Monetary Policy (management of money supply and
interest rates)
Europe
I would like to start
with Christine Lagarde and her staggering statement during the interview for RTL
radio in France on October 30, just two days before she became European Central
Bank (ECB) president. For those unfamiliar with Ms Lagarde, she is a French
politician and lawyer served as Minister of the Economy, Finance and Industry
(2007–2011), Minister of Agriculture and Fishing (2007) and Minister of
Commerce (2005–2007) in France. She also was Chairman and Managing Director of
the International Monetary Fund (IMF) during 5 July 2011 – 12 September 2019
period.
Currently in the
Eurozone, deposit rate is set by the ECB at -0.50% level (yellow line on the below chart), harming savers,
especially those (pension funds, insurance companies) who are holding government bonds such as
German bunds. When asked about negative
rates she said that people should be “happier” to have a job than a higher
saving rate. Does that mean people who have been working their entire lives
and saving money aside in order to secure worthy retirement will be not able to
achieve that anymore? Or to put it differently, will be not allowed to achieve
that? The time will show but we have already seen that pension funds struggle
to attain their expected returns and many of them invest in more risky assets
such as 100-year Argentine government bonds (since 1800 Argentina has defaulted
on its sovereign debt eight times!).
source: Holger
Zschäpitz
Under this tweet you
can see how the ECB staff together with the FinTwit (Finance Twitter) community
welcomed Christine Lagarde in her new role. https://twitter.com/Lagarde/status/1191425218922926081
In the meantime,
Deutsche Bank AG, largest German lender announced a week ago that it will pass
negative rates to large corporate clients and wealthy individuals, giving
temporary relief for most retail clients. Of course, it is not the first bank
deciding on such a move, at the beginning of October Berliner Volksbank, German
second-largest cooperative lender, has started to charge retail clients -0.5%
rate on deposits exceeding 100,000 euros ($ 110,000). Similar charges have been
already implemented in Denmark by Spar Nord Bank A/S, Sydbank A/S as well as
Jyske Bank A/S and in Switzerland by UBS, Credit Suisse and Julius Baer. I am going to sum
up this paragraph using quote of the former Credit Suisse CEO and UBS Executive
Oswald Gruebel: "Negative interest
rates are crazy. That means money is not worth anything anymore."
During the week, we have also had another voice of common sense, at least partially. Austrian ECB governor Robert
Holzmann told Bloomberg TV that the monetary policy has reached its limit,
signalling that European Central Bank is basically out of bullets to
spur further growth. However, he argued that it is time for fiscal policy
spending (governments action). I think that to solve the problem governments
should rather purse lower taxes and more transparency by getting rid of many
unnecessary regulation. Find out more about possible solutions in Daniel Lacalle, PhD thread: https://twitter.com/dlacalle_IA/status/1172075195881988097
Last important thing
on the European monetary policy front was the FT (Financial Times) reporting some analysts’ comments about a possibility of larger central bank purchases of
green bonds (Green Quantitative Easing) to address climate change. The idea
supported by Ms Lagarde has been already criticized by Jens Weidmann, Bundesbank
President who said that this type of decisions should be left to politicians
instead of unelected central bankers. As Professor Tuomas Malinen rightly
tweeted: “There's absolutely no reason
for the #ECB to "invest" in Green Bonds. It would just distort that
market further and make all reasonable price discovery and capital allocation
impossible.”
One thing is certain,
Christine Lagarde will have rough first few months in her new job.
United
States
Last week brought us 10 Federal Reserve speakers, the largest central bank in the world. Most of
them have been reiterating that the U.S. economy is in a good place and the Fed policy
is accommodative which in layman terms mean that they are addressing economic
slowdown by lowering interest rates and increasing money supply to boost the
economy. That is why we have seen third rate cut at the end of October and they
are conducting “No QE” or money printing, injecting liquidity to the money
market (where commercial banks deal with each other as well as with the Fed).
QE - Quantiative Easing = asset purchases by a central bank on a massive scale using electronically 'printed' money.
QE - Quantiative Easing = asset purchases by a central bank on a massive scale using electronically 'printed' money.
One statement,
however, deserves more attention and it was by the New York Fed President John
Williams who said that in case of a recession Fed will cut interest rates to zero
(right now stand at 1.50% level), will use communication (speeches like that one) and asset
purchases. He did not mention, what kind of purchases it could be. So far, there
have been purchasing only government bonds and mortgage backed securities (MBS or an asset
similar to bond which is created from a basket of home loans). It is therefore
not excluded, that in case of a recession they will be purchasing also corporate
and municipal bonds or even REITs (Real Estate Investment Trusts) and stocks.
