventual disappointment.
Crisis Dynamics tend to be a process. There’s the manic phase followed by some type of shock. There’s at least a partial recovery and a return of optimism – bolstered by dovish central bankers. It’s the second major leg down when things turn more serious – for sentiment, for market dynamics and illiquidity. Disappointment turns to disenchantment and, eventually, revulsion. It’s been a long time since market participants were tested by a prolonged, grinding bear market.
The February 2018 “short vol” blowup was a harbinger of trouble to come. I believe the January 3, 2019 “flash crash” portends serious Issues 2019 in global currency markets. An 8% intraday move in the yen vs. Australian dollar exposed problematic liquidity dynamics. Last year, the “short vol” market signal was initially dismissed then soon forgotten. The recent currency market “flash crash” is an ominous development of potentially momentous significance.
Our so-called “king dollar” is indicating some vulnerability to begin the new year. Newfound Fed dovishness has caught many traders too long the U.S. currency and short the yen, Canadian dollar, renminbi and EM currencies more generally. A clash among a band of fundamentally weak currencies is a critical Issue 2019. When the current currency market short squeeze runs its course, I see a marketplace that’s lost its bearings. A new global currency regime of extraordinary uncertainty, instability and volatility is an Issue 2019. This unsettled new regime is not conducive to speculative leverage.
The U.S. dollar has serious fundamental issues: Trillion-dollar fiscal deficits; large structural Current Account Deficits; huge government, corporate and household debt loads; fragile securities markets; a maladjusted Bubble Economy; political dysfunction and, potentially, Washington chaos; and festering geopolitical risks.
The world’s reserve currency is fundamentally unsound. The dollar is also the nucleus for a financial apparatus financing much of the world’s levered speculative holdings. De-risking/Deleveraging Dynamics in 2018 saw waning liquidity and widening funding and hedging costs in the entangled world of dollar funding markets. With the likes of Goldman Sachs and Deutsche Bank seeing CDS prices rise significantly late in 2018, mounting systemic fragility would appear a serious Issue 2019.
China’s currency has serious fundamental issues: A vulnerable banking system approaching $40 TN of assets (more than quadrupling since the crisis), with Trillions of potentially suspect loans; a troubled “shadow” banking apparatus; an historic housing Bubble with an estimated 65 million vacant units; a deeply maladjusted economic structure; Bubble economic and financial structures dependent upon ongoing loose financial conditions and rapid Credit expansion; huge financial and economic exposures to the emerging markets and the global economy more generally; a population with significantly elevated expectations prone to disappointment and dissatisfaction; and mounting geopolitical risks. In short, China’s historic Bubble is increasingly susceptible to a disorderly collapse.
Hong Kong’s Hang Seng China H-Financial Index dropped 18% in 2018, although China’s banks outperformed the 28% fall in Japan’s TOPIX Bank Index. I would tend to see Asia finance as especially vulnerable to the unfolding global Bubble collapse. Waning confidence in the region’s financial stability would portend acute currency market instability. China’s currency is especially vulnerable to capital flight and the imposition of draconian capital controls. The big unknown is how much “hot money” and leverage has accumulated in Chinese markets. The Indonesia rupiah remains vulnerable to tightening global finance. I worry about India’s banking system after years of Bubble excess. I have concerns for the region’s financial institutions generally. The stability of the perceived stable Hong Kong and Singapore dollars is on the list of Issues 2019.
Fragile Asian finance has company. Italian banks sank 30% in 2018, slightly outperforming the 28% drop in European bank shares (STOXX 600). Italy’s 10-year yields traded to 3.72% in late-November, before ending the year at 2.74% (up 73bps in ’18). Italian – hence European – stability is an Issue 2019.
I believe a problematic crisis is likely to unfold in 2019, perhaps sparked by dislocation in Italian debt markets and the resulting crisis of confidence in Italy’s fragile banking system. Serious de-risking/deleveraging in Italian debt would surely see contagion in the vulnerable European periphery – including Greece, Spain and Portugal. Italy’s Target2 balances (liabilities to other eurozone central banks) almost reached $500 billion in 2018. Heightened social and political instability would appear a major Issue 2019, not coincidental with the end of ECB liquidity operations. Draghi kicked the can down the road. Markets, economies, politicians and protestors have about reached the can.
