'Crazy Inverted Yield Curves' And The Danger Of Reflexivity

by: The Heisenberg

- On Friday morning, the University of Michigan's Richard Curtin said something profound about the reflexive nature of consumer sentiment and the Fed.

- His assessment, which accompanied the second-worst consumer sentiment reading of the Trump presidency, has a parallel in the bond market.

- If the Fed tightened us into a slowdown in Q4 2018, we're in danger of talking ourselves into one in Q3 2019.
On Friday morning, Richard Curtin, director of the University of Michigan consumer survey, delivered a rather sobering message.
"The main takeaway for consumers from the first cut in interest rates in a decade was to increase apprehensions about a possible recession", Curtin said.
That assessment came alongside the second-worst consumer sentiment print of the Trump presidency.
The 92.1 preliminary print for August missed estimates by a mile and represented a sharp drop from 98.4 in July.
Curtin's brief take on how the US consumer interpreted the Fed's July rate cut was profound, even if he didn't mean for it be. In reality, the US consumer is doing fine. Retail sales rose 0.7% in July, more than doubling estimates and printing ahead of even the most optimistic forecast from 70 economists. It was the fifth consecutive monthly gain, and underscored the message from the second quarter GDP report, which featured a strong read on personal consumption.
Most Americans don't know that much about monetary policy and I'd be willing to bet that less than 2 out of ten voters can tell you what the yield curve even represents. That, in turn, means that left to their own devices, the vast majority of Americans wouldn't have the first clue about whether Fed policy is or isn't "too tight" and thereby constraining the US economy.
President Trump and his advisers (with an emphasis on Peter Navarro, who has made numerous appearances on television this week, each time calling for Fed rate cuts), have raised the Fed's public profile and made Jerome Powell a household name. What the preliminary read on consumer sentiment clearly shows is that Americans, suddenly attune to the situation, were spooked by the Fed's rate cut.
The worry is that if the consumer begins to take his/her cues from the Fed, as Curtin suggested on Friday, it will eventually undermine an otherwise healthy US economy. As the economy decelerates, the Trump administration would doubtlessly call for more rate cuts, potentially spooking Americans further, in a self-feeding loop.
There's a parallel with what's going on in the bond market. I've talked about this before, but it's obviously gone into hyperdrive in August.
30-year yields in the US fell below 2% this week and, as mentioned previously, ultra futures tripped the extended hours circuit breaker on Wednesday, a testament to just how "crazy" (to quote one trader) the rally has been.
There are a variety of factors that help explain what can very fairly be described as one of the more incredible bond rallies in recent memory, but do bear in mind that some of what you're seeing is a self-fulfilling prophecy.
For instance, receiving flows have magnified things over the past several sessions. This is the same dynamic I discussed at length in these pages earlier this year, only to be dismissed by some readers as employing unnecessary "jargon".
Fast forward to August, and you can understand why I was so intent on making the point back in March. Bloomberg ran an entire article on this Friday called "Treasury Rally Gets Supercharged by Pension, Insurer Hedge Flows". Below, find a bit of additional color from the same BofA rates strategists cited by Bloomberg, which isn't available in their piece.
From an August 9 note:
While we’ve been highlighting the risk of a positioning squeeze in the belly, the long end is still underinvested in our view. As we’ve discussed recently, the strategic asset allocation flows (the duration and convexity grab) from liability driven investors may still have a long way to go. In the past, this flow often occurred in a higher rates environment as the funding gap closes. Today, the deteriorating growth outlook also provides incentive for long end demand as investors grab yields and hedge for tail events.
From an August 16 note:
Convexity-related receiving flows from both pensions, who are likely the most underfunded they have been since 2016, and the mortgage universe are likely to remain ongoing factors for long end spread tightening.
As Bloomberg reminds you, "these transactions have in turn helped drive down US Treasury yields even further [in a] feedback loop".
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, and around we go. Hence the borderline ridiculous rally in bonds.
  (Heisenberg, current through Thursday afternoon)
Of course, what's happening in the US bond market is influenced by dynamics abroad, where yields continue to plunge. 10-year yields in Germany approached -0.70% this week and JGB yields touched -0.255% on Friday before the Bank of Japan cut purchases in the five-to-10-year bucket in a bid to avoid a severe undershoot of the lower-end of the yield-curve-control band.
Term premium spillovers from overseas are pushing down long-end yields stateside, and it's not a coincidence that Japan surpassed China as America's biggest creditor for the first time since May 2017 in June, the latest TIC data, out Thursday afternoon, showed.
(Heisenberg, Treasury Dept)
All of that is, in one way or another, being exacerbated by global growth concerns tied to trade tensions. The more acute things get, the more convinced the market becomes that central banks will be forced to act, and those expectations further fuel the fixed income rally. The total global stock of negative-yielding debt rose more than $1 trillion this week alone.
The problem in the US is that the Fed is staring at, among other things, five consecutive months of relatively robust retail sales, a still healthy labor market, two straight months of hotter-than-expected core CPI readings, firming wages, rebounding manufacturing gauges (besides MNI's noisy Chicago barometer, which looks awful) and a very decent second quarter GDP report.
That informs the FOMC's contention that the July rate cut should be seen as a "mid-cycle adjustment", a characterization which is preventing the short-end from rallying as quickly as it would if the Fed were committed to aggressively cutting rates.
Well, with incessant pressure on the long-end tied to all of the factors outlined above, you're left with a relentless, bullish flattener. Here's BofA again, and this is from a separate note from those mentioned above:
Domestic drivers include expectations for further downgrades of the neutral rate, cheapening of 2yT to OIS on stressed funding conditions, and a Fed that put itself squarely behind the curve by characterizing the July cut as a mid-cycle-tweak, effectively sterilizing the rate cut in the process. External drivers include the expectation of lower for long global yields. the downgrade of global growth expectations on the exacerbation of trade war rhetoric, and end-cycle allocations that tend to favor USD assets and are compounded in this cycle by scarcity of safe haven assets.
Coming full circle, this flattening feeds back into the original self-fulfilling prophecy mentioned here at the outset.
That is, the US consumer might not know that much about the yield curve, but, as mentioned elsewhere earlier this week, the 2s10s gets the front-page treatment on the business section of every major news outlet in the country. It is, frankly, the only curve that "matters" to the general public, even if market participants and the Fed prefer other tenors or different indicators of impending recession altogether.
It would be damaging enough to consumer sentiment to have headlines about an "infallible" recession indicator plastered all over the front page of the nation's newspapers without having the one person in the world who absolutely shouldn't be amplifying the message, tweeting about it in the most alarmist fashion imaginable (and please do note that I couched that in apolitical terms - I'm saying it's damaging to sentiment, not that the President is necessarily "wrong"):
Not to put too fine a point on it, but that is precisely the kind of thing that contributes to the self-fulfilling prophecy described by the University of Michigan's Curtin in Friday's consumer sentiment report.
That is, the shrill rhetoric draws the public's attention to Fed policy and the bond market, with the effect of "increasing apprehensions about a possible recession", to quote Curtin.
The more apprehensive everyone gets, the faster all of the loops described above spin, which is why you're seeing what you're seeing in bonds.
In the fourth quarter of 2018, it was entirely fair to suggest that the Fed had tightened the US economy into a slowdown, as Nomura put it at the time.
In the third quarter of 2019, it's equally accurate to suggest that we're about to talk ourselves into another one.

