Weekly Commentary: Thoughts On Liquidity

“Money” challenged – and sometimes confounded – financial thinkers for hundreds of years. It features each as a “medium of exchange” and “unit of account.” Simple sufficient. Too usually the main target has been how one can use cash to stimulate financial exercise and obtain political features. From my perspective, cash’s significance rests with its basic roles as a “Store of Value” and because the bedrock of monetary programs. Unsound cash has been a root reason behind plenty of turmoil all through historical past – together with the financial fiasco that collapsed in 2008. Yet considerations for the soundness of up to date “money” lately are seen as hopelessly archaic.

My pondering on modern “money” has been tailored from a a lot earlier concentrate on cash’s “preciousness.” Traditionally, cash was treasured both as a result of it was made from or backed by gold/treasured metals. It retained preciousness solely as long as its amount remained rigorously contained. Throughout historical past, the worth of “paper money” has invariably moved inversely to the amount issued – suits and begins, enthusiasm and revulsion and, too usually, a path to worthlessness.

Today, “money” is essentially digital/digitized IOUs/Credit – however a particular sort of Credit. Money is a perceived protected and liquid retailer of (nominal) worth. This notion assures primarily insatiable demand. Unlimited demand creates a robust propensity for over-issuance. Historically, financial inflation ensured the Scourge of Inflationism. Monetary extra distorted flows to items markets, setting in movement problematic inflationary dynamics in incomes, spending patterns and financial construction.

Despite cash’s important position inside an economic system, a consensus view on how finest to outline, monitor and handle the “money supply” escaped each the economics group and policymakers extra usually. Too usually, politics and beliefs muddied already murky analytical waters. What is cash lately, and the way finest to handle financial issues? Does anybody even care – as long as the securities markets are sturdy?

If points surrounding “money” aren’t complicated sufficient, how about this factor we discuss with as “Liquidity.” As we wrap up a wild 12 months in international markets, it could be becoming to label 2018 “The Year of Liquidity.” The 12 months started with a bang, as liquidity inundated the rising markets. It’s simple to overlook that the Shanghai Composite jumped 5.3% in January. Brazil’s Ibovespa surged 11.1% in January and was up nearly 15% by late February. The rising market ETF (NYSEARCA:EEM) had jumped 10.5% by January 26th. South Korea’s KOSPI index rose 4.0% in January, and India’s Sensex gained nearly 6%.

One might fairly assert that “Liquidity” was in nice abundance – in EM and international markets effectively into 2018. “Money” was flowing readily into the rising markets, though it could be extra correct to state “finance” was flowing. Speculative Credit was most definitely increasing quickly, as “carry trades” and a large number of derivatives methods funneled newly generated buying energy into “developing” markets and economies. To make sure, the notion of a world awash in “Liquidity” ensured a problematic buildup of speculative leverage.

In normal, free-flowing Credit is inherently self-reinforcing and validating (ongoing growth supporting the perceived creditworthiness of the prevailing Credit construction) – therefore unstable. Credit for securities hypothesis – speculative leveraging – is acutely unstable. The growth of speculative Credit creates a stream of shopping for energy, or Liquidity, that inflates securities costs and engenders solely larger demand for speculative Credit. Resulting Liquidity abundance fosters confidence that markets will proceed to increase skyward. “Money” all over the place.

The growth of GSE Credit was key to the notion of Liquidity abundance early within the mortgage finance Bubble interval. The growth of GSE liabilities generated a robust stream of shopping for energy/Liquidity into {the marketplace}. Moreover, the flexibility and willingness to aggressively increase GSE Credit within the occasion of heightened market stress fostered the notion {that a} governmental quasi-central financial institution entity was accessible to backstop system liquidity when wanted. By late within the cycle, a booming Credit growth was creating such a prodigious stream of Liquidity that markets had little concern that fraud on the GSEs primarily eradicated their capability to backstop market Liquidity.

Simplifying the evaluation, we are able to take into account 4 key – and interrelated – parts to market “Liquidity.” First, the precise buying energy (i.e. deposits, cash market funds, and many others.) accessible to buy securities. Second, the convenience of availability of speculative Credit for the leveraging of securities. Third, the willingness and capability of market-makers and operators to build up holdings within the face of intense promoting stress. And, fourth, the notion of Liquidity flows that might be injected into the system within the occasion of market instability and illiquidity danger (GSE backstop bid throughout the mortgage finance Bubble – and central financial institution QE all through the worldwide authorities finance Bubble).

M1 cash provide ended final week at $3.736 TN, with M2 at $14.415 TN. M2 is a reasonably simple calculation including Currency, Deposits (checking/saving/small time/different) and Retail Money Market Funds. The Federal Reserve prior to now calculated M3, a broader measure of cash (including giant time deposits, institutional cash funds and repurchase agreements). Long arguing that broad “money” was analytically superior to the slim aggregates, I nonetheless misplaced no sleep when the Fed discontinued publishing M3 (nonetheless too slim!). Our analytical frameworks ought to attempt to include the broadest view of “money,” Credit and “finance,” though the broader the view taken the more difficult the evaluation.

I might posit that a while in the past Liquidity utterly supplanted the financial aggregates as the important thing focus for market stream evaluation. Unfortunately, there isn’t a amount of “Liquidity” to measure and tabulate. I’m not aware of an satisfactory definition and even widespread understanding. The idea of up to date “money” has proved extremely problematic for the economics group. Yet Liquidity makes “money” seem fairly simple. If it will probably’t be outlined or calculated, it is definitely unfit of inclusion in econometric fashions. Liquidity Disregarded.