A crisis of confidence in Europe would ensure problematic currency market instability. Such a scenario would portent difficulties for vulnerable “developing” Eastern European markets and economies. Many economies would appear vulnerable to being locked out of global financing markets. A full-fledged financial crisis engulfing Turkey cannot be ruled out. Last year saw significant currency weakness also in the Russian ruble, Iceland krona, Hungarian forint and Polish zloty. I would see 2018 difficulties as a harbinger of much greater challenges ahead.
Bubbles are mechanism of wealth redistribution and destruction. This reality has been at the foundation of my ongoing deep worries for the consequences of history’s greatest global Bubble. We’ve witnessed the social angst, a deeply divided country and waning confidence in U.S. institutions following the collapse of the mortgage finance Bubble. I fear that the Bubble over the past decade has greatly increased the likelihood of geopolitical tensions and conflict. Aspects of this risk began to manifest in 2018, as fissures developed in the global Bubble. Geopolitical conflict is a critical Issue 2019. Trade relations are clearly front and center. Going forward, I don’t believe we can disregard escalating risks of military confrontation.
Bubbles inflate many things, including expectations. I worry that the protracted Chinese Bubble has so inflated expectations throughout China’s large population. With serious cracks in their Bubble, Beijing will continue to craft a strategy of casting blame on the U.S. (and the “west”). The administration’s hard line creates a convenient narrative: Trump and the U.S. are trying to hold back China’s advancement and ascendency to global superpower status. A faltering Bubble and deteriorating situation in China present Chinese leadership a not inconvenient time to confront the hostile U.S. The South China Sea and Taiwan could loom large as surprise flashpoint Issues 2019.
There are a number of potential geopolitical flashpoints. Without delving into detail, I would say generally that geopolitical risks will continue to rise rapidly in the post-Bubble backdrop. Issues easily disregarded during the Bubble expansion (i.e. the Middle East, Russia, Ukraine, Iran, etc.) may in total become more pressing Issues 2019. I can see a scenario where the U.S. is spending significantly more on national defense in the not too distant future.
“Chairman Powell ‘very worried’ about massive debt” was an early-2019 headline. I believe the U.S. Treasury market in 2018 hinted at a momentous change in Market Dynamics. And while a bout of “risk off” and a powerful short squeeze fueled a big year-end rally, there were times when Treasuries’ traditional safe haven appeal seemed to have lost some luster. The unfolding bursting Bubble predicament turns even more problematic if ever Treasury yields rise concurrently with faltering risk markets. Such a scenario seemed more realistic in 2018. With huge and expanding deficits as far as the eye can see, the suspect dollar and mounting geopolitical tensions, the potential for a disorderly rise in Treasury yields is a potential surprise Issue 2019.
Whether Treasury yields surprise on the upside or fall further in an unfolding crisis backdrop, U.S. corporate Credit is a pressing Issue 2019. Thursday (Jan. 10) ended a 40-day drought in junk bond issuance (longest stretch since at least 1995). Both high-yield and investment-grade funds suffered major redemptions in late-2018, exposing how abruptly financial conditions can tighten throughout corporate finance. Fueling liquidity abundance throughout the boom, ETF flows were exposed as a critical market risk.
Flows for years been dominated by trend-following and performance-chasing strategies on the upside. The reversal of bullish speculative flows was joined in late-2018 by speculative shorting and hedging-related selling. Liquidity abundance abruptly transformed into unmanageable selling pressure and acute illiquidity. Pernicious Market Structure was exposed and, outside of short squeezes and fleeting bouts of optimism, I believe putting the ETF humpty dumpty back together again will prove difficult. The misperception of ETF “moneyness” is being cracked wide open.
Enormous leverage has accumulated throughout corporate Credit over the past decade. This portends negative surprises and challenges in the unfolding backdrop. At this point, I’ll assume some type of trade agreement is cobbled together with the Chinese. This might provide near-term support for the markets and global economy. But I don’t believe a trade agreement would fundamentally change the backdrop of faltering global financial and economic Bubbles.