This statement is so important because from twelve regional Federal Reserve
Banks, New York Fed is the largest Reserve Bank in terms of both assets and
volume activity, which means it is first among equals. In addition, only the
NY Fed has a market desk conducting various market operations.
One of the ongoing
operations are on the repo market. To put it simply, the Fed injects liquidity
(electronically printed money) to the money market to facilitate functioning of the financial system,
the so called “Not QE”. In effect, the U.S. Central Bank balance sheet has
moved back above $4 trillion, up $280 billion since August 28. It can be seen on
the graph below that there has been only a one time in history when Fed was
printing money faster and it was during the Great Financial Crisis (grey area
on the chart).
I will not go into
details why is it happening because there has been an extensive debate on FinTwit about the topic as well as in the entire finance industry. However, if the problems do not
disappear soon and the pace continue, we will see a new Fed balance sheet record by
February 2020, as noted by Jim Bianco Research (see the chart).
Together with 20
billion euros of the ECB monthly QE, started November 1 and the recent return of the Chinese Central Bank (People’s
Bank of China) to liquidity injections (also money printing) it is not a
surprise that the S&P 500 stock index has reached another all time high
(also boosted by the ‘trade war optimism’).
source:
zerohedge
Blue line on the chart
shows Global ‘Liquidity’ Proxy or Global Money Supply which measures M2 money
supply for 12 major economies including the U.S., China, the Eurozone and Japan
(M2 is a measure of the money supply that contains cash, short-time bank
deposits and 24-hour money market funds). It is clearly seen that the more
money has been printed the more the S&P 500 has been increasing over the
year. “Don’t fight the Fed” works perfectly this year, which is a common believe that the Fed will not let the market falling down.
It is worth to remind
that this habit has started on Oct 20, 1987, when Fed Chairman Alan Greenspan said, “The Federal Reserve, consistent with its
responsibilities as the Nation's central bank, affirmed today its readiness to
serve as a source of liquidity to support the economic and financial system.”, ensuring liquidity injections in order to protect financial system, so and the stock market.
As you can see, it
continues to this day.
Trade War between the U.S. and China
The Trade War saga can
be compared to Brexit and surely called a never ending story. Constantly repeated
headlines and comments from Donald Trump, U.S. and Chinese authorities may
confuse even the most careful observers. Unsurprisingly, over the last week it
was no different, so let me list those events in chronological order:
1. On Monday some
people familiar with internal discussions reported that China wants Donald
Trump to remove not only 15% tariff scheduled to go into effect mid-December,
which is $160 billion of Chinese goods but also a 15% tariff that was imposed
on September 1 on $112 billion goods.
In the next phases
China also see 25% tariff on additional $250 billion Chinese goods removed or
at least half of it. (Earlier this year Trump was planning to increase the
tariff to 30% but he suspended that on October 2015).
2. Also on Monday,
Financial Times reported that the U.S. is actually considering whether to
withdraw 15% duties on $112 billion of Chinese goods including clothing,
appliances and flatscreen monitors.
3. In the meantime,
both countries are looking for possible locations of signing a “phase one deal”
after cancellation of the Asia-Pacific Economic Cooperation summit in Chile
(16-17 November).
On Sunday, November 3,
Trump said that a deal could be signed somewhere in the United States. Also
U.S. Commerce Secretary Wilbur Ross said that it could be Iowa, Alaska, Hawaii
or even China.
4. On Tuesday, editor-in-chief
of Chinese and English editions of the Global Times (daily tabloid newspaper
under the auspices of the Chinese Communist Party's People's), Xu Xijin tweeted
that the tariffs must to be removed in proportion to how much agreement has
been reached.
Remember that his
voice is basically the voice of Chinese authorities (at least in case of the
trade war).
5. And then, also on
Tuesday, South China Morning Post wrote that China needs more U.S. commitments
if they want Chinese President Xi Jinping to sign a deal in the U.S. Read, removing
more tariffs. It was confirmed by Reuters on Wednesday. China has also said
that the goal of buying up to $50 billion farm goods per annum over the next
two years is unrealistic and allegedly proposed $20 billion.
6. After that, again
on Wednesday, one of the White House’s officials said CNBC that the meeting
between U.S. and Chinese presidents could be delayed until December because
they need to agree on the terms of a deal and a new place for signing. However,
White House still believes that an agreement will be reached on November 16.
7. On Thursday the Chinese
Ministry of Commerce Gao Feng said that “If
China and the US reach a phase one deal, both sides should roll back existing
additional tariffs in the same proportion simultaneously.” Emphasizing that
economic and trade teams from both countries have been in constant
communication.
8. On the same day
Edward Lawrence Fox News Correspondent tweeted that “Trade sources from both sides say the US and China still negotiating
using the APEC timeframe. They want to
have a Phase One deal down on paper by the end of next week. I will let you
know if anything changes.”