Liquidity is an amalgam of actual monetary flows and intangible market perceptions. There isn’t any combination that might sign whether or not Liquidity is both increasing or contracting. Even if general Liquidity is seen as both ample or poor, there would nonetheless be extensively divergent Liquidity manifestations for particular person sectors, markets, international locations and areas. And how can seeming Liquidity overabundance so briskly rework into illiquidity?

“Money supply” was a useful software for gauging system “Liquidity” again when financial institution liabilities (i.e. deposits) had been the prevailing mechanism for cash and Credit growth. Analysis has modified profoundly with the adoption globally of non-bank market-based Credit. I’ve argued that market-based Credit is extremely unstable – speculative Credit perilously so. I might contend that “Liquidity” is often regular however at occasions extremely erratic. So lengthy as the worldwide Credit increase is ongoing, speculative Credit expands, and markets stay steady, the notion of Liquidity abundance ensures ample buying energy to maintain the bull market. But the Wildness Lies in Wait.

For years now, international central financial institution insurance policies have been basic to the notion of uninterrupted Liquidity abundance. Chairman Bernanke’s zero charges and QE measures triggered a historic stream of buying energy (Liquidity) into stock and fixed-income funds. This advanced right into a momentous shift of monetary flows into “passive” danger market methods (perceived as low-risk and, usually, money-like). Ultra-low charges and the idea that central banks had been backstopping market Liquidity basically altered each the stream of Liquidity and, over time, the construction of {the marketplace}.

The stream of Trillions into ETF and different “passive” methods modified the character of world leveraged hypothesis. Not solely had been the leveraged speculators incentivized by close to zero (and even damaging) borrowing prices and confidence within the central financial institution Liquidity backstop, they had been now emboldened by the predictability of big “retail” flows (home and worldwide) into stock and fixed-income funds. Booming flows into equities and bonds basically loosened monetary circumstances on an unprecedented international foundation.

Loose finance stoked asset inflation, booming M&A and buybacks, all conducive to financial growth and surging company earnings. Liquidity circulating briskly all through each the Financial and Economic Spheres bolstered the notion of an countless Liquidity increase. Booming securities markets fueled U.S. consumption and ongoing large commerce deficits, greenback Liquidity flowing out to the world – solely to be recycled proper again into U.S. securities and asset markets (i.e. EM central financial institution Treasury/company purchases, hedge funds borrowing in offshore markets to leverage in U.S. securities, Chinese shopping for U.S. Treasuries and actual property, and many others.). Meanwhile, booming international markets and the convenience of “investing” passively by means of the ETF advanced stoked unprecedented U.S. flows to international markets – as soon as once more producing a stream of world Liquidity that might be readily “recycled” again into U.S. markets.

Early CBBs launched the idea of the “infinite multiplier effect.” Contemporary finance (largely devoid of capital and reserve necessities) left the outdated fractional reserve banking deposit “money multiplier” within the mud. The stream of buying energy/Liquidity would flow into and recirculate, within the course of fueling each unfettered Credit growth and asset inflation. The international authorities finance Bubble interval – with its zero charges, Trillions of recent “money,” and central financial institution liquidity backstops – has seen the “infinite multiplier” at work on an unprecedented international scale. Liquidity created by the central banks, in addition to by means of huge authorities debt growth and leveraged hypothesis, has circulated freely on a world foundation, inflating securities/asset costs, stoking financial growth and selling a self-reinforcing notion of countless Liquidity.

For essentially the most half, modern market Liquidity is just not actual. It’s primarily a market notion. It’s based mostly on the view that monetary flows into markets will stay constructive and, on these uncommon events once they’re not, central banks will step in and guarantee “money” flows unabated into the monetary markets. It’s based mostly on confidence and religion – in modern central banking, in market construction, within the derivatives advanced, in fashionable applied sciences and ingenuity. It’s based mostly on the view that international Credit will proceed to increase, premised on confidence that Beijing will guarantee ongoing Credit growth and that U.S. Credit is basically sturdy. It’s based mostly on the overarching perception that international finance is basically sound, policymakers possess acumen and enlightenment, central financial institution energy is boundless, and the worldwide economic system is on strong footing.

I imagine the February blow-up of “short vol” methods was a key preliminary crack within the international Bubble. Huge speculative extra had amassed in a significant market used for buying safety in opposition to market declines – writing “flood insurance” throughout a protracted central bank-induced drought. Abrupt market losses and illiquidity modified the danger/reward calculus for “selling” market “insurance” – lowering the provision and growing the worth of safety. Not lengthy after, indications of fledgling danger aversion started to beset the worldwide “Periphery.” EM Liquidity started to wane, an particularly problematic dynamic following a speculative blow-off interval. As EM flows reversed, de-risking/deleveraging dynamics took maintain. Liquidity that appeared so ample early within the 12 months all of the sudden disappeared, changed by faltering markets, dislocation and worry of increasing market illiquidity all through the “Periphery.”

On a world foundation, the Liquidity backdrop had modified momentously. For the primary time in a number of years, a major de-risking/deleveraging dynamic was unfolding with out the advantage of large central financial institution QE liquidity injections. Rapid forex collapses in Turkey and Argentina signaled a important international Liquidity inflection level. And as de-risking/deleveraging gained momentum, Contagion turned a significant concern. China and Asia, the epicenter of Liquidity excesses over this cycle, noticed their currencies, equities and bonds fall below vital stress. Dollar-denominated debt, having so flourished throughout Liquidity abundance, was all of the sudden going through sinking costs and Liquidity points. The shifting Liquidity backdrop was additionally manifesting within the colossal worldwide derivatives markets (i.e. forex, swaps and fixed-income).