Expect ongoing global pressure on leveraged speculation. As an industry, the hedge funds did not experience huge redemptions in 2018. I expect redemptions and fund closures to be a significant issue following the next bout of serious de-risking/deleveraging. A similar dynamic could be expected for the ETF complex. Late-2018 outflows were likely just a warmup for the type of destabilizing flows possible in a panic environment.
In my view, an important interplay evolved during this protracted cycle between the ETF complex and a booming derivatives marketplace. Reliable inflows and abundant liquidity in the ETF universe created an advantageous backdrop for structuring and trading various derivatives strategies. This seemingly symbiotic relationship has run its course. The now highly uncertain ETF flow backdrop translates into a potentially problematic liquidity dynamic for derivative-related trading. ETF outflows pose risk to derivatives strategies, and a derivatives-induced market dislocation risks destroying investor faith in the liquidity and safety of ETF passive “investing.”
The possibility of a 1987-style “portfolio insurance” debacle except on a grander – global, multi-asset class - scale is an Issue 2019. The U.S. economy has vulnerabilities. Yet Unsound Finance is a predominant Issue 2019. Outside of possible dreadful geopolitical developments, I would argue that the key major risk for 2019 is the seizing up of global markets. Unprecedented amounts of risks have accumulated across markets around the globe. Consider a particularly problematic scenario: a major de-risking/deleveraging episode sparks upheaval and illiquidity across currencies, equities and fixed-income markets. Such a scenario might incite a crisis of confidence in major global financial institutions, including derivatives markets and counterparties. Central bankers better not disappoint.
Last week’s dovish turn by Chairman Powell broke the bearish spell and reversed markets higher, though this came weeks late in the eyes of most market participants. “We know that long periods of suppressed volatility can lead to the build-up of risks and to a disruptive ending, and the idea that monetary policy can ignore that and leave it to macroprudential tools just is not credible to me.” This prescient comment (released Friday) is extracted from 2013 Federal Reserve transcripts. Governor Powell at the time clearly had a firmer grasp of the risks associated with QE than chairman Bernanke and future chair Yellen.
It is my long-held view that the Fed (and the other major central banks) will see no alternative than to resort to QE when global markets “seize up.” Ten-year Treasury yields at 2.70%, German bund yields at 22 bps and JGBs at zero don’t seem inconsistent with this view. It’s been a decade (or three) of Monetary Disorder. Now come the consequences, commencing with acute market and price instability. I believe this instability will end in a serious and prolonged crisis. There will be policy interventions, of course. But it will become increasingly clear that flawed monetary doctrine and policies are more the problem than the solution. In an increasingly acrimonious world, how closely will policymakers coordinate crisis responses? Will central bankers stick with “whatever it takes”? How quickly will they react to the markets – and with how much firepower? Uncertainty associated with monetary policymaking in a global crisis environment is an Issue 2019.
THE WORLD´S ECONOMY IS COOLING OFF(BUT IT´S NOT ALL BAD) - PART I: UNITED STATES / SEEKING ALPHA
The World's Economy Is Cooling Off (But It's Not All Bad) - Part I: United States
- It's important to remember that the state of the economy and the behavior of the market aren't necessarily walking hand-in-hand.
- Like anything else in life, there are also pros and cons in the US economy, and this is not a black-or-white type of article.
- Having said that, it certainly seems/feels like there are more from the latter.
Investment Thesis
- Only a few weeks post the market entering a bear market territory. While a bear market doesn't automatically/necessarily lead to a recession - this isn't something that should be easily dismissed.
- Still seeing parts of the yield curve inverting, especially the up tenors up to five years. Once again, although a full inverted yield (usually measured by the 2s10s spread) is neither certain nor guaranteeing a recession - a 10-2 inversion is a very reliable indicator and, if and when we get there, investors should be very mindful of it.
- Keep getting mostly negative/"broken" economic data. As this article suggests, there are many areas within the world's economy (generally speaking) and the US (specifically) that need to be addressed.