Finally - and perhaps most importantly - don't let it be lost on you that the more extreme pricing gets in the bond market, the more difficult it is for the Fed to deliver a "dovish surprise". That, in turn, raises the odds that each successive rate cut will be ineffective at reducing the pressure in funding markets and in the curve, until eventually, we hit the zero lower bound having accomplished very little along the way.

Trade tensions are strangling American manufacturing

Slowing industrial production could portend a wider economic contraction

Megan Greene

Workers at a Ford plant in Chicago. US manufacturing output grew in May and June, driven by the auto sector, which is forecast to slow later this year © AFP

The US manufacturing sector has now contracted for two consecutive quarters, according to the Federal Reserve, raising concerns a general recession is drawing near. But those fears remind me of a triathlon I recently completed. With burning lungs and a pounding heart, I’d really flagged during the swimming section. Then I recovered and finished fine. So does a limping manufacturing sector really mean the American expansion will end?

A recession is a bit like the death of a star — you can only see it clearly after it happens. We can’t be certain manufacturing is leading the US to contraction. But it could be a portent: industrial production was down 1.9 per cent annually in the first three months of the year and 1.2 per cent annually in the second quarter. Manufacturing production was down 1.9 per cent and 2.2 per cent, respectively. The definition of a technical recession is two quarters of contraction. And while manufacturing output grew relative to the previous month in May and June, it appears to have been largely driven by auto and auto part production, widely forecast to slow later this year. Automakers such as Ford and Nissan are cutting jobs and earnings forecasts.

President Donald Trump’s trade policies are receiving much of the blame. Not only have trade tensions contributed to weaker demand from China for US goods, they have disrupted supply chains and inventory management for US manufacturers. Operating a business when you don’t know what the rules will be is like trying to complete a triathlon with a weight around your neck.

Now, a manufacturing recession need not necessarily result in an economic one. Fifty years ago, manufacturing represented almost 25 per cent of US gross domestic product. Today it accounts for only 11 per cent of GDP and 8 per cent of employment. America has become a services-based economy, and service industry data have remained buoyant in the US and abroad.

Furthermore, the nature of investment has changed drastically over the past few decades. In 1998, nearly 50 per cent of non-residential fixed investment went into new structures and industrial equipment to boost manufacturing capacity, while about 30 per cent went into informational processing equipment and intellectual property. In the first half of this year the percentages were reversed, with roughly 30 per cent going into structures and equipment and 50 per cent into technology.

Optimists will highlight the potential for these tech investments to result in higher productivity growth and potential growth. However, the impact will be felt only in the medium term, once workers have learnt to use the new technologies to improve their productivity. In the short term, this shift from tangible to intangible investment tends to be bad for workers: factories create more jobs than the likes of WhatsApp.

Some analysts see parallels with the manufacturing recession of 2015-16 and worry this time it will lead to an overall contraction. In both cases, weakness was driven by an economic slowdown in China and a strong US dollar. In 2015-16 as now, the dollar appreciated in part because of stronger perceived economic fundamentals in the US than abroad.

The Fed’s decision to pause rate rises as financial conditions tightened sharply in late 2015 helped weaken the dollar and arguably kept the slowdown in manufacturing from dragging the overall economy into recession. Today, however, financial conditions are already easy. The Fed’s rapid shift in tone from rate rises to rate cuts since the end of last year has done little to affect the currency.

Meanwhile, factory orders and purchasing managers’ indices for the eurozone, the UK, Japan and China all show manufacturing contracting. That puts pressure on their currencies and makes American exporters less competitive.

But there are other important differences from four years ago. In 2015-16, consumer spending rose at an average 2.8 per cent annual rate. In the most recent quarter, it grew by a brisk 4.3 per cent. Then, a collapse in oil prices crimped investment in energy; today, oil prices are much higher than in 2015. China’s slowdown then was driven by a deliberate campaign to deleverage. Today, Chinese authorities are trying to reflate growth that has foundered amid a trade war with the US.

Given its impact on Chinese demand and American factories, the trade war is the key to whether the US slips into recession. If Mr Trump were to call it off, it would remove the weight around manufacturers’ necks — and allow the US economy to power through swimmingly.