Market perceptions with regard to worldwide Liquidity modified meaningfully. The similar couldn’t be mentioned for the U.S. If something, expectations for ongoing Liquidity abundance turned solely extra deeply ingrained. Keep in thoughts that the Federal Reserve concluded QE operations in 2014. With the bull market having not missed a beat, it was extensively believed that QE was irrelevant for the U.S. Not appreciated was the main position QE was having on worldwide Liquidity, with “money” created by the ECB, BOJ and others discovering its method into U.S. securities markets and the American economic system. This 12 months’s instability on the “Periphery” initially exacerbated flows to “Core” U.S. markets, pushing already extremely speculative markets into Melt-Up Dynamics.

From a Liquidity perspective, speculative blow-offs are extremely problematic. A bout of manic shopping for and leveraging culminates in extremely elevated and unsustainable costs and monetary flows. The notion of Liquidity abundance sows the seeds of its personal destruction. When costs inevitably reverse, the onset of de-risking/deleveraging dynamics ensures a extremely problematic Liquidity surroundings.

When The Crowd is absolutely on board, who’s left to purchase? When the leveraged speculating group reverses course, who however central banks have the capability to accommodate deleveraging? If a major section of {the marketplace} strikes to hedge market danger, the place is the wherewithal to shoulder such danger? And let’s not overlook the important subject of market danger shifting to speculators and merchants that anticipate to dynamically-hedge possibility danger written/offered within the market (planning, when vital, to ascertain brief positions in a declining market). Current Market Structure ensures severe Liquidity points upon the inevitable bursting of speculative Bubbles. Who needs to get in entrance of the algos?

Progressively extra reckless central financial institution measures over the previous decade have been vital to advertise the notion of ample and sustainable Liquidity. But with Crisis Dynamics having not too long ago stricken the “Core,” it’s troublesome for me to not see a Liquidity surroundings basically altered. Confidence has taken a major hit. I imagine the leveraged speculating group has been impaired, with outflows and normal danger aversion making certain ongoing de-risking/deleveraging. Similarly, with confidence in “passive” (stock, fixed-income, worldwide) ETF methods now badly shaken, it is troublesome to envisage a return to booming business inflows. And with derivatives gamers stung by abrupt market losses and a spike in volatility (possibility premiums), I anticipate we have handed a important inflection level within the pricing and availability of market safety.

The backdrop factors to an inhospitable Liquidity backdrop. Serious market structural points have bubbled to the floor, points market members both have not appreciated or just believed can be readily rectify by central banks earlier than confidence was impacted. The orientation of highly effective monetary flows has been upset. Hedging and derivatives markets have dislocated. The nice fallacy of “moneyness” for dangerous shares, bonds and derivatives is being laid naked.

Importantly, I view speculative Credit because the marginal supply of world Liquidity. I imagine a historic Bubble in securities and derivatives-related Credit has been pierced. This Bubble was fueled by years of zero/damaging charges and Trillions of central financial institution “money”. As we noticed this week, bear market rallies are typically ferocious. And when a brief squeeze and unwind of hedges is in play, surging costs will spur hope that the sell-off has run its course and that Liquidity has returned to the markets.

It’s simply not going to be that easy. Global markets face severe structural points years and a long time within the making. Hopefully markets can keep away from crashes and make vital changes over an prolonged time period. For some time now, I’ve feared a state of affairs the place illiquidity turns into a systemic international subject. From carefully analyzing earlier booms and bust episodes, issues usually show even worse than I anticipate.

For the Week

The S&P 500 rallied 2.9% (down 7.0% y-t-d), and the Dow gained 2.7% (down 6.7%). The Utilities fell 1.8% (down 0.3%). The Banks gained 3.2% (down 20.2%), and the Broker/Dealers recovered 3.9% (down 11.3%). The Transports rose 2.6% (down 14.2%). The S&P 400 Midcaps elevated 2.2% (down 13.4%), and the small cap Russell 2000 jumped 3.5% (down 12.9%). The Nasdaq100 recovered 3.9% (down 1.7%). The Semiconductors surged 4.2% (down 8.4%). The Biotechs jumped 4.7% (down 2.3%). With bullion leaping $25, the HUI gold index elevated 1.1% (down 17.8%).

Three-month Treasury invoice charges ended the week at 2.32%. Two-year authorities yields dropped 12 bps to 2.52% (up 63bps y-t-d). Five-year T-note yields declined eight bps to 2.56% (up 35bps). Ten-year Treasury yields fell seven bps to 2.72% (up 31bps). Long bond yields slipped a foundation level to 3.02% (up 28bps). Benchmark Fannie Mae MBS yields dropped 9 bps to 3.53% (up 53bps).

Greek 10-year yields added two bps to 4.35% (up 27bps y-t-d). Ten-year Portuguese yields gained three bps to 1.72% (down 22bps). Italian 10-year yields fell 9 bps to 2.74% (up 73bps). Spain’s 10-year yields added a foundation level to 1.42% (down 15bps). German bund yields slipped one foundation level to 0.24% (down 19bps). French yields gained a foundation level to 0.71% (down 8bps). The French to German 10-year bond unfold widened two to 47 bps. U.Okay. 10-year gilt yields fell 5 bps to 1.27% (up 8bps). U.Okay.’s FTSE equities index elevated 0.2% (down 12.4%).

Japan’s Nikkei 225 equities index declined 0.8% (down 12.1% y-t-d). Japanese 10-year “JGB” yields fell 4 bps to 0.00% (down 5bps). France’s CAC40 slipped 0.3% (down 11.9%). The German DAX equities index declined 0.7% (down 18.3%). Spain’s IBEX 35 equities index fell 0.7% (down 15.4%). Italy’s FTSE MIB index slipped 0.4% (down 16.1%). EM equities had been combined. Brazil’s Bovespa index jumped 2.6% (up 15.0%), whereas Mexico’s Bolsa was little modified (down 16.0%). South Korea’s Kospi index declined 1.0% (down 17.3%). India’s Sensex equities index gained 0.9% (up 5.9%). China’s Shanghai Exchange declined 0.9% (down 24.6%). Turkey’s Borsa Istanbul National 100 index fell 1.6% (down 21.6%). Russia’s MICEX equities index elevated 0.5% (up 11.8%).