- From a more aggressive approach to being more defensive.
- Less growth (e.g. technology), more income (e.g. REITs).
- Reducing risk and HY, adding safety and IG.
- Dumping long-duration, focus on short-to-medium duration and relatively shorter tenors/intervals.
- Increasing the floating-rate exposure at the expense of fixed-rate.
- Employing more hedges by using pair trades, option-trading, and short selling.



Five Signs that Things Aren't that Bad After All


- more people than expected are having a job;
- people are getting paid more than expected (as well as more that the rise of inflation);
- higher wages are translated into more money to be spent by consumers;
- more people are attracted (back) to the labor market, thus increasing the participation rate; and
- increasing unemployment rate is reducing (or at least keeping potential) inflationary pressures in check.


CHINA STEPS UP FISCAL SPENDING AS IT APPROVES $125BN OF RAIL PROJECTS / THE FINANCIAL TIMES
China steps up fiscal spending as it approves $125bn of rail projects
Measure aimed at boosting economy highlights fears about slowing growth
Tom Hancock in Shanghái
China will add 6,800km of rail lines this year © Reuters
China has approved new rail projects worth more than $125bn in the past month as it steps up fiscal spending to counteract a slowdown in its economy, a move that could give Beijing more breathing space in its trade confrontation with Washington.
The National Development and Reform Commission, China’s top planning agency, has approved urban rail projects in eight cities and regions worth a total of Rmb860bn ($125bn) since December 5, according to official statements.
The investment drive comes as Washington and Beijing on Monday began their first face-to-face talks since presidents Donald Trump and Xi Jinping agreed a trade truce at the G20 Summit in Buenos Aires late last year.
It also highlights Beijing’s fears about slowing growth, with official data last week showing the first monthly contraction in manufacturing activity since 2016, and China’s central bank issuing its largest cut to bank reserve requirements in over a year.
China will add 6,800km of rail lines this year, a 40 per cent increase from the amount added last year, said the state-run China Railway Corp. The plans include 3,200km of high-speed rail.
The surge in project approvals is in dramatic contrast with the beginning of 2018, when Beijing abruptly cancelled subway lines in several cities to slow the growth of local government debt.
Beijing has signalled an easing of its deleveraging drive in recent months, after investment growth in fixed assets fell to the lowest rate on record, and retail spending growth slowed to its slowest pace in 15 years.
Cheng Shi, chief economist at the international division of Chinese bank ICBC, wrote in a note this month that he expected four separate cuts to bank reserve requirements this year, the same number as in 2018. “In 2019, fiscal policy will replace monetary policy to become the main tool to manage short-term demand,” he said.
ING predicts Beijing will unleash a Rmb4tn fiscal stimulus this year, which will help cushion downward pressure on demand from the trade war with Washington. “Though some fiscal money will be used for debt repayment and loan rollovers, the rest will go into infrastructure projects, which will support manufacturing activities, even if the trade war continues to escalate,” said Iris Pang, the Dutch bank’s chief China economist.
Among the projects approved, Shanghai will add six subway lines and three inter-city rail lines priced at Rmb298bn, while the city of Wuhan in central China will add four subway lines and four inter-city lines costing Rmb147bn. Jiangsu province in east China will build Rmb218bn of inter-city lines as it seeks to connect its urban centres with populations above 200,000. Half of the spending will be funded by tax revenue and equity financing, the NDRC said, with the remainder coming from bank loans and other debt.
China has in the past decade constructed some of the world’s most advanced infrastructure — including the longest high speed rail network of any country, covering more than 25,000km — meaning future projects will face diminishing returns.
While China accounted for 30 per cent of global city rail at the end of last year by track length, it accounted for only a quarter of ridership, a sign that some lines were underused, according to the International Association of Public Transport.
But some economists argue that there is room for accelerated infrastructure spending. “China has over-invested in industrial infrastructure, but I do not think it has over invested in infrastructure overall,” said Bo Zhuang, China economist at TS Lombard in Beijing. “It is under-invested in urban and consumption related infrastructure, urban metros, sanitisation, and anything to do with urban services.”
