Power
Doug Nolan
Chair Powell’s post-meeting press conferences always leave me wanting for some probing questions.
It’s as if journalists abide by an unwritten rule to avoid anything contentious.
I found Thursday’s Q&A session sponsored by the Dallas Regional Chamber – and moderated by The Washington Post’s Catherine Rampell – more satisfying and pertinent enough for CBB attention.
Rampell:
“In addition to the potential long-term risks that higher deficits and debt present for growth, are there also risks to the functionality of the Treasury market – when shocks hit the market and, if so, how might the Fed respond?”
Chair Powell:
“The functioning of the Treasury market is incredibly important, and it does function very well.
It’s the most liquid and most important, probably, financial market in the world - certainly one of the most important.
At the beginning of the pandemic, the Treasury market lost function.
Normally, in an emergency, money flies into the Treasury market.
But the pandemic was such an unusual event, people didn’t want to own long-term securities.
They only wanted to own, effectively, cash.
We had to jump in and support that.
I think more broadly than that, it’s just important that the Treasury market remain well-regulated and that companies have an incentive to do intermediation in the Treasury market.
It’s relatively low risk.
It’s very important for the economy.
It’s important that that be the case.”
Rampell:
“In the March 2020 episode that you’re referring to, the Fed ultimately had to step in as a lender of last resort.
Would the Fed do that if there were similar disruptions in the initial issuance of Treasuries – that was in the secondary market…?”
Powell:
“We’re not a fiscal actor.
We have a mandate that we share with other agencies to look after financial stability.
Part of that is if really important markets break down – and they all kind of broke down at the beginning of the pandemic.
They just stopped working.
We set up a series of facilities to backstop those markets.
But they actually didn’t get used because just the fact that we had the facilities restored credibility and the markets started working on their own.
It was remarkable.
In the case of a financial stability event like that – or the global financial crisis where really the whole global financial system was at risk given the failure of a number of large financial institutions around the world.
In those kinds of things, we can use these emergency tools.
But they’re not for every event.
They’re really for financial stability events.”
While market attention is understandably fixated on Trump administration nominations and policy focus, there is no more important – and potentially pressing – issue than Treasury market function.
For starters, Powell at least acknowledged the financial stability mandate, the Fed’s overarching responsibility that, especially lately, has been given short shrift to maximum employment and stable prices.
As I’ve written in the past, Powell is a “good man.”
I went out of my way to support him early in his chairmanship, expecting the Fed Chair to be tarred and feathered for a big crisis mainly the result of actions and doctrine made by his predecessors Greenspan, Bernanke, and Yellen.
But when your central bank prints $5 TN, maintains excessively low rates, disregards monumental financial stability risks (i.e., market Bubbles, manias, egregious leverage), and accommodates spikes in consumer prices and national debt, well, you’ve ensured your place in history.
A Trillion plus Treasury “basis trade” (and multi-Trillion “carry trades” and other speculative leverage) poses a grave threat to financial stability.
Today’s unprecedented Treasury market leverage is a direct consequence of the Fed bailing out the “basis trade” players in March 2020.
While I guess Powell can claim that the Fed’s backstop facilities “actually didn’t get used” - “it was remarkable,” but surely the Fed Chair hasn’t forgotten that Federal Reserve assets ballooned (a remarkable) almost $3 TN in the first 14 weeks of the pandemic crisis.
It was a full-scale market – including Treasuries and “basis trade” leverage – bailout without parallel.
Powell’s answer to the Treasury market function question was telling.
He suggests that the breakdown in long-term Treasury market function was because the “pandemic was such an unusual event.”
But the critical issue was that Covid hit after a major increase in speculative leverage – “basis trades” and otherwise – following the Fed’s misguided summer of 2019 rate cuts and, importantly, restart of QE in response to “repo” market instability.
Speculative leverage creates fragility – and “basis trades,” in particular, are egregiously levered.
Of course, the Fed will do whatever it takes to thwart financial collapse – an issue that takes on great prominence late in the cycle.
But at least adopt an aggressive regulatory posture once crisis dynamics have subsided.