Investment-grade bond funds noticed outflows of $4.416 billion, and junk bond funds posted outflows of $3.938 billion (from Lipper).

Freddie Mac 30-year fastened mortgage charges fell seven bps to a four-month low 4.55% (up 56bps y-o-y). Fifteen-year charges declined six bps to 4.01% (up 57bps). Five-year hybrid ARM charges added two bps to 4.00% (up 53bps). Bankrate’s survey of jumbo mortgage borrowing prices had 30-yr fastened charges down 4 bps to a ten-month low 4.42% (up 27bps).

Federal Reserve Credit final week declined $4.1bn to $4.044 TN. Over the previous 12 months, Fed Credit contracted $374bn, or 8.5%. Fed Credit inflated $1.233 TN, or 44%, over the previous 320 weeks. Elsewhere, Fed holdings for international house owners of Treasury, Agency Debt fell $6.3bn final week to $3.397 TN. “Custody holdings” rose $35bn y-o-y, or 1.0%.

M2 (slim) “money” provide slipped $8.2bn final week to $14.415 TN. “Narrow money” gained $566bn, or 4.1%, over the previous 12 months. For the week, Currency elevated $1.5bn. Total Checkable Deposits dropped $82.9bn, whereas Savings Deposits jumped $61.6bn. Small Time Deposits gained $5.0bn. Retail Money Funds rose $6.6bn.

Total cash market fund property jumped $30.3bn to $3.039 TN. Money Funds gained $193bn y-o-y, or 6.8%.

Total Commercial Paper dropped $18.7bn to close an eight-month low $1.056 TN. CP declined $24bn y-o-y, or 2.2%.

Currency Watch

The U.S. greenback index declined 0.6% to 96.402 (up 4.6% y-t-d). For the week on the upside, the South African rand elevated 1.5%, the Mexican peso 1.4%, the Swiss franc 0.9%, the Japanese yen 0.9%, the Norwegian krone 0.7%, the euro 0.6%, the Brazilian actual 0.6%, the South Korean gained 0.6%, the Singapore greenback 0.6%, the Swedish krona 0.5%, the British pound 0.4% and the Australian greenback 0.1%. For the week on the draw back, the Canadian greenback declined 0.3% and the New Zealand greenback dipped 0.2%. The Chinese renminbi elevated 0.41% versus the greenback this week (down 5.41% y-t-d).

Commodities Watch

The Goldman Sachs Commodities Index declined 1.4% (down 15.2% y-t-d). Spot Gold jumped $25 to $1,281 (down 1.7%). Silver surged 5.0% to $15.436 (down 10%). Crude slipped 26 cents to $45.33 (down 25%). Gasoline recovered 0.6% (down 26%), whereas Natural Gas sank 13.4% (up 12%). Copper elevated 0.3% (down 19%). Wheat declined 0.5% (up 20%). Corn fell 0.8% (up 7%).

Market Dislocation Watch

December 25 – Wall Street Journal (Gregory Zuckerman, Rachael Levy, Nick Timiraos and Gunjan Banerji): “Behind the broad, swift market slide of 2018 is an underlying new reality: Roughly 85% of all trading is on autopilot-controlled by machines, models, or passive investing formulas, creating an unprecedented trading herd that moves in unison and is blazingly fast. That market has grown up during the long bull run, and hasn’t until now been seriously tested by a prolonged downturn… Today, quantitative hedge funds, or those that rely on computer models rather than research and intuition, account for 28.7% of trading in the stock market, according to data from Tabb Group – a share that’s more than doubled since 2013… Add to that passive funds, index investors, high-frequency traders, market makers, and others who aren’t buying because they have a fundamental view of a company’s prospects, and you get to around 85% of trading volume, according to Marko Kolanovic of JP Morgan. ‘Electronic traders are wreaking havoc in the markets,’ says Leon Cooperman… [from] Omega Advisors. Behind the models employed by quants are algorithms, or investment recipes, that automatically buy and sell based on pre-set inputs… ‘The speed and magnitude of the move probably are being exacerbated by the machines and model-driven trading,’ says Neal Berger, who runs Eagle’s View Asset Management… ‘Human beings tend not to react this fast and violently.'”

December 26 – Reuters (Charles Stein): “Investors are bailing out of mutual funds as if it were 2008. Mutual funds suffered redemptions of $56.2 billion in the week ended Dec. 19. That’s the biggest outflow since the week ended Oct. 15, 2008, according to… the Investment Company Institute. And the numbers over the last several weeks have only gotten worse…”

December 26 – Reuters (Trevor Hunnicutt): “U.S. fund investors battered bond markets with the biggest withdrawals in seven weeks and snatched the most cash from foreign stocks since mid-2015 as the Federal Reserve hiked interest rates, Investment Company Institute (ICI) data showed… Some $12.2 billion tumbled from U.S.-based bond funds during the week ended Dec. 19…”

December 24 – Bloomberg (Christopher DeReza): “U.S. investment-grade bond spreads widened every day last week to end Friday at 148 bps, the highest since July 2016.”

December 24 – Bloomberg (Kelsey Butler): “The Markit CDX North America High Yield Index dropped 0.20% to 100.84 – lowest since March 8, 2016… amid plunging equity and oil markets.”

December 26 – Reuters (Richard Leong): “A barometer of overall demand for U.S. five-year Treasury note supply on Wednesday declined to its weakest in nearly 9-1/2 years with the note being sold at a yield at its lowest level since March… The ratio of bids to the amount of five-year notes came in at 2.09, the lowest reading since July 2009.”