The writer is a senior fellow at the Harvard Kennedy School

The new censors

The global gag on free speech is tightening

In both democracies and dictatorships, it is getting harder to speak up

ON JUNE 22ND there was an alleged coup attempt in Ethiopia. The army chief of staff was murdered, as was the president of Amhara, one of the country’s nine regions. Ordinary Ethiopians were desperate to find out what was going on. And then the government shut down the internet. By midnight some 98% of Ethiopia was offline.

“People were getting distorted news and were getting very confused about what was happening...at that very moment there was no information at all,” recalls Gashaw Fentahun, a journalist at the Amhara Mass Media Agency, a state-owned outlet. He and his colleagues were trying to file a report. Rather than uploading audio and video files digitally, they had to send them to head office by plane, causing a huge delay.

Last year 25 governments imposed internet blackouts. Choking off connectivity infuriates people and kneecaps economies. Yet autocrats think it worthwhile, usually to stop information from circulating during a crisis.

This month the Indian government shut down the internet in disputed Kashmir—for the 51st time this year. “There is no news, nothing,” says Aadil Ganie, a Kashmiri stuck in Delhi, adding that he does not even know where his family is because phones are blocked, too. In recent months Sudan shut down social media to prevent protesters from organising; Congo’s regime switched off mobile networks so it could rig an election in the dark; and Chad nobbled social media to silence protests against the president’s plan to stay in power until 2033.

Tongues, tied

Free speech is hard won and easily lost. Only a year ago it flowered in Ethiopia, under a supposedly liberal new prime minister, Abiy Ahmed. All the journalists in jail were released, and hundreds of websites, blogs and satellite TV channels were unblocked. But now the regime is having second thoughts. Without a dictatorship to suppress it, ethnic violence has flared. Bigots have incited ethnic cleansing on newly free social media. Nearly 3m Ethiopians have been driven from their homes.

Ethiopia faces a genuine emergency, and many Ethiopians think it reasonable for the government to silence those who advocate violence. But during the alleged coup it did far more than that—in effect it silenced everyone. As Befekadu Haile, a journalist and activist, put it: “In the darkness, the government told all the stories.”

Some now fear a return to the dark days of Abiy’s predecessors, when dissident bloggers were tortured. The regime still has truckloads of electronic kit for snooping and censoring, much of it bought from China. It is also planning to criminalise “hate speech”, under a law that may require mass surveillance and close monitoring of social media by police. Many fret that the law will be used to lock up peaceful dissidents.

According to Freedom House, a watchdog, free speech has declined globally over the past decade. The most repressive regimes have become more so: among those classed as “not free” by Freedom House, 28% have tightened the muzzle in the past five years; only 14% have loosened it. “Partly free” countries were as likely to improve as to get worse, but “free” countries regressed. Some 19% of them (16 countries) have grown less hospitable to free speech in the past five years, while only 14% have improved (see map).

There are two main reasons for this. First, ruling parties in many countries have found new tools for suppressing awkward facts and ideas. Second, they feel emboldened to use such tools, partly because global support for free speech has faltered. Neither of the world’s superpowers is likely to stand up for it. China ruthlessly censors dissent at home and exports the technology to censor it abroad. The United States, once a champion of free expression, is now led by a man who says things like this:

“We certainly don’t want to stifle free speech, but ... I don’t think that the mainstream media is free speech ... because it’s so crooked. So, to me, free speech is not when you see something good and then you purposely write bad. To me, that’s very dangerous speech and you become angry at it.”

Really? Seeing something that the government claims is good and pointing out why it is bad is an essential function of journalism. Indeed, it is one of democracy’s most crucial safeguards. President Donald Trump cannot censor the media in America, but his words contribute to a global climate of contempt for independent journalism. Censorious authoritarians elsewhere often cite Mr Trump’s catchphrases, calling critical reporting “fake news” and critical journalists “enemies of the people”.

The notion that certain views should be silenced is popular on the left, too. In Britain and America students shout down speakers they deem racist or transphobic, and Twitter mobs demand the sacking of anyone who violates an expanding list of taboos. Many western radicals contend that if they think something is offensive, no one should be allowed to say it.

Authoritarians elsewhere agree. What counts as offensive is subjective, so “hate speech” laws can be elastic tools for criminalising dissent. In March Kazakhstan arrested Serikzhan Bilash for “inciting ethnic hatred”. (He had complained about the mass incarceration of Uighurs in China, a big trading partner of Kazakhstan.) Rwanda’s government interprets almost any criticism of itself as support for another genocide. In India proposed new rules would require digital platforms to block all unlawful content—a tough task given that it is illegal in India to promote disharmony “on grounds of religion, race, place of birth, residence, language, caste or community or any other ground whatsoever”.

One way to silence speech is to murder the speaker. At least 53 journalists were killed on the job in 2018, slightly more than in the previous two years, according to the Committee to Protect Journalists (CPJ), a watchdog. Few of the killers were caught. The deadliest country for journalists was Afghanistan, where 13 were killed. In one case, a jihadist disguised himself as a journalist so as to mingle with, and slaughter, the first reporters and medics to arrive at the scene of an earlier suicide bombing.

Perhaps the most brazen murder in 2018 was of Jamal Khashoggi, a critic of the Saudi regime. A team of assassins landed in Turkey on easily identifiable private jets, drove in luxury cars to the Saudi consulate in Istanbul and cut Khashoggi to pieces on consular property. Whoever ordered this presumably thought there would be no serious consequences for dismembering a Washington Post contributor. He was right. Although Germany, Denmark and Norway stopped arms sales to Saudi Arabia, Mr Trump stressed America would remain the kingdom’s “steadfast partner”.