Why the Fed Backed Off on Interest Rates
By Randall W. Forsyth
Federal Reserve Chairman Jerome Powell at the Economic Club of Washington, D.C., on Jan. 10. Photography by Win McNamee/Saul Loeb/AFP/Getty Images
If a foolish consistency is the hobgoblin of little minds, as Emerson famously wrote, the Federal Reserve under Jerome Powell has proved itself to be eminently broad-minded.
Already in this new year, the Fed chairman has emphasized the central bank’s willingness to be patient in raising interest rates while indicating some flexibility on the pace of reduction of its balance sheet. That represented a reversal from expectations that there would be two rate increases of one-quarter percent in 2019 and that the reduction of the central bank’s assets was to proceed on autopilot.
The alleged Fed flip-flop appeared to stem from the vicious late-2018 selloff in risk assets, notably in the stock market. After the new year got off on the wrong foot, with a 660-point plunge in the Dow Jones Industrial Average on Jan. 3, Powell changed his tune in an appearance on Jan. 4 with his two immediate predecessors, Janet Yellen and Ben Bernanke.
The market value of U.S. stocks jumped by about $1.1 trillion in the first six trading sessions of 2019, or some 3.85%, according to Wilshire Associates, which topped the previous record early-year spurt of $1 trillion gained in the first eight sessions of 2018.
Good news, right? Not to some critics who accused the Fed, and Powell in particular, of kowtowing to the equity markets.
“James Carville’s endlessly repeated witticism about wanting to come back to earth as the bond market because the bond market bosses everybody around is as dated today as the Clinton presidency. It’s the stock market that a politically ambitious person would choose to become in a second life,” writes Jim Grant, editor of Grant’s Interest Rate Observer and a Barron’s alumnus.
Danielle DiMartino Booth blasts Powell for “groveling to whiny investors.” Early in his tenure as a Fed governor, back in 2012, Powell said that the central bank should not protect them from losses. Writing in her Money Strong newsletter, Booth also deemed especially galling “the deference, the flattery, the accolades he showered on Bernanke and Yellen,” given the former Fed chiefs’ previous apparent willingness to alter policy when stocks actually failed to rise all the time.
Stephanie Pomboy, channeling the Who’s Pete Townshend, tersely wrote in her MacroMavens missive: “We can now invest with confidence that the new boss is, in fact, the same as the old boss.”
In other words, the Fed “put” option—an insurance policy against losses provided by the central bank by easing money whenever stocks and other risk assets tank, originated by former Fed chief Alan Greenspan in the October 1987 crash—lives on. “Risk is dead. BTFD,” she concludes. (Google that acronym if you’re not already familiar with it.)
To these illustrious observers of finance and economics, we must demur. The policies of the Fed (along with those of other central banks) were draining global liquidity, spreading asset deflation, and threatening the long-run U.S. economic expansion and shaky economies abroad.
The stock market’s capitalization swelled by $9.2 trillion at its peak after Donald Trump’s election victory in November 2016, writes Scott Anderson, chief economist of Bank of the West, a unit of BNP Paribas .But since the market’s September highs, some $4.5 trillion of investor gains have been wiped out in three months. “What starts on Wall Street, rarely stays on Wall Street,” he contends.
Consumer confidence, while high by historical standards, has begun to ebb and could fall further as the losses sink in—probably with the receipt of year-end statements. Based on the historic wealth effect of a drop between two and five cents for every dollar lost in wealth, Anderson’s back-of-the-envelope calculations suggest consumers could cut spending by $90 billion to $225 billion.
The wealth drag could lower real consumer spending by 0.7-to-1.7 percentage points, to a sluggish growth rate of 0.5%-1.5%, measured from the fourth quarter of 2018 to the fourth quarter of 2019.
“In short, the real-world economic impacts from the stock market carnage could be substantial and may fundamentally alter the U.S. economic outlook over the coming year if sustained,” Anderson writes in a research note. The earnings warning from Macy’s(ticker: M), whose shares plunged more than 17% on Thursday, may be more significant when viewed against that backdrop, he adds. Little wonder the Fed adopted a more dovish tone following the stock selloff, he concludes.