9. Few hours after Gao
Feng speech Reuters reported that White House plan to withdraw tariffs faces
“fierce internal opposition” and there is no decision yet.
10. Subsequently, Chinese sources
said that China wants all tariffs to be rolled back (proportionally) while
progressing through additional phases but the U.S. wants majority of duties to
stay “until the Chinese reach certain
milestones after the full trade deal is completed”.
11. On early Thursday,
Larry Kudlow, Trump’s Economic Adviser, during the interview with Bloomberg
said “If there’s a phase one trade deal,
there are going to be tariff agreements and concessions,”
12. And then, on late
Thursday, White House trade adviser Peter Navarro said: “There is no agreement at this time to remove any of the existing
tariffs as a condition of the phase one deal,” “The only person who can make
that decision is President Donald J. Trump, and it’s as simple as that.”
13. However, White
House Press Secretary Stephanie Grisham said Friday “We’re very optimistic for
some kind of a deal, and I imagine if we reach one then some tariffs could be
lifted,”
14. During the Friday
U.S. stock market trading session President Trump said that he has not agreed to tariff rollback
but China “would like” him to do that and that China wants to make trade deal
(nothing new though).
If I had to believe someone in the trade war topic, it would be Donald Trump.
The chart below (Dow Jones Industrial Average Index) summarizes Thursday and Friday news flow (points 7-14)
source:
zerohedge
As you can see, there is a lot of
uncertainty, but is seems like market still believes in some deal giving it 66% of
probability. Remember, however, that on April the odds have been even higher
and then, all of a sudden China backtracked.
source:
zerohedge
If you want to be up
to date with the Trade War News here is the link to Edward Lawrence profile. https://twitter.com/EdwardLawrence
Stock Markets
On Tuesday last week, the S&P
500 index in the United States has reached another all-time high,
and on Friday closed slightly below that level. As you can see, looking at the longer
perspective we can see a really strong upside trend.
On the 5 year chart, it is easier to see that the index is almost 200 points away from its 200-day moving
average. This run has been supported by the Fed, ‘trade war optimism’ as well as companies Q3 earnings surprises (beating expectations). As reported by FactSet, 89% of the companies in the S&P
500 have reported actual results for Q3 2019. The percentage of companies
reporting actual EPS above estimates (75%) is above the five-year average. As
of November 1, 45 companies have reported negative earnings guidance for Q4
2019 and 19 companies positive guidance.
What to expect in the
next week? As you can see, Relative Strength Indicator has just crossed 70 mark
which signals that the S&P 500 is in overbought territory. In addition, the index
is 6.7% above 200-day moving average. It does not mean, however, that it is an
opportunity to short this market but it is also not a good place to get in.
Next week, there are two key
events to watch which could trigger significant market moves with the more
focus on the first one:
1. On Tuesday U.S.
lunch time, President Donald Trump speaks to the Economic Club of New York.
This event will be closely watched by investors as there is still need for
clarity about a ‘phase one’ trade deal.
2. On Wednesday,
Federal Reserve Chairman, Jerome Powell gives a testimony to the Congressional
Joint Economic Committee, as well as before the House Budget Committee on Thursday.
In this case, he will probably confirm the Fed message which has been sent on October 30, after the rate cut. Namely, that the economy is in a good place and the next central bank moves will depend on economic data.
Seems like everything has calmed down for now. Also the market does not see any reason for the Fed action.
Probability of the next rate cut by the end of this year is just 8%.
Calm before the storm?
At this point I would
like to show some indicators showing extreme optimism which can be perceived as
contrarian indicators. If there be some negative shock, news, event then it could trigger market
sell-off.
Source: CNN
First is the Fear
& Greed index which is currently at levels not seen since 2017, showing extreme greed of investors.
Next is the Call/Put Ratio. Call and Puts are options (or derivatives), call is a bet for a asset price increase, put a bet for a price decrease. As SentimenTrader
noted, options traders on the ISE exchange bought 238 calls for every 100 puts
today. That's the most since December 2005.
Below you can see VIX
(Volatility Index) net speculative positions showing historically record
shorts (bets that the market will not experience volatility).
Source:
zerohedge and stockcharts
VIX index also called
fear index (because it spikes when investors are very uncertain about the market
prospects and sell shares in panic) is also at relatively low levels and
below 200-day moving average.
So far, everything goes smoothly but some unexpected event could change it.
For now, I would watch and stay aside.
World and Europe
Meanwhile, German Dax is 2-3% away from its all time
high.
So Europe Stoxx 600
index is:
Source:
zerohedge
No wonder then why
global stocks are also near a new record and in overbought territory based on Relative Strenght Index, such as the S&P 500
and DAX.