On December 1st 2018 the CPJ counted more than 250 journalists in jail for their work: at least 68 in Turkey, 47 in China, 25 in Egypt and 16 in Eritrea. The true number is surely higher, since many journalists are held without charge or publicity. However, the number in Eritrea may be lower, since nearly all have been held in awful conditions since President Issaias Afwerki shut down the independent media in 2001, and some are probably dead.

Rather than risking the bother and bad publicity of putting journalists on trial, some regimes try to intimidate them into docility. In Pakistan, when military officers ring up editors to complain about coverage, the editors typically buckle. Ahmad Noorani, a reporter who dared to write about the army’s role in politics, was ambushed by unknown assailants on a busy street in the capital, Islamabad, and beaten almost to death with a crowbar.

In India journalists who criticise the ruling Bharatiya Janata Party receive torrents of threats on social media from Hindu nationalists. If female, those threats may include rape. Reporters are often “doxxed”—pictures of their families are circulated, inviting others to harm them. Barkha Dutt, a television pundit, filed a complaint against trolls who had sent her a death threat and published her personal telephone number as that of an escort service. Four suspects were arrested in March.

Occasionally, the worst threats against Indian journalists are carried out, lending chilling credibility to the rest. Gauri Lankesh, an editor who often lambasted Hindu nationalism, was gunned down outside her home in 2017. Pro-BJP commenters celebrated. The man arrested for pulling the trigger told police that his handlers told him he had to do it to “save” his religion.

Intimidation does not always work. Ivan Golunov, a Russian reporter, investigated Moscow city officials buying mansions with undeclared millions and security officers going into business with the mafia. His stories were little known, published on a small website called Meduza. On June 6th police grabbed Mr Golunov, bundled him into a car, took him to a government building, beat him up and claimed to have found drugs in his backpack. The ministry of interior posted nine photos of drugs allegedly found in his flat, but then removed eight of them, admitting that they were taken elsewhere and saying they had been published by mistake.

Mr Golunov’s supporters think the drugs were planted. To the authorities’ surprise, the story spread rapidly on Facebook and Twitter—Russia does not have anything like China’s capacity for suppressing unwelcome posts on social media. Street protesters demanded Mr Golunov’s release. Foreign media picked up the story, which overshadowed Mr Putin’s summit with Xi Jinping, China’s president, that week. An embarrassed Kremlin ordered Mr Golunov’s release. When his new investigation was published by Meduza a few weeks later, it was read by 1.5m people—several times its usual audience.

Breaking the news

As the advertising revenues that used to support independent journalism dwindle, many governments have found it easier to distort the news with taxpayers’ hard-earned cash. The simplest method is to pump it into state media that unctuously support the ruling party. Most authoritarian regimes do this. China and Russia go further, sponsoring global media outlets that seek to undermine democracy everywhere. However, the problem with state media, from an autocrat’s point of view, is that they tend to be boring.

So another method is to use government advertising to reward subservience and punish uppityness. In many countries the government is now by far the biggest advertiser, so newspapers and television stations are terrified of annoying it.

A subtler method is to cultivate tycoons who depend on the state for permits or contracts, and urge them to buy up media outlets. Unlike normal moguls, they don’t need their media firms to make profits. The favours their construction firms receive far outweigh any losses they incur running obsequious television stations. Indeed, they can often undercut their independent media rivals, exacerbating the financial distress caused by the decline of advertising, aggressive tax audits, unreasonable fines and so forth. Cash-strapped independent media are of course cheaper for the president’s cronies to buy and de-fang.

Several ruling parties use these techniques. India’s uses most of them, as do Russia’s and Turkey’s. Israel’s prime minister, Binyamin Netanyahu, is accused of promising favourable regulation to a telecoms firm in exchange for positive coverage on a news website it owns. In January, Nicaragua’s most popular newspaper ran a blank front page to complain that its imported supplies of ink, paper and other materials had been mysteriously impounded at customs after it published critical reports about the ruling Sandinista party.

Such skulduggery has even crept into supposedly democratic parts of Europe. Hungary’s ruling party, Fidesz, has used public money to dominate the national conversation. The state news agency has been stuffed with toadies and offers its bulletins free to cash-strapped outlets. “When you get a news flash on [an independent] rock radio station, [it’s] totally government propaganda...because it’s free,” complains a local journalist.

The Hungarian government’s advertising budget has swollen enormously since 2010, when Prime Minister Viktor Orban took power. His cronies have bought up previously feisty broadcasters and websites. “It’s an unstoppable process,” says an independent editor. “Hungarians are used to the idea that online news is free.

So [media firms] become reliant on the money of their owners. And many of the businessmen in public life are linked to the government.” Last year the proprietors of 476 media firms, including practically all the local newspapers in Hungary, gave them without charge to a new mega-foundation run by a pal of Mr Orban. Starved of cash, serious journalists find it hard to do their jobs. “It’s practically impossible to investigate even the major corruption stories, because there are so many,” says Agnes Urban of Mertek, a media watchdog.

Meanwhile, in mature democracies, support for free speech is ebbing, especially among the young, and outright hostility to it is growing. Nowhere is this more striking than in universities in the United States. In a Gallup poll published last year, 61% of American students said that their campus climate prevented people from saying what they believe, up from 54% the previous year. Other data from the same poll may explain why. Fully 37% said it was “acceptable” to shout down speakers they disapproved of to prevent them from being heard, and an incredible 10% approved of using violence to silence them.

Many students justify this by arguing that some speakers are racist, homophobic or hostile to other disadvantaged groups. This is sometimes true. But the targets of campus outrage have often been reputable, serious thinkers. Heather Mac Donald, for example, who argues that “Black Lives Matter” protests prompted police to pull back from high-crime neighbourhoods, and that this allowed the murder rate to spike, had to be evacuated from Claremont McKenna College in California in a police car. Furious protesters argued that letting her speak was an act of “violence” that denied “the right of black people to exist”.