December 26 – Wall Street Journal (Dawn Lim): “The investor pullback from the asset-management industry in 2018 is the most severe since the last financial crisis, a sign that doubts about the direction of global markets are intensifying. Net inflows for U.S. mutual and exchange-traded funds in the first 11 months of the year fell to $237 billion, according to… Morningstar. That was down 62% from the year-ago period, the steepest decline since 2008. Asset managers attracted a record $629.5 billion in net flows during the same period in 2017, a boom year for the industry.”

December 26 – Reuters (Trevor Hunnicutt): “U.S. fund investors battered bond markets with the biggest withdrawals in seven weeks and snatched the most cash from foreign stocks since mid-2015 as the Federal Reserve hiked interest rates, Investment Company Institute (ICI) data showed… Some $12.2 billion tumbled from U.S.-based bond funds during the week ended Dec. 19…”

December 27 – Bloomberg (Sarah Ponczek): “Exchange-traded fund investors who use factor-based products to juice returns or protect themselves from wild swings will probably look back on 2018 as the year when nothing worked. ETFs that promised everything from defensive characteristics like low volatility to more aggressive strategies such as growth and momentum suffered this year, with the largest funds for each factor tracked by Bloomberg set to end in the red. And as equity market performance took a marked shift from gung-ho to risk averse in the second half of the year, the leader-board for performance and flows has experienced a makeover.”

December 26 – Bloomberg (Vildana Hajric and Carolina Wilson): “Investors are fleeing the largest exchange-traded fund tracking U.S. financial stocks at the fastest monthly pace on record, having withdrawn more than $3.5 billion from it through Dec. 24. Outflows from the $21 billion Financial Select SPDR Fund, or XLF, are driving the record $9.2 billion that’s been pulled from all ETFs tracking financials this year.”

December 24 – Reuters: “Japanese government bond yields hit multi-month lows on Tuesday, with the benchmark 10-year yield hitting zero percent, as U.S. political chaos engulfed global financial markets causing the worst day for Tokyo stock prices in more than two years. Demand for the safety of government bonds increased as investors have grown increasingly nervous about the political outlook in the United States in addition to concerns about a global economic slowdown.”

December 26 – Reuters (Lewis Krauskopf): “The Dow Jones Industrial Average surged more than 1,000 points for the first time on Wednesday, leading a broad Wall Street rebound after a report that holiday sales were the strongest in years helped mollify concerns about the health of the economy. Following Wall Street’s worst-ever Christmas Eve drop in the previous session, the advance was also fueled by investors’ reversing bets against a wide range of stocks. By the close, the Dow, S&P 500 and Nasdaq had notched their largest daily percentage gains in nearly a decade… The Dow Jones Industrial Average rose 1,086.25 points, or 4.98%, to 22,878.45, the S&P 500 gained 116.6 points, or 4.96%, to 2,467.7, and the Nasdaq Composite added 361.44 points, or 5.84%, to 6,554.36.”

December 26 – Reuters (Saqib Iqbal Ahmed and Lewis Krauskopf): “One notable factor in Wall Street’s monster rally on Wednesday was a record gain in an index of stocks that have the largest bets placed against them by market contrarians. The Thomson Reuters United States Most Shorted Index rose 6%, the biggest percentage rise in its six-year history, as some investors moved to cover bearish bets on the 51 stocks in the index…”

Trump Administration Watch

December 21 – Bloomberg (Jennifer Jacobs, Saleha Mohsin and Margaret Talev): “President Donald Trump has discussed firing Federal Reserve Chairman Jerome Powell as his frustration with the central bank chief intensified following this week’s interest-rate hike and months of stock-market losses, according to four people familiar with the matter. Advisers close to Trump aren’t convinced he would move against Powell and are hoping that the president’s latest bout of anger will dissipate over the holidays… Some of Trump’s advisers have warned him that firing Powell would be a disastrous move.”

December 24 – Reuters (Saleha Mohsin, Lananh Nguyen and Jennifer Jacobs): “Treasury Secretary Steven Mnuchin looked to quash big-bank worries over plunging stock markets and reports that President Donald Trump might move on his Federal Reserve chief by assuring the financial community on Sunday that market liquidity is in good shape. Some market participants, however, questioned why Mnuchin answered a question that no one was asking. Even after recent market losses, a liquidity squeeze or fresh financial crisis hadn’t been on the market’s mind. Mnuchin’s assertion of ample liquidity risked raising doubts. Mnuchin tweeted late Sunday afternoon that he’d called the chief executive officers of the nation’s six largest banks and that those chiefs ‘confirmed they have ample liquidity available for lending to consumer, business markets, and all other market operations.'”

December 24 – Reuters (Jason Lange): “The Trump administration is arranging a phone call on Monday with top regulators to discuss financial markets amid a rout on Wall Street. Treasury Secretary Steven Mnuchin will host the call with the president’s Working Group on Financial Markets, known colloquially as the ‘Plunge Protection team.'”

December 24 – Reuters (Andrew Mayeda and Mike Dorning): “President Donald Trump renewed his attacks on the Federal Reserve, commenting publicly on the central bank for the first time following last week’s interest-rate hike and reports he has discussed firing Chairman Jerome Powell. ‘The only problem our economy has is the Fed. They don’t have a feel for the Market, they don’t understand necessary Trade Wars or Strong Dollars or even Democrat Shutdowns over Borders,’ Trump said in a tweet Monday. ‘The Fed is like a powerful golfer who can’t score because he has no touch – he can’t putt!'”