The most recent precedent for the Fed pausing in its policy tightening would be in 2016. Following its initial lift in rates from near-zero in December 2015, the central bank was expected to raise its federal-funds target range four more times in quarter-point increments in the next year. But those plans changed with the slide in stocks and speculative-grade bonds. Then, in June 2016, came the Brexit vote and the ensuing market upheavals. Only after the U.S. elections, and the ensuing rebound in stocks, did the Fed resume raising rates.
But the closest analog to the recent stock swoon appears to be the bear market from October 1956 to October 1957, according to Jeffrey deGraaf, who heads Renaissance Macro Research. That presaged the “Eisenhower recession” of August 1957 to April 1958, when gross domestic product plunged 10.4% and unemployment soared to 7.4% from 4.1%, he writes.
That inspired me to take my tattered copy of A Monetary History of the United States: 1867-1960, the monumental work by Milton Friedman and Anna J. Schwartz, from the bookshelf. They wrote that the Fed raised interest rates from 1955 until August 1957, when the recession had already begun and the bear market was well along. By November 1957, the central bank did an about-face and began cutting rates. Moreover, Friedman and Schwartz wrote, the Fed began to buy government securities—what is now called quantitative easing—in March 1958 at the most vigorous pace since during the Great Depression in 1931. The recession bottomed in the next month, attesting to the impact of QE.
In contrast, deGraaf finds, the cumulative balance sheets of the world’s major central banks—not just the Fed, but the People’s Bank of China, the Bank of Japan, the European Central Bank, plus some smaller actors—have been shrinking at nearly a 5% annual rate. That is the largest contraction since the “great experiment” in monetary expansion began with the financial crisis.
Morgan Stanleyeconomists say the shrinkage in the Fed’s balance sheet played an important role in the volatility of asset markets in late 2018. As a result, they expect the Federal Reserve to end the “normalization” of its asset holdings by next September—earlier than most expect.
The reasons extend beyond the stock market swoon, however. Steven Ricchiuto, U.S. chief economist at Mizuho Securities, writes in a client note that the reduction of the Fed’s balance sheet, to just over $4 trillion from a peak of $4.4 trillion in October 2017, has shrunk excess reserves in the banking system far more, by $1 trillion.
That has forced foreign banks, the main holders of these excess reserves, to find alternative funding sources and push up money-market rates, which boosts borrowing costs for businesses and consumers. Ricchiuto says this rise supports his contention that the Fed should slow its balance-sheet contraction by March, at the latest.
Powell has observed on several occasions that the past three recessions haven’t been caused by inflation, leading the Fed to tighten, but by financial accidents—most recently, the financial crisis of 2008 and the dot-com bubble at the end of the last century.
Some may call it a flip-flop, but avoiding another unforced policy error seems like the right decision.
The partial shutdown of the Federal government dominates the news, but has so far had minimal market impact, even as 800,000 government workers failed to receive regular paychecks on Friday. Capital Economics estimates the impact of the temporary income loss may be small, but the data-dependent Fed and investors won’t have numbers like December’s retail sales and housing starts as scheduled.
The Labor Department is still open, so the key employment data should be collected, but the shutdown will skew the January numbers. Some 380,000 federal workers are furloughed, which means they will be classified as unemployed in the survey of households, from which the jobless rate is derived, according to JPMorgan economist Daniel Silver. The closely watched payroll data could also reflect a drop of 380,000 government employees and print a negative number.
The knock-on effects of federal workers’ cutting spending will likely depend on how long the shutdown drags on. Greg Valliere, chief global strategist at Horizon Investments, thinks a deal may come by the end of this coming week as the suffering extends to air-traffic controllers to FBI employees to farmers failing to receive subsidy payments.
Beyond the economic effects, the impasse between President Trump and congressional Democrats offers a dismal preview of divided government. The next test will be passage of a new debt ceiling when the present suspension ends on March 1, Northern Trust economists write. When the debt limit was used as a political football in 2011, the U.S. suffered its first-ever credit downgrade, resulting in a market rout.