Such verbal contortions have become common on the left. Many radicals argue that words are “violence” if they denigrate disadvantaged groups. Some add that anyone who allows offensive speakers a platform is condoning their wicked ideas. Furthermore, as America has polarised politically, many people have started to divide the world simplistically into “good” people (who agree with them) and “evil” people (who don’t). This has led to bizarre altercations.

At Reed College in Portland, Oregon, Lucia Martinez Valdivia, a gay, mixed-race lecturer with post-traumatic stress disorder, was accused of being “anti-black” because she complained about the aggressive students who stood next to her shouting down her lectures on ancient Greek lesbian poetry (to which the hecklers objected because the poet Sappho would today be considered white). As Greg Lukianoff and Jonathan Haidt argue in “The coddling of the American mind”:

“If some students now think it’s OK to punch a fascist or white supremacist, and if anyone who disagrees with them can be labelled a fascist or a white supremacist, well, you can see how this rhetorical move might make people hesitant to voice dissenting views on campus.”

The habit of trying to silence opposing views, instead of rebutting them, has spread off campus. In Portland, Oregon, this weekend, far-right extremists are planning to rally, their “antifa” (anti-fascist) opponents are expected to try to stop them, and both sides are spoiling for a fight. When the same groups clashed in June, a conservative journalist, Andy Ngo, was so badly beaten that he was hospitalised with a brain haemorrhage.

Similar intolerance has spread to Europe, too. French “yellow jacket” protesters have repeatedly beaten up television crews. In Britain any discussion of transgender issues is explosive. In September, for example, Leeds City Council barred Woman’s Place UK, a feminist group, from holding a meeting because activists had accused them of “transphobia”. (The feminists do not think that simply saying “I am a woman” should confer on biological males the right to enter women’s spaces, such as changing rooms and rape shelters.)

“It’s nearly impossible to have a free debate [on this topic]. I’ve never seen anything like it,” says Ruth Serwotka, a co-founder of Woman’s Place UK. Today, the group only tells members where meetings will take place a couple of hours in advance, to avoid disruption. Feminists who question “gender self-identification” (the notion that if you say you are a woman, you should automatically be legally treated as one) are routinely threatened with rape or death. Some have faced organised campaigns to get them sacked from their jobs, barred from Twitter or arrested.

In March, for instance, Caroline Farrow, a Catholic journalist, was interviewed by British police after someone complained that she had used the wrong pronoun to describe a transgender girl. Another feminist, 60-year-old Maria MacLachlan, was beaten up by a transgender activist at Speakers’ Corner in London, where free speech is supposed to be sacrosanct.


Doug Nolan

The Chinese Credit machine sputtered in July. Growth in Total Aggregate Financing dropped to $144 billion, almost 40% below consensus estimates. This was less than half of June’s $320 billion increase and the slowest expansion since February. The sharp slowdown was beyond typical seasonality, with the month’s growth in Aggregate Financing 18% below July 2018. Despite July’s weak growth, Total Aggregate Financing was still up 10.7% over the past year.

New Bank Loans fell to $150 billion from June’s $235 billion, with growth 28% below that from July 2018. At $2.331 TN, New Loans were still up 12.6% over the past year. Consumer Loans dropped to $74 billion, the weakest showing since February. Consumer Loans were nonetheless up 16.5% over the past year, 38% in two, 71% in three and 138% over five years.

Loans to the non-financial corporate sector collapsed in July to $42 billion, about a third June’s level. Somewhat offsetting this decline, Corporate bond issuance almost doubled in July to $32 billion.

The ongoing contraction in “shadow” finance accelerated in July, with declines in outstanding Trust Loans, Entrusted Loans, and Banker Acceptances. On a year-over-year basis, Trust Loans were down 4.3%, Entrusted Loans 10.0% and Bankers Acceptances 15.0%.

China’s July Credit data were alarming on multiple levels. For starters, the sharp Credit slowdown supports the view that financial conditions tightened meaningfully after the government takeover of Baoshang Bank (and attendant money market instability). It also raises the increasingly pressing question as to the willingness of the banking system to continue to take up the slack in the face of a broadly deteriorating backdrop. And in a new development, analysts have begun contemplating the possibility of waning Credit demand.

The sharp pullback in Consumer Loans raises the specter of an inflection point in household mortgage borrowings. Bubbling apartment markets have supported a resilient consumer sector along with an unrelenting housing construction boom. Government tightening measures may be having some impact. It is possible as well that market sentiment has begun to shift.

August 14 – Reuters (Huizhong Wu, Yawen Chen and Stella Qiu): “China’s economy stumbled more sharply than expected in July, with industrial output growth cooling to a more than 17-year low, as the intensifying U.S. trade war took a heavier toll on businesses and consumers. Activity in China has continued to cool despite a flurry of growth steps over the past year, raising questions over whether more rapid and forceful stimulus may be needed, even if it risks racking up more debt. After a flicker of improvement in June, analysts said the latest data was evidence that demand faltered across the board last month, from industrial output and investment to retail sales… Industrial output growth slowed markedly to 4.8% in July from a year earlier…, lower than the most bearish forecast in a Reuters poll and the weakest pace since February 2002.”

August 14 – Reuters (Roxanne Liu): “China’s property investment slowed to its weakest pace this year in a sign the housing market’s resilience may be waning as Beijing toughens its crackdown on speculative investments and holds back on new stimulus… Property investment in July rose 8.5% year-on-year, easing from June’s 10.1% gain and was the slowest since December’s 8.2%...”

China is now only a faltering apartment Bubble away from a period of major economic upheaval and acute financial instability.