December 26 – Associated Press: “President Donald Trump says parts of the government will stay shut as long as Democrats refuse to build more barriers on the U.S.-Mexico border, seemingly dashing hope for a Christmas miracle that would soon allow several departments to reopen and employees to return to work. Asked when the government would reopen, Trump said: ‘I can’t tell you when the government’s going to be open. I can tell you it’s not going to be open until we have a wall or fence, whatever they’d like to call it.’ ‘I’ll call it whatever they want but it’s all the same thing,’ he said…”

December 26 – Reuters (Makini Brice): “President Donald Trump on Tuesday expressed confidence in Treasury Secretary Steven Mnuchin amid worries over a weakening economy and a stock market slump, but repeated his criticism of the U.S. Federal Reserve, saying it has raised interest rates too quickly. Speaking to reporters in the Oval Office… Trump also said U.S. companies were ‘the greatest in the world’ and presented a ‘tremendous’ buying opportunity. Asked if he has confidence in Mnuchin, Trump said: ‘Yes, I do. Very talented guy. Very smart person,’ he said. His comments came after Mnuchin on Monday held a conference call with U.S. regulators to discuss plunging U.S. stock markets.”

December 26 – Reuters (Eric Beech): “A U.S. trade team will travel to Beijing the week of Jan. 7 to hold talks with Chinese officials, Bloomberg reported… The delegation will be led by Deputy U.S. Trade Representative Jeffrey Gerrish and will include David Malpass, Treasury undersecretary for international affairs, Bloomberg said.”

December 21 – Reuters (Makina Brice and Jason Lange): “The United States and China might not reach a trade deal at the close of a 90-day negotiating window unless Beijing can agree to a profound overhaul of its economic policies, White House trade adviser Peter Navarro said. In an interview with Japanese business daily Nikkei published on Friday, Navarro said it would be ‘difficult’ to strike a deal without China being ready for a full overhaul of its policies for trade and industry.”

December 22 – Wall Street Journal (Nick Timiraos): “President Trump hasn’t suggested firing Federal Reserve Chairman Jerome Powell and doesn’t believe he has the authority to do so, Treasury Secretary Steven Mnuchin said Saturday. Mr. Trump has been furious over the Fed’s decision to raise interest rates this past week, say people familiar with the matter, and he is also unhappy over the central bank’s effort to shrink its holdings of bonds acquired after the 2008 financial crisis. ‘I think the increasing of interest rates and the shrinking of the Fed portfolio is an absolutely terrible thing to do at this time, especially in light of my major trade negotiations which are ongoing,’ Mr. Trump said in a statement to Mr. Mnuchin that the Treasury secretary posted on Twitter.”

December 26 – Reuters (Trevor Hunnicutt): “The head of the U.S. Federal Reserve faces no risk of losing his job and President Donald Trump is happy with his Treasury secretary, a White House official said in an apparent attempt to calm Wall Street nerves frayed by Trump’s criticism of the Fed. Asked on Wednesday if Fed Chairman Jerome Powell’s job was safe, White House economic adviser Kevin Hassett told reporters: ‘Yes, of course, 100%.'”

December 26 – Reuters (David Shepardson and Diane Bartz): “President Donald Trump is considering an executive order in the new year to declare a national emergency that would bar U.S. companies from using telecommunications equipment made by China’s Huawei and ZTE, three sources familiar with the situation told Reuters. It would be the latest step by the Trump administration to cut Huawei Technologies and ZTE… out of the U.S. market. The United States alleges that the two companies work at the behest of the Chinese government and that their equipment could be used to spy on Americans.”

Federal Reserve Watch

December 26 – Bloomberg (Alyza Sebenius): “President Donald Trump won’t try to fire Federal Reserve Chairman Jerome Powell, a top White House economic adviser said. Kevin Hassett, chairman of the White House Council of Economic Advisers, told reporters “sure, after all, one hundred percent” on Wednesday after he was asked whether Powell’s job is safe. Hassett also said that U.S. banks aren’t facing a liquidity crisis.”

December 24 – Wall Street Journal (Michael S. Derby): “Four veteran Federal Reserve officials-most of whom have signaled support for more interest-rate increases-will step into the limelight in 2019 as they become voters on the central bank’s rate-setting committee. That status prompts greater scrutiny of their views because they will be taking an official and public stand by voting on monetary policy-and will have the opportunity to directly dissent to Federal Open Market Committee decisions and detail their objections. The turnover comes at an uncertain time for the central bank…”

U.S. Bubble Watch

December 25 – Wall Street Journal (Jessica Menton): “Investors are running out of places to hide as the stock-market rout accelerates. The S&P 500 and the Dow Jones Industrial Average have slumped 19% from their recent highs… The technology-heavy Nasdaq Composite, the Russell 2000 index of small-capitalization stocks and the Dow Jones Transportation Average have already breached those levels… Only the defensive sectors of the S&P 500-utilities, real estate, health care and consumer staples-that are known for their steady dividend payments have avoided such steep declines, for now. All are down at least 9% from their highs. ‘I haven’t seen managers this shell-shocked and confused in a very long time,’ said Robert Duggan, senior portfolio manager at… SkyBridge Capital. ‘People have been heading for the exits and selling their positions over the last two weeks.'”

December 25 – Wall Street Journal (Sarah Nassauer): “Shoppers delivered the strongest holiday sales increase for U.S. retailers in six years… Total U.S. retail sales, excluding automobiles, rose 5.1% between Nov. 1 and Dec. 24 from a year earlier, according to Mastercard SpendingPulse, which tracks both online and in-store spending with all forms of payment. Overall, U.S. consumers spent over $850 billion this holiday season, according to Mastercard.”