Jay Taylor: Gold Is The Go-To Safe Haven Of 2019
by John Rubino
Which Safe Haven Markets Will Dominate in 2019?
If we are, as I believe, on the precipice of a major decline in stocks, the question in my mind as we head into 2019 is to what extent U.S. Treasuries will continue to be the main go-to market in the risk-off trade and to what extent might a loss of confidence in the dollar as the world’s reserve currency lead to a rise in the price of gold?
The answer requires an examination of likely flows of money in 2019 and beyond, and those flows are very much determined by the point at which we exist in the current credit cycle.
We are in one of the longest credit cycles on record, with 2018 being the tenth year of expansion. GoldMoney’s Alasdair Macleod quite correctly points out that in the late stages of the credit cycle money flows out of the financial sector into the real economy and with the flow out of financial assets, interest rates begin to rise.
10-Year U.S. Treasury yields rose from 1.385% on July 5, 2016, to 3.227% on October 1, 2018. The 10-year rate has corrected to 2.652% as of this writing, but it is clear that with the real economy doing better, interest rates have risen, which in turn has put downward pressure on stocks. With increased volatility in U.S. equities, the recent decline in rates reflects the safe haven risk off attitude.
But should we take it as a given, as most mainstream analysts do, that a flow out of stocks automatically means the only safety bunker to hide out in when stocks collapse is the U.S. Treasury market? The answer is an unequivocal “NO!” As Alasdair points out, in the late stages of a credit cycle, Main Street bids the total flows of money away from financial assets. So yes, some money has flowed from stocks to U.S. Treasuries in the latest equity market decline, thus providing the “correction” noted above since October 2018 in the 10-Year Treasury. But the point remains that in the late stages of the credit cycle, less money flows into financial assets, thus causing their prices to decline.
Once a major crash occurs and a new round of QE is administered, a new cycle usually begins. But can we assume that will happen again, especially with the existing credit cycle bubble, which is now the biggest global bubble yet by far?
Given its confidence in the ability of the PhD standard to replace the gold standard, mainstream pundits assume the U.S. Treasury market is better than gold. And the standard answer to my question is a resounding “Yes!” Taylor, can’t you see the performance of geniuses like Greenspan and Bernanke? Well, this 71-year-old author is old enough to remember when the gods of money were not able to hold the system together. During the late 1970s, there was a massive exodus from both stocks and bonds, while at the same time, gold rose from $35 to a momentary $850 price tag.
Might we now be facing a replay of the late 1970s when confidence is lost in the government’s ability to repay its debt obligations? And given the magnitude of much greater debt and debt to GDP ratios, might the pathology be many, many times greater than the late 1970s when confidence was lost in the dollar and gold skyrocketed from $38 to $850 in just a couple of years? Alasdair noted in his January 3 missive that “The credibility of government debt is based on the assumption the issuer can afford to continue to roll it over rather than repay it.”
Everyone knows the U.S. debt of $22 trillion will never be repaid, but at present the assumption remains that it can always be rolled over. But that assumption was lost in the late 1970s after Nixon removed the gold standard from international trade and the U.S. began printing mountains of dollars out of thin air to pay for socialism and Vietnam. Years of con-artistry since then by Keynesian central banks have left most investors confident that elitist bankers can always save the day.
But now take a look at the exponential level of debt since the late 1970s until now and note how much faster debt is growing relative to GDP (yellow line). You don’t have to be a rocket scientist to realize at some point if debt is growing exponentially and income (GDP) on at some low level of linear growth, a day of bankruptcy lies ahead. Yet with each bubble, the U.S. continues to pile more debt upon debt, and the ratio of Debt to GDP continues to grow still further.
Over time, more and more debt-based money becomes less productive and eventually counterproductive so that the more debt owed, the less income is generated. We are clearly at the counter-productive level now, not only because of mal investment that occurs with artificially low interest rates, but also because the cost of servicing the debt becomes greater and greater at the expense of productive use of capital. What happens is that income declines to such an extent that the only way debt can be serviced is one of two ways: (1) Either rates must rise to levels that reward savers, resulting in horrendous depression, necessary to set the table for long-term honest growth; or (2) Governments/central banks engage in hyperinflationary money growth that totally destroys the fabric of society and sets the stage for radical changes of government. I believe the U.S. is at such a crucial point of time now.