Powell paid lip service to “well-regulated.”
More interestingly, he stated it was important “companies have an incentive to do intermediation in the Treasury market.”
Inquisitive minds want to know: Does the Fed see the highly levered “basis trade” players providing an intermediation function?
I’m reminded of how, in the early nineties, Alan Greenspan slashed rates and manipulated the yield curve to help recapitalize an impaired (post-eighties Bubble) banking system.
An unusually steep yield curve provided a windfall for the fledgling leveraged speculating community.
Essentially, Greenspan realized that hedge fund and Wall Street speculative leverage provided powerful impetus to Credit growth, asset inflation, and economic activity.
Incredibly powerful forces were unleashed that would go on to propagate three decades of serial boom and bust dynamics, with each bursting Bubble triggering only more powerful reflationary measures.
It seemed so beneficial – and innocuous – such a pragmatic expedient.
“Free markets” just needed some occasional support.
Central banker souls were sold: inflationism.
Rampell:
“Do we get to a point where deficits and debt get so high that it makes your job harder essentially – that it makes it harder for the Fed to achieve its goals?”
Powell:
“We’re not at that point know.
I want to be clear.
We’re not in anyway taking into account fiscal issues when we…
Let me say it this way, the debt issue is not an issue that is guiding our judgements…
As I’ve often said, and as all of my predecessors have noted, the U.S. federal government budget is on an unsustainable path.
It’s not that the debt we have is at an unsustainable level.
It’s not.
It’s that we’re on a path that’s not going to be unsustainable.”
Quickly could be.
Questions regarding the sustainability of federal debt become a pressing issue come the next serious bout of de-risking/deleveraging and unwind of “basis trade” leverage.
Levered “basis trade” funding of deficit spending is not only unsustainable, but it also creates major systemic vulnerability.
The current extraordinary backdrop argues loudly against complacency.
November 14 – Wall Street Journal (Peggy Noonan):
“The first wave of nominees to the Trump administration announced this week included normal Republicans…
But the second wave—it is impossible to tell if Mr. Trump is announcing appointments or trolling his enemies.
Pete Hegseth as defense secretary?
This is unserious and deeply alarming…
As for Matt Gaetz being nominated as attorney general—well, this is just straight-out trolling, right?...
The choice obviously isn’t meant to reassure anyone outside the MAGA base—or even those within it who are intelligent.
It is an insolent appointment, guaranteed to cause trouble and meant to cause friction.”
This is such a critical juncture.
As an analyst, I much prefer to focus on markets and avoid politics.
It’s just not possible; much too intertwined at this point.
President Trump, of course, has every right to choose his nominations.
Gaetz, Hegseth, Gabbard, RFK Jr.
Is this how it’s going to go?
“Trolling enemies” takes precedence over the issue of a deeply fractured nation?
“Trump is Already Testing Congress and Daring Republicans to Oppose Him.”
An empowered President-Elect is clearly hankering for a fight – and its starts with Senate Republicans.
“By and with the Advice and Consent of the Senate” - or not.
Prospects for endless trolling, fighting and turmoil caught up to a frothy stock market late in the week.
November 15 – Bloomberg (Angel Adegbesan and Joe Easton):
“Health stocks slumped on Friday as Wall Street weighed the impact that prominent vaccine skeptic Robert F. Kennedy Jr. could have on the industry after President-elect Donald Trump nominated him to lead the nation’s health and medical research agencies…
Shares of health-care companies in the US fell, with the S&P 500 Health Care Index dropping 1.9% to its lowest level since May.
Kennedy’s selection ‘could have far-reaching and difficult-to-project implications for the biotechnology sector, adding a considerable layer of uncertainty and challenging investability,’ according to Brian Abrahams, an analyst at RBC Capital Markets…
Shares of biotechnology companies also tumbled with the SPDR S&P Biotech ETF (XBI) dropping 5.3%, the most since June 2022.”