December 26 – Bloomberg (Molly Schuetz): “ Inc. reported a record-breaking holiday season as shoppers loaded their online baskets with items from Echo speakers to Calvin Klein clothes, suggesting consumer optimism isn’t being deterred by a tumbling stock market. The internet retailer said ‘tens of millions of people worldwide’ signed up for its Prime service… In the U.S. alone, more than 1 billion items were shipped for free using Prime…”

December 26 – Bloomberg (Jeff Kearns): “The Federal Reserve Bank of Richmond’s manufacturing gauge fell by a record as shipments and new orders weakened, the fourth district bank factory index to drop this month and the latest evidence that President Donald Trump’s trade war is becoming a greater headwind for U.S. producers.”

December 26 – Associated Press: “U.S. home price growth slowed in October, a likely consequence of higher mortgage rates having worsened affordability and causing sales to fall. The S&P CoreLogic Case-Shiller 20-city home price index rose 5% from a year earlier, down from an annual gain of 5.2% in September. That’s down from a 5.5% yearly gain in the previous month.”

December 23 – Wall Street Journal (Laura Kusisto): “A long rally in the housing market stumbled in 2018 and looks poised to slow further, another headwind for a U.S. economic expansion already contending with choppy financial markets and global trade tensions. The recent decline in home sales reflects a lack of inventory and the rising cost of homes… Home prices are now at all-time highs and inventory levels in recent months have begun climbing back from their lowest level in three decades. Rising mortgage rates, which nearly touched 5% late this year as they climbed to their highest level in more than seven years, are the latest blow. ‘Suddenly the light turned off in the second half of the year, with sales tumbling down and inventory rising,’ said Lawrence Yun, chief economist at the National Association of Realtors.”

December 23 – Financial Times (Ed Crooks): “All industrial revolutions need two things: technology and finance. The US shale revolution was made possible by the advances in horizontal drilling and hydraulic fracturing that allowed oil and gas to be released from previously unyielding rocks. But the industry’s financing was equally important in turning those innovations into a production boom that has shaken the world… Often they use derivatives to hedge some or all of their revenues, giving lenders confidence in their ability to make interest payments if oil and gas prices fall. For most of the shale boom, that financial infrastructure has been underpinned by the low interest rates and quantitative easing that followed the financial crisis. The surge in US oil production has been a result of monetary stimulus, just as much as the tech start-up boom and the rise in the S&P 500 have been.”

December 23 – Reuters (Devika Krishna Kumar and Jennifer Hiller): “U.S. shale producers are slamming the brakes on next year’s drilling with crude prices off 40% and mounting fears of oversupply, paring budgets that in some cases were set only weeks earlier. The reversal is alarming because blistering growth in shale fields has propelled U.S. crude output 16% to about 10.9 million barrels per day for 2018, above Saudi Arabia and Russia. Production has been expected to rise 11% more in 2019 as large oil firms and independents added wells this year.”

December 26 – Bloomberg (James Tarmy): “Ten people (or companies, or people masquerading as companies) spent a combined half-billion dollars on their Manhattan apartments this year. Impressive as it might seem, the numbers are down significantly from the previous three years. The highest point in the market, which this year was represented by a $73.8 million duplex penthouse in a new tower designed by Robert Stern, was down 26% from the 2014 high. (That year a penthouse on 57th street with views of Central Park sold for just over $100 million.) Moreover, in the last 12 months, eight out of the top 10 sales were heavily discounted-one apartment at 157 West 57th street took a $17 million price cut before it found a buyer.”

China Watch

December 26 – Bloomberg: “China enters trade talks said to begin early next month in Beijing having made concerted efforts to end the standoff with the U.S., and also unsure it’s done enough. Since Presidents Xi Jinping and Donald Trump came to a temporary truce almost a month ago, China’s removed a retaliatory duty on U.S. automobiles and is drafting a law to prevent forced technology transfers. It’s also slashed import tariffs on more than 700 products and began buying U.S. crude oil, liquefied natural gas and soybeans again. Officials have been in constant contact with the U.S. to try to determine what else is needed to move things forward in January… It appears to Chinese officials that the U.S. itself isn’t clear on what it wants, said the people…”

December 27 – Bloomberg: “China’s economy is deteriorating and risks heading for a much weaker 2019 as plentiful borrowing by state and private firms is failing to boost growth, according to the China Beige Book. Borrowing was strong for a third consecutive quarter in the final three months, contradicting the mainstream view that risk-averse lenders want nothing to do with capital-starved firms, according to CBB International… State-owned and large companies borrowed more often but private firms and small- and medium-size enterprises continued to borrow at elevated levels and loan rejection rates remained close to an all-time low, it said. ‘The problem isn’t lack of borrowing, it’s that plentiful borrowing isn’t boosting growth,’ said CBB… ‘CBB numbers show firms borrowing already, yet not investing. They are paying bills or otherwise cushioning cash flow problems while economic growth continues to slow.'”

December 22 – Reuters (Philip Wen): “The head of China’s top economic planning agency said it would roll out more supportive measures to boost the economy especially in the advanced manufacturing sector, state media reported on Saturday. China will vigorously support the private sector and resolve the financing difficulties of private firms, the official Xinhua news agency quoted National Development and Reform Commission chairman He Lifeng as saying…”

December 26 – Bloomberg: “Chinese authorities are studying plans to help banks replenish capital as they look to continue with their crackdown on financial risk without hurting credit growth. The move to promote sales of perpetual bonds as soon as possible comes as new regulations on asset management force banks to absorb off-balance-sheet debts. Swelling soured loans and a slump in share prices are making it harder for banks to raise money. Stronger capital buffers also put the banks in a position to increase lending to private companies and help meet the government’s vow to support the struggling sector.”