Global bond markets were this week nothing short of incredible. Ten-year German bund yields dropped 11 bps to a record low negative 0.69%, and French yields fell 15 bps to negative 0.41%. Swiss 10-year yields sank 19 bps to negative 1.14%. Spanish and Portuguese yields fell 18 bps to 0.08% and 0.11%. Italian yields sank 41 bps to 1.40%. Sovereign yields ended the week at negative 0.69% in Denmark, negative 0.57% in Netherlands, negative 0.49% in Slovakia, negative 0.44% in Austria, negative 0.43% in Sweden, negative 0.42% in Finland, negative 37 bps in Belgium, negative 0.26% in Slovenia, negative 0.18% in Latvia, and negative 0.14% in Ireland. Japanese 10-year yields ended the week down a basis point to negative 0.23%.

Extraordinary in its own right, the Treasury market garnered intense media focus: CNBC: “Bond Market Close to Sending Biggest Recession Signal Yet.” Fox Business: “Recession Indicator with Perfect Track Record Flashing Red.” Business Insider: “The Market's Favorite Recession Indicator Just Flashed its Starkest Warning Since 2007.” NBC: “Wall Street Slides as Inverted Yield Curve Rings Recession Alarm Bells.” Money and Markets: “Yield Curve Blares Loudest Recession Warning Since 2007.”

Ten-year Treasury yields collapsed 19 bps this week to 1.56%, the low going back to August 2016. Thirty-year bond yields traded as low at 1.91% in Thursday’s session, dipping below 2.00% for the first time (ending the week down 22 bps to 2.04%). Two-year yields fell 17 bps to 1.47%, with December Fed funds futures implying a 1.49% funds rate. Wednesday’s inverted Treasury curve was widely cited as the key factor behind the equities' selloff.

August 14 – Reuters (Gertrude Chavez-Dreyfuss and Dhara Ranasinghe): “The U.S. Treasury yield curve inverted on Wednesday for the first time since June 2007, in a sign of investor concern that the world's biggest economy could be heading for recession. The inversion - where shorter-dated borrowing costs are higher than longer ones - saw U.S. 2-year note yields rise above the 10-year yield.”

At this point, Treasury yields have little association with the U.S. economy. The structure of the Treasury curve (along with Federal Reserve monetary policy) has detached from U.S. economic performance. Treasuries are instead caught up in an unprecedented global market phenomenon. Sovereign debt, after all, has traded for hundreds of years. Yet bonds have never traded with negative yields. Never have global bond prices spiked in unison, with yields collapsing to unprecedented lows across the globe.

I understand why market professionals, pundits and journalists focus on the conventional “recession risk” explanation for sinking Treasury yields and the inverted curve. For one, there is insufficient awareness as to the deep structural impairments that today permeate global finance. Besides, no one wants to contemplate that global bond yields might portend serious problems ahead – that global yields are signaling the reemergence of Crisis Dynamics.

Throughout this decade’s long Bubble period, I’ve often written and stated, “I hope things are not as dire as I believe they are.” Along the way, Bubble Analysis has appeared flawed and hopelessly detached from reality. And that’s exactly how these things work.

But I’ve never wavered from the view that this would end badly. Never have I believed that manipulating and distorting markets would achieve anything but epic Bubbles and inevitable terrible hardship. I’ve not seen evidence to counter the view that the longer the global Bubble inflates the greater the downside risk (moreover, such risk grows exponentially over time). And not for one minute did I believe zero rates and QE would resolve deep financial and economic structural issues. Indeed, I have fully expected reckless monetary mismanagement to ensure a global crisis much beyond 2008. From my analytical perspective, the global Bubble has followed the worst-case scenario.

It sounds archaic, but sound money and Credit are fundamental to sound financial systems, sound economic structure, cohesive societies and a stable geopolitical backdrop. The most unsound “money” in human history comes with dire consequences. Global finance now suffers from irreparable structural impairment. Economies across the globe are deeply maladjusted. Global imbalances are unprecedented. The trajectory of geopolitical strife is frightening.

Meanwhile, central banks are locked in flawed inflationist doctrine. Their experiment is failing, yet in failure they will resort to only more reckless market manipulation and monetary inflation. This analysis is corroborated both by collapsing sovereign yields and a surging gold price. The clear and present risk is of an abrupt globalized market dislocation, financial crisis and resulting economic and geopolitical instability. It may sound like crazy talk, except for the fact that such a scenario is alarmingly consistent with signals now blaring from global bond markets.

August 16 – Bloomberg (John Authers): “There has been a tendency since the financial crisis to label any market that is rallying or deemed overvalued to be in a ‘bubble.’ The word has become overused and debased. But if we treat it rigorously, the bubble concept is still vital in navigating financial markets. And the rigorous treatment reveals that bonds really are in a bubble. Longview Economics Chief Market Strategist Chris Watling published a fascinating research note applying the framework introduced by Charles Kindleberger in his book ‘Manias, Panics, and Crashes.’ …Watling reminds us that Kindleberger needed to satisfy four conditions before he diagnosed a bubble: i) cheap money underpins and creates the bubble; ii) debt is taken on during the bubble build-up, which helps fuel much of the speculative price increases (e.g. buying on margin); iii) once a bubble is formed, the asset price has a notably expensive valuation; & iv) there’s always a convincing narrative to ‘explain away’ the high price. Reflecting that, there’s a wide acceptance in certain quarters that the price is rational (and ‘this time it’s different’).”

I’m biased, but what could be more fascinating than Bubble Analysis? My analytical framework owes a debt of gratitude to Charles Kindleberger’s work. I’ll interject my definition: “A Bubble is a self-reinforcing but inevitably unsustainable inflation.” This “unsustainable” facet has become critical in this bizarro world of central bank finance and accompanying runaway Bubbles. At a decade and counting, it is reasonable to assume that the realm of central bank supported bull markets is everlasting. Such optimism is today dangerously misplaced.