November 15 – Reuters (Caroline Valetkevitch, Lance Tupper and Lewis Krauskopf):
“Shares of defense companies and government contractors were lower on Friday, extending recent losses amid uncertainty surrounding President-elect Donald Trump's proposed Department of Government Efficiency…
Among defense contractors, shares of General Dynamics fell 1.5% on Friday, while… Northrop Grumman was down 1.3%...
Shares of government contractors also continued their recent slide on Friday, including Leidos Holdings, which was down 4.4%; Science Applications International, which was down 2.8%; and Booz Allen Hamilton, which fell 3%.
General Dynamics was down about 7% for the week, while Leidos fell 19%.
Both stocks suffered their biggest weekly percentage drops in more than four years.”
November 14 – Axios (Ivana Saric):
“As President-elect Trump rolls out his Cabinet picks, he has called on the Senate to allow for recess appointments — a process that would allow him to install officials without congressional approval…
By demanding recess appointments, Trump is asking the Senate to surrender its advise-and-consent role for Cabinet confirmations, a key lever in the system of checks and balances against presidential power.
Trump could use this power in an unprecedented way, potentially forcing Congress into a recess, then using it to make unilateral appointments, Charles Cameron, a professor of politics and public affairs at Princeton University, told Axios...
Trump’s ‘gambit would be a gigantic delivery of power to the President,’ the professor said.”
“Wall Street Risk Fanatics Cool Down on Fed, Trump Trade Rethink.”
There’s more to the fledgling rethink than Fed rate cuts and trade policy.
Markets must now confront the prospect of a powerful President eager to gamble for virtually unchecked power – the so-called “Trump 2.0 without guardrails.”
Trump is girding to play hardball in a manner unknown in modern American politics.
There will be disruption, upheaval, and a resolve to crush the existing order – all in the name of an election mandate.
And it's difficult to see how all the associated uncertainty is bullish for markets.
Peggy Noonan (from above) concluded:
“People say they fear authoritarianism from Mr. Trump, latent or overt fascism, a reign of intolerance.
My fears are in the area of foreign policy.
Mr. Trump no doubt believes he’s ready for a major foreign crisis, but he’s never had one…
He tends to think foreign affairs comes down to personal relationships, but it doesn’t.
Xi Jinping, ‘Little Rocket Man’—he had them all wary in his first term.
Who is this guy?
Better not push him.
But now they know him—how he operates, what he wants.
He isn’t a mystery to them anymore.
He isn’t a mystery to anyone.
That will have some impact on things going forward.”
We’ll see if President Trump can overpower the Senate - along with Washington checks and balances.
But hopefully he is under no illusion that his extraordinary domestic power will translate internationally.
Putin, of course, will embrace negotiations to end the Ukraine War.
But why would he give an inch?
Xi will welcome trade talks – ready to counter Trump with a show of strength and resolve.
They know him, and the process is now underway.
November 15 – Bloomberg (Archie Hunter and Jack Ryan):
“Aluminum jumped on Friday after China said it would cancel a tax rebate that’s helped fuel a decades-long boom in exports and shielded an industry prone to overcapacity.
Futures… jumped as much as 8.5% following the announcement from the country’s Ministry of Finance.
China’s aluminum industry historically has exported significant amounts of the metal as semi-finished products…
The shipments of the metal used in everything from beer cans to automobiles have been a trigger point for trade battles with the US and Europe in the past…
‘This could be seen as a strategic move in the context of trade tensions following Trump’s win in the US presidential elections,’ said ING Bank NV commodity strategist Ewa Manthey.”
November 15 – Bloomberg (Jonathan Tirone, Ari Natter and Will Wade):
“Russia is temporarily limiting exports of enriched uranium to the US, creating potential supply risks to utilities operating American reactors that generate almost a fifth of the nation’s electricity.
The Russian government didn’t provide details of the restrictions or their duration in a Friday statement…”
And on the topic of adversaries that know him: Did the adversarial relationship between the Trump administration and the Treasury market get started this week?
Just think of the size of deficits created by a divided Congress and hamstrung executive branch.
The Treasury market will be nervously monitoring the President’s powerplays.