GOLD
Gold is catching some
breath after great run during this year. The yellow metal fell 3.7% this week, the
most since November 2016.
Looking for a reason? There
may be a few, apart from the ‘trade deal optimism’.
Firstly, market has
started to believe that the Fed with their three 0.25% rate cuts and "No QE" flooding market with liquidity may manage the so-called
“soft landing”. In other words U.S. may avoid a recession. Secondly, there have
been some slight improvement in the economic data across the world which has triggered some bonds sell-off (when bond prices go down, then the yields go
up). And many of previously negative yielding bonds now trade with positive
yields.
Gold is a non yielding asset, which means that it does not provide any interest or dividend. Thus, the more negative yielding bonds the better for the metal.
Gold is a non yielding asset, which means that it does not provide any interest or dividend. Thus, the more negative yielding bonds the better for the metal.
Source:
zerohedge
Above chart shows the
value of global negative-yielding debt (bonds with negative yield) which has
fallen below $12 trillion from $17 trillion recorded in the end of August (red
line). Gold also initially dropped, then were going sidelines and eventually followed
through, recording the worst week since 2016 (gold line).
This has been also confirmed
by U.S. bonds which was rightly noticed by The Market Ear Team. TLT (purple line) is
Exchanged Traded Fund tracking long-term (20+ year) U.S. Treasury bonds.
I believe, however,
that pick up in bond yields could be temporary what is suggested by the chart
below.
Blue line is the U.S.
10 year bond yield 13-week change and red line is Citi U.S. economic surprise
index measuring economic data positive or negative surprises in the United
States (if it is above 0 on the right scale it means that there has been more
data releases which has been better than economists’ forecasts than data which has been
worse than estimates). These two indicators have quite close relationship and we
can see on the chart that the recent positive economic surprises came to an end. If that continues then yields will likely to follow.
From my point of view, $1400 per ounce could be a good place to start thinking about adding some gold, in the medium term (it should be around its 200-day moving average).
Quick look at the US
Dollar Index and WTI Crude Oil
Dollar is trading
within moderate ascending channel since mid-2018.
WTI Crude Oil just
testing 200-day moving average.
Global Economy Recap – Bonus
1. China is increasing
its credit activity:
China credit impulse
(a measure of the change in new credit issued as a % of GDP), which leads the
real economy by 9 to 12 months, is moving back to positive territory, currently
running at minus 0.4% of GDP (chart below).
This business cycle is
mainly driven by Chinese debt pilling and other forms of stimulating their economy.
Will it work once again? I think you will find the answer in Professor Tuomas
Malinen thread:
Meanwhile, Chinese
authorities are trying to rescue their banking sector, mainly smaller banks. China has more than 3000 small banks and many of them are struggling with
increasing amount of bad loans. Ways to fight these problems: mergers,
restructuring, central bank liquidity (money printing). It has to be emphasized
that China has also the largest banking system in the world.
2. International
Monetary Fund issues another warning over the last several weeks:
"Global debt --
both public and private -- has reached an all-time high of $188 trillion. This
amounts to about 230 percent of world output," Georgieva said in a speech
to open a two-day conference on debt. This is up from the previous record of $164
trillion in 2016. It is worth to add that it does not include financial
corporations’ debt.
3. ‘Sign of a
recession?’: CEOs stepping down at levels not seen since 2008
"According to
Challenger, Gray & Christmas’ report, 1,332 CEOs have already left their
companies, far outstripping the total 1,257 departures by this time in
2008."
Interesting article
showing how CEOs running out of their companies amid the longest U.S. Economic
Expansion in history.
This coincidences with
record divergence between CEO expectations and consumer expectations about the
U.S. economy (Deutsche Bank's Analyst Torsten Slok chart). CEOs are much more negative about the future prospets than consumers.
Gray areas = previous
recessions.
4. At the end, two
warnings about the Eurozone economy (where monetary policy has practically no bullets to fight the slowdown).
First comes from the
International Monetary Fund which warned that the monetary policy is almost
exhausted and risk is spreading around the region. IMF emphasized that Eurozone
needs emergency plans to prepare for the worst, calling for “a synchronized
fiscal response” (basically they want European governments to spend more – at the
beginning it was explained why it is not the case).
The fact is that
German is falling into recession (two consecutive quarters of negative GDP
growth) with Italy on a brink of a recession and there is still a lot of
uncertainty around Brexit.
Second is a warning
from the European Commission: “EU Warns
Worst May Be Ahead as Euro-Area Resilience Wanes”
EU chief economist
Marco Buti warned in his report that the European economy has been hit hard by
the slowdown in global demand and weak trade, apart from domestic issues
(policy uncertainty and economic shocks.
Have a great week!
Seb.
Disclaimer: This content includes only personal
opinion and that should not be considered professional financial investment
advice.
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