I’ll take somewhat exception to John Authers’, “[Bubble] has become overused and debased.”

The key issue is that Bubble Dynamics took root across asset classes and across the world.

Never has “Bubble” applied to so many markets in so many places – never has finance created Bubble Dynamics on an almost systemic basis.

I have argued post-crisis monetary stimulus unleashed a historic global Bubble in “financial assets” more generally, a “global government finance Bubble” that fueled hyperinflation in prices for stocks, bonds, structured finance, real estate, private businesses, collectibles, and so on around the world. The word “Bubble” has not been overused and debased, as much as the overuse of central bank and government Credit has worked to debase “money” more generally.

Authers also states: “But if we treat it rigorously, the bubble concept is still vital in navigating financial markets.” The problem is markets love Bubbles – jump aboard and make easy “money.” And for the past decade central banks have incentivized speculation and speculative leverage across assets classes and around the world.

Bubble Analysis is vital for both navigating markets and for policymaking. For a decade now, speculators have been playing Bubbles, while central bankers have been denying their existence. Global bond markets have become convinced the Bubble is faltering, with the expectation that central banks have no alternative than to drive rates even lower while monetizing further Trillions of government bonds (throwing in some corporate debt and even equities for good measure). This expectation of additional aggressive monetary stimulus has bolstered the view within the risk markets that the bottomless central bank punchbowl will keep the party rocking.

At this point, the overarching issue is not the U.S. vs. China trade war, and it’s not specifically the vulnerable Chinese economic boom. The U.S. economy is certainly not the focal point of global market dynamics. Importantly, the trade war is a catalyst for pushing China’s vulnerable economy to the downside. After a historic Bubble inflation, a faltering Chinese economy is a catalyst for pushing China’s fragile Credit and financial systems beyond the precipice. And as the marginal source of global finance and economic growth, faltering Chinese Credit and economic systems will be a catalyst for bursting Bubbles around the globe.

August 10 – Reuters (Cassandra Garrison and Nicolás Misculin): “Argentine voters soundly rejected President Mauricio Macri’s austere economic policies in primary elections on Sunday, raising serious questions about his chances of re-election in October… A coalition backing opposition candidate Alberto Fernandez - whose running mate is former president Cristina Fernandez - led by a wider-than-expected 14 percentage points with 47.1% of votes, with fourth-fifths of ballots counted.”

Granted, opposition candidate Fernandez’s margin of victory was larger than expected. But what a market reaction. The Argentine peso sank 14.5% in Monday trading. Argentina’s Merval Equities Index collapsed 38% (48% in U.S. dollars) Monday and ended the week down 31.5%. The price of Argentina’s dollar-denominated 30-year bonds sank 25%, as yields surged 300 bps in Monday trading to 12.51%. Yields jumped above 15% during Wednesday’s trading before ending the week at 13.5%.

August 13 – Reuters (Tom Arnold): “The cost of insuring against an Argentine sovereign default jumped again on Tuesday as investors continued to react to the heavy defeat of President Mauricio Macri in the country’s primary elections at the weekend. Argentine 5-year credit default swaps (CDS) were marked at 2,116 basis points, up from what was already a five-year high of 1,994 bps the previous day, according to… IHS Markit. Markit calculations estimate that level prices the probability of a sovereign default within the next five years at more than 72%.”

After ending convertibility to the U.S. dollar at a one-to-one rate with the onset of Argentina’s 2001 financial crisis, it now requires 55 pesos to exchange for one dollar. Oversubscribed when issued in the summer of 2017, Argentina’s 100-year bond lost 30% of its value this week and now trades at 52 cents on the dollar.

Market reaction to Argentina’s primary election is further evidence the global market environment has changed. “Risk off” is gaining momentum. De-risking/deleveraging dynamics have altered the liquidity backdrop, leading to more chaotic market reactions along with heightened contagion risk. This week’s EM currency declines included the Russia’s ruble 1.9%, Brazil’s real 1.6%, Turkey’s lira 1.5%, Poland’s zloty 1.4% and Mexico’s peso 1.3%. Major equities indices were down 4.0% in Brazil, 3.9% in Turkey, 3.3% in Russia and 2.7% in Mexico.

It was not as if there weren’t constructive developments. At least for the week, the People’s Bank of China could stabilize the renminbi (up 0.27% vs. the dollar). Monday’s ugly market performance apparently spurred President Trump to delay imposing additional Chinese tariffs on many goods until December 15th. China announced plans to boost household disposable income. And, from an ECB official, the clearest signal yet that “whatever it takes” is about to shift into overdrive.

August 15 – Wall Street Journal (Tom Fairless): “The European Central Bank will announce a package of stimulus measures at its next policy meeting in September that should exceed investors’ expectations, a top official at the central bank said. …Olli Rehn said the slowing global economy would see the ECB rolling out fresh stimulus measures that should include ‘substantial and sufficient’ bond purchases as well as cuts to the bank’s key interest rate. ‘It’s important that we come up with a significant and impactful policy package in September,’ said Mr. Rehn, who sits on the ECB’s rate-setting committee as governor of Finland’s central bank. ‘When you’re working with financial markets, it’s often better to overshoot than undershoot, and better to have a very strong package of policy measures than to tinker,’ Mr. Rehn said.”

The President’s trade war retreat tweet had a notably short market half-life. It appears markets these days are less invigorated by talk of additional Chinese stimulus. And Olli Rehn’s “significant and impactful policy package” essentially bypassed equities markets while throwing gas on the raging bond fire.

It’s been a full decade of government and central bank backstops, with the “Trump put” a relatively late addition. It sure appears the Trump, central bank and Beijing “puts” have lost some potency. And in about a month we’ll have a better read on the “Fed put.” It’s a reasonable bet the stock market will go into the September 18th FOMC meeting with a gun to its head: “50 bps or we’ll shoot!”