December 24 – Reuters: “Business confidence among entrepreneurs in China worsened in the fourth quarter compared with the previous one, and was at the lowest since the second quarter of 2017, according to a survey by the People’s Bank of China… The entrepreneurs’ confidence index dropped to 67.8% in the fourth quarter, 3.4 percentage points lower than in the third quarter… A separate PBOC survey of urban households showed a decline in the number of respondents believing housing prices will continue to rise in the next quarter.”

December 25 – Financial Times (Lucy Hornby and Archie Zhang): “Shanghai office worker Jin Linglan had just put a downpayment on a car when she realised her savings were gone. Like many prosperous Chinese, Ms Jin invested in financial products that promised a high rate of return. And, like many of her fellow investors, she has made the painful discovery that her money has been swallowed up by the recurring defaults in China’s shadow banking market. The losses absorbed by middle class families in a nation famous for its diligent savers have taken a quiet financial and emotional toll. Many of the failures have been peer-to-peer lending platforms. Outstanding peer-to-peer loans in China topped Rmb1.2tn ($174bn) in the first quarter this year, before sliding to about Rmb800bn as hundreds of peer-to-peer platforms shut, according to… Moody’s.”

December 26 – Reuters (Stella Qiu, Min Zhang and Ryan Woo): “Earnings at China’s industrial firms in November dropped for the first time in nearly three years, as slackening external and domestic demand left businesses facing more strain in 2019 in a sign of rising risks to the world’s second-largest economy. The gloomy data points to a further loss of economic momentum as a trade dispute with the United States piles pressure on China’s vast manufacturing sector and as firms, bracing for a tough year ahead, shelve their investment plans, executives say.”

December 27 – Bloomberg (Alfred Cang): “China is the latest victim of the wild swings in oil prices that have roiled trading firms across the globe this year. Two top officials at Unipec, one of the country’s most powerful trading companies, were suspended this week following losses on bets related to oil prices in the second half of the year… Trading companies from Azerbaijan to Russia and the U.S. have been forced to overhaul their strategy, restructure operations or cut jobs in a year when oil surged to a 2014 high and then dramatically tumbled into a bear market within a matter of weeks.”

Global Bubble Watch

December 25 – Wall Street Journal (Trefor Moss): “A downturn in China’s car market has wrong-footed some of the world’s biggest auto makers, saddling them with factories they no longer need and that are costly to retool. Ford Motor Co., Peugeot SA and Hyundai Motor Co. especially mistimed recent expansions, opening new plants just as the seemingly unstoppable growth of China’s auto market went into reverse… At a Ford plant, workers’ shifts have been reduced to a few days a month… Now these auto makers face a painful dilemma: Abandon those big investments, or invest even more to turn around dying plants at an uncertain time in a crucial market. ‘Looking back, it wasn’t the right choice’ to build new factories, said Paul Gong, an auto analyst at UBS Group AG. ‘No one was willing to predict that they might ever lose market share in China.'”

December 26 – Wall Street Journal (Jean Eaglesham and Dave Michaels): “About a year ago, Charles and Claudia Wildes maxed out their credit cards and invested more than $40,000 in a hot new digital currency, just as the crypto mania peaked. Now, all that money is gone-a small part of the billions investors lost as cryptocurrencies plunged in recent months. But the Wildeses’ losses aren’t just because of bad timing: The digital coin they bought, called BitConnect, was one of many alleged frauds pervading the market. The Securities and Exchange Commission is investigating BitConnect, people close to the probe said…”

Japan Watch

December 25 – Reuters (Tetsushi Kajimoto): “A Japanese official said… that volatility was rising in the currency market and the government stands ready to take necessary steps if the market becomes too erratic. ‘Volatility is rising. Each country shares the G7/G20 view that excess volatility and disorderly moves are undesirable for the economy,’ Masatsugu Asakawa, vice finance minister for international affairs, told reporters.”

Leveraged Speculation Watch

December 27 – Bloomberg (Saijel Kishan and Shelly Hagan): “It has been yet another year to forget in the world of hedge funds. Hardly a month went by without news of the high-fee money managers – young and old, running large and small shops, big and little-known names – shutting down. Many struggled to navigate markets marked by violent stock swings and slumping oil prices, others decided to restructure their firms to make riskier or longer-term bets, while some said they simply had enough of trading. Now as the year comes to a close, the $3.2 trillion industry is headed for its worst annual performance since 2011… About 444 funds shuttered in the first nine months of the year, the data provider said. That’s well below the record 1,471 liquidations during the 2008 financial crisis.”

Geopolitical Watch

December 26 – Associated Press (Vladimir Isachenkov): “Russian President Vladimir Putin oversaw a test… of a new hypersonic glide vehicle, declaring that the weapon is impossible to intercept and will ensure Russia’s security for decades to come. Speaking to Russia’s top military brass after watching the live feed of the launch of the Avangard vehicle from the Defense Ministry’s control room, Putin said the successful test was a ‘great success’ and an ‘excellent New Year’s gift to the nation.’ The test comes amid bitter tensions in Russia-U.S. relations, which have sunk to their lowest level since the Cold War times…”

December 26 – Bloomberg (Henry Meyer and Stepan Kravchenko): “Russia warned the U.S. against any effort to influence the royal succession in Saudi Arabia, offering its support to embattled Saudi Crown Prince Mohammed bin Salman, who’s under continuing pressure over the killing of a government critic. President Vladimir Putin’s envoy to the Middle East said Prince Mohammed has every right to inherit the throne when the ailing 82-year-old King Salman dies. ‘Of course we are against interference. The Saudi people and leadership must decide such questions themselves,’ Mikhail Bogdanov… ‘The King made a decision and I can’t even imagine on what grounds someone in America will interfere in such an issue and think about who should rule Saudi Arabia, now or in the future. This is a Saudi matter.'”

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