In the 1970s when double digit interest rates were required to dampen rising levels of inflation, the problems faced by then Chairman Volcker were “kids’ stuff” compared to the problems Jay Powell faces now. Even so, Treasury rates north of 12% were required to dampen excess consumption caused by excess government spending and a lack of monetary discipline by the Fed, which was pushed by President Nixon, much as President Trump is pushing Jay Powell now. But the Federal debt then was just a few hundred billion dollars, not $22 trillion as it is now! A mere 1% rise in interest rates now leads to $220 billion of additional government expense, without the government providing any additional services! To add to the problems of Jay Powell, the U.S. continues to spend trillions on wasteful military excursions, and aging baby boomers are now leading to a spiral of debt, taking the U.S. debt levels north of $50 trillion over the next 30 years.
But that’s not all. In the past, the U.S. has gotten away with living beyond its means because foreigners like Japan and China have been willing and even eager to buy U.S. Treasuries. That began to change in earnest with the financial crisis of 2008 in no small part because of the financial injury to foreigners by dishonest U.S. bankers. Also, the rest of the world was then realizing that the U.S. Empire was expanding to the point where bankruptcy lay at some point in its not-too-distant future.
So now late in the current credit cycle, we are going to face a moment of truth. With interest rates far from anything like the double digits of the late 1970s and with a declining appetite to own U.S. Treasuries by foreigners, we are seeing rates rise rather dramatically, leading to massive volatility in stocks and the beginning of a very painful bear market in equities. At some point, history suggests that the Fed will begin to print money in whatever quantity it takes to keep the banks from going bankrupt, just as they did in 2008-09. The big question is, at what point is it obvious that the Emperor is wearing no clothes and there are no longer any takers of U.S. Treasuries, causing the Fed to print so much money so rapidly that foreigners completely abandon the dollar, leaving the Fed with no choice but to hyper-inflate?
Given the timing of the current credit cycle, we are nearing a point in time when either the Fed is somehow able to hold the dollar system together for another cycle or the system itself blows up or implodes, leading to a new global monetary regime.
In the optimistic scenario gold is likely to behave as it did after 2008, when it rose for the next four years. If my more pessimistic (but very realistic) possible outcome takes place, the dollar will be replaced as the world’s reserve currency and gold will be the only safe haven, leaving it priced at levels in terms of dollars that may be beyond the imagination of even the craziest gold bugs. It’s simple math: if the dollar nears a state of worthlessness, gold rises to levels approaching infinity.
How Brazil Outgrew Mercosur
By Allison Fedirka
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Bienvenida
Les doy cordialmente la bienvenida a este Blog informativo con artículos, análisis y comentarios de publicaciones especializadas y especialmente seleccionadas, principalmente sobre temas económicos, financieros y políticos de actualidad, que esperamos y deseamos, sean de su máximo interés, utilidad y conveniencia.
Pensamos que solo comprendiendo cabalmente el presente, es que podemos proyectarnos acertadamente hacia el futuro.
Gonzalo Raffo de Lavalle
Friedrich Nietzsche
Quien conoce su ignorancia revela la mas profunda sabiduría. Quien ignora su ignorancia vive en la mas profunda ilusión.
Lao Tse
“There are decades when nothing happens and there are weeks when decades happen.”
Vladimir Ilyich Lenin
You only find out who is swimming naked when the tide goes out.
Warren Buffett
No soy alguien que sabe, sino alguien que busca.
FOZ
Only Gold is money. Everything else is debt.
J.P. Morgan
Las grandes almas tienen voluntades; las débiles tan solo deseos.
Proverbio Chino
Quien no lo ha dado todo no ha dado nada.
Helenio Herrera
History repeats itself, first as tragedy, second as farce.
Karl Marx
If you know the other and know yourself, you need not fear the result of a hundred battles.
Sun Tzu
Paulo Coelho

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