Much can happen in a month – especially at the current mercurial clip of developments. But the Fed will be in a really tough spot. Don’t give the market 50 bps and ultra-dovish commentary and risk getting hit with a heated market tantrum. Give markets what they demand and risk a “sell the news” response and a critical change in market sentiment. It has the feel that a decade of egregious monetary inflation and speculative Bubbles is about to get Some Comeuppance.

Russia and China

Partnership is much better for China than it is for Russia

Just how much better might not become clear for a few years yet

IT IS THE love triangle of global politics. Since the second world war, China, Russia and the United States have repeatedly swapped partners. The collapse of the Sino-Soviet pact after the death of Josef Stalin was followed by Richard Nixon’s visit to China in 1972 and Mikhail Gorbachev’s detente with China 30 years ago. Today’s pairing, between Vladimir Putin and Xi Jinping, was cemented in 2014 after Russia annexed Crimea. In each case the country that was left on its own has always seemed to pay a price, by being stretched militarily and diplomatically.

This time is different. Though America is out in the cold, the price is falling chiefly on Russia. China dominates every aspect of the two countries’ partnership. Its economy is six times larger (at purchasing-power parity) and its power is growing, even as Russia’s fades. What seemed a brilliant way for Mr Putin to turn his back on the West and magnify Russia’s influence is looking like a trap that his country will find hard to escape. Far from being an equal partner, Russia is evolving into a Chinese tributary.

That may seem a harsh judgment. Russia is still a nuclear-weapons state with a permanent seat on the UN Security Council. It has modernised its armed forces and, as in Syria, is not afraid to use them. This week Russian and Chinese warplanes conducted what appeared to be a joint air patrol for the first time, causing alarm when South Korea said a Russian plane had intruded into its airspace.

But the real news is how rapidly Russia is becoming dependent on its giant neighbour (see article). China is a vital market for Russian raw materials: Rosneft, Russia’s national oil company, depends on Chinese financing and is increasingly diverting its oil to China. As Russia seeks to evade the hegemony of the dollar, the yuan is becoming a bigger part of its foreign-currency reserves (the share of dollars fell by half to 23% during 2018, while the yuan’s share grew from 3% to 14%).

China supplies vital components for Russia’s advanced weapons systems. And China is the source of the networking and security gear that Mr Putin needs to control his people. Last month Russia struck a deal with Huawei, a Chinese telecoms firm distrusted by America, to develop 5G equipment—thus rooting Russia firmly in China’s half of the splinternet.

This suits China just fine. It wants a lasting friendship with Russia, if only to secure its northern border, the scene of clashes in 1969, and a source of worry in the 1990s when Russia looked as if it might drift into the West’s orbit. Russia also serves as an enthusiastic vanguard in China’s campaign to puncture Western ideas of universal human rights and democracy, which both countries see as an incitement to “colour revolutions”.

Mr Putin can point to several arguments for his partnership with China, in addition to their joint hostility to the liberal project. One is expediency. Western sanctions, imposed after his annexation of Crimea, the meddling in American elections in 2016 and the lethal use of a nerve agent in Britain two years later, have left Russia without many alternatives.

Mr Xi has also given Russia cover for its military action in Syria and, to some extent, Crimea. And, in contrast to the end of the 17th century, when Peter the Great looked to Europe as the wellspring of progress, Mr Putin can plausibly argue that the future now belongs to China and its system of state capitalism.

However, Mr Putin is mistaken. For a start, the Russian version of state capitalism is a rent-seeking, productivity-sapping licence for the clique that surrounds him to steal freely from the national coffers—which is one reason why Chinese investment in Russia is rather limited.

There is also a contradiction between Mr Putin’s claim to be restoring Russian greatness and the increasingly obvious reality of its subordinate role to China. This creates tension in Central Asia. Because stability in the region is important for China’s domestic security—it wants Central Asia to keep Islamic extremism at bay—the People’s Liberation Army is stationing troops in Tajikistan and staging exercises there, without consulting Russia.

And, at some level, the aims of Russia and China diverge. There is a limit to how much ordinary Russians will forgo Western freedoms. If the regime holds on to power by means of Chinese technology, it will feed popular anger towards China and its Russian clients.

Who can say when the strains will show? Imagine that Mr Putin chooses to step down in 2024, when the constitution says he must, and that his successor tries to mark the change by distancing Russia from China and turning towards Europe. Only then will it become clear how deep China’s influence runs and how much pressure it is prepared to exert to retain its sway. Russia’s next president may find that the country has lost its room for manoeuvre.

Does this mean that the rest of the world—especially the West—should seek to prise Russia from China’s embrace, before it is too late? That idea will tempt those diplomats and analysts who think Russia is too important to alienate. But it seems unlikely. America does not suffer from the Xi-Putin alignment today as it would have done in the cold war. Although Russia and China do indeed undermine the West’s notion of universal values, with President Donald Trump in the White House that doctrine is, alas, hardly being applied universally in any case.

What is more, China’s influence over Russia has compensations. An angry declining power like Russia is dangerous; it may feel tempted to lash out to show it is still a force to be reckoned with, by bullying Belarus, say, or by stoking the old fears of Chinese expansion into Siberia.

But China has no appetite for international crises, unless they are of its own devising. As Russia’s partner, China can serve as a source of reassurance along their joint border, and temper Russia’s excesses around the world.

Sweet patience

Rather than railing against Russia or trying to woo it back, the West should point out its subordination and wait. Sooner or later, a President Alexei Navalny or someone like him will look westwards once again. That is when Russia will most need Western help. And that is when the man or woman in the Oval Office should emulate Nixon—and go to Moscow. ■