Ten-year Treasury yields jumped 14 bps this week to a 20-week high of 4.44%.
Long-bond yields traded this week to the high (4.65%) since May.
The market ended the week pricing a 58% probability of a 25 bps cut at the December 18th FOMC meeting.
The expected rate for December 2025 rose another six bps this week to 3.83%, implying only 75 bps of rate reduction over the next 13 months.
This compares to the 163 bps priced at the end of September.
More strong data this week (NFIB Small Business Optimism, Unemployment Claims, Retail Sales, Empire Manufacturing), along with comments from Powell: “The economy is not sending any signals that we need to be in a hurry to lower rates.”
November 14 – Bloomberg (Alexandra Harris):
“A rise in funding costs is spilling into the market for repurchase agreements backed by equities, a phenomenon that’s unlikely to abate, according to JPMorgan…
The amount of equity collateral that dealers need to finance the repo market has swelled, driven by the benchmark S&P 500 Index rallying to new highs and robust investor demand for leverage equity exposure, said strategists Teresa Ho, Pankaj Vohra and Bram Kaplan in a note...
As a result, the total amount of primary-dealer equity financing in repos has hit the highest level since April 2013…”
The equities market melt-up has surely been fueled by a surge in leverage, some margin debt, and an enormous amount of derivatives-related leverage.
For one, those forced to hedge call options that had been sold before the rally use the “repo” market to finance the purchase of the underlying stocks and ETFs.
Not surprisingly, the crazy inflation of money market fund (the key “repo” market lender) assets runs unabated.
Total money fund assets surged another $81.6 billion the past week to a record $6.667 TN.
Demonstrating “blowoff” monetary inflation dynamics, money fund assets have surged an incredible $533 billion over the past 15 weeks, a blistering 30% annualized rate.
We’ll look back and ponder how conspicuous signs of peak speculative excess were ignored.
The Power of Manias.
November 15 – Financial Times (Harriet Clarfelt and Nicholas Megaw):
“Corporate borrowers are rushing to tap the US bond market, taking advantage of ‘eye-poppingly’ buoyant conditions after Donald Trump’s election victory.
Companies… have raised more than $50bn this week, according to LSEG data.
That total is far above bankers’ expectations and the busiest week since a burst of activity in September, when companies typically return to the market after a summer lull.
Credit and equity markets have rallied since Trump’s win last week, pushing corporate borrowing costs relative to US Treasuries to their lowest level in decades, as investors bet that tax cuts will boost profits.”
November 15 – Reuters (Gaurav Dogra and Patturaja Murugaboopathy):
“U.S. equity funds witnessed a significant boost in investor demand in the week through Nov. 13…
According to LSEG data, investors acquired a massive $37.37 billion worth of U.S. equity funds in their largest weekly net purchase since at least January 2014.
The small-cap equity funds segment saw robust demand, securing the largest weekly inflow in four months at $7.43 billion net.
Meanwhile, the large-cap segment attracted $18.89 billion…”
November 15 – Bloomberg (Isabelle Lee):
“This year was already a landmark one for exchange-traded funds, but as of Friday the ETF universe can add another superlative: biggest annual inflows on record.
The insatiable appetite for the investor-friendly wrapper, an all-time high number of product launches and a relentless bull market fueled by Donald Trump’s presidential victory have helped push total net inflows into US ETFs past $913 billion…
That beats 2021’s record haul with still one more month to go.
Further signs of the markets ebullience: total US ETF assets hit the $10 trillion mark for the first time in September, more than 600 new products have debuted since the start of the year and nearly all ETFs in the US posted positive 12-month returns…”
All signs point to peak Bubble excess.
Now a highly levered Treasury market will confront an administration ready to slam through its pricey agenda – including an aggressive tariff regime.
Understandably, the Fed is signaling a more cautious approach to rate cuts.
Meanwhile, rising bond yields threaten the President Trump’s wrath coming down on Powell’s head.
Things could turn messy.
The new administration appears hellbent on imposing new power structures.
It will be fascinating to see if highly levered and fragile markets prove the ultimate power broker.
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