China Beige Book Warns Economic Slowdown Has Begun

When it comes to the global economy, few things matter as much as China, the trajectory of its economy and especially the pace and impulse of its credit creation, which is ironic because virtually all data coming out of China is fabricated and manipulated, and thoroughly untrustworthy, either on purpose or "by accident."

The latest example of the former was highlighted over the weekend, when we discussed that a nationwide Chinese audit found some local governments inflated revenue levels and raised debt illegally, once again making a mockery of China"s credibility on the global stage. As Bloomberg reported ten cities, counties or districts in the Yunnan, Hunan and Jilin provinces, as well as the southwestern city of Chongqing, inflated fiscal revenues by 1.55 billion yuan, the National Audit Office said in a statement on its website dated Dec. 8.

An even more blatant example of the former was highlighted in October ahead of China"s Communist Party Congress, when the local securities watchdog literally "advised" some loss-making companies to avoid publishing quarterly results ahead of the Congress as authorities sought to ensure stock-market stability during the critical gathering of China"s political elite.  As a result, at least 17 Shenzhen-listed companies announced delays to their earnings reports from Oct. 20 to Oct. 24, up from three during the same period last year.

However, now that the Party Congress is long over, China"s recent economic data offer a "warning for 2018" now that Beijing"s leaders are less motivated to prop up fake "growth" for purely optical purposes. That is the opinion of China Beige Book, and its president Leland Miller who said that "Incentives to ensure the economy was growing smartly at the time of the Communist Party Congress do not apply as next year wears on," CBB president Leland Miller and chief economist Derek Scissors said in a report released on Wednesday.

According to a private survey by CBB International, which collects anecdotal accounts similar to those in the Federal Reserve’s Beige Book, Q4 results already show some signs of a transition to slower growth,  The most recent sampling of 3,300 Chinese businesses showed:

• Hiring stopped accelerating due to a strong base of comparison


• Manufacturing orders also stopped accelerating 


• Inventory accumulation "is too fast for comfort"


• Sales-price inflation is weaker than in the second quarter


• Wage gains have stopped accelerating

Come to think of it, the CBB data is not that different from the official Chinese data which showed continued slowdown across most economic verticals:

 

"None of these is genuinely alarming yet, and none would be out of place in a typical quarter," the CBB"s Miller wrote. "But the first results after a CPC are not a typical quarter. If you expect a noticeable slowdown in 2018, the first post-Congress returns support those expectations."

To be sure, even here there is confusion: while at the 19th Party Congress, which marked the start of President Xi Jinping’s second five-year term, top leaders signaled less emphasis on pursuing economic growth at all costs, and greater dedication to deleveraging, during the main economic planning conclave in December which set priorities for 2018, they pledged to focus on "critical battles" against financial risk, pollution and poverty in coming years. Meanwhile, deleveraging - Xi Jinping"s endless crusade - was strangely forgotten. Indeed, as Goldman observed last week, "there was no explicit mention of deleveraging" as "recent policy statements increasingly use the phrase "control of leverage", in our view likely a reflection of increasing realism in policy making." This significant policy reversal prompted the WSJ last week to report that Beijing has effectively given up on its deleveraging pledge.

Leverage or not, the table below - courtesy of Bloomberg - shows CBB’s breakdown of how support for the expansion may erode:

Furthermore, evidence from the retail sector doesn’t support the government’s claims of a consumption boom, CBB said. While some large firms have strong sales and profitability improved this quarter, retail revenue growth finished last among major sectors, Miller and Scissors wrote.

"Retail’s performance is decidedly uninspiring. Revenue, capex, and hiring are inferior to manufacturing, while inventory growth is much higher."

The good news: overall hiring has held up and was generally in line with the prior quarter, with 48% of firms staffing up and 3% cutting workers. "Job growth remained stronger at state firms than private, regardless of company size," CBB’s survey found, although as we will show in a subsequent post, while hiring may remain strong, wages are tumbling in a troubling indication that China"s middle class is set for imminent disappointment and anger.

Meanwhile, inflation in wages, prices, and input costs were also roughly the same as in the prior quarter, and were moderately faster than last year, the report said. Profit growth improved.

That said, despite predictions of gloom as we enter 2018, the world’s second-largest economy proved bears fully wrong this year, exceeding analyst estimates in the first and second quarters, and is now on pace for the first full-year acceleration in growth since 2010, with GDP seen growing at 6.8% this year and 6.5% in 2018. There is a problem: this growth was on the back of a near record credit impulse since the February 2016 Shanghai accord, an impulse which is now over.

Which means that all else equal, and absent another gargantuan credit injection in the coming months, China"s bears are about to have their day in the sun all over again.

Bubble Watch: The Fed KNOWS We"re in a 1999-Type Mania...

The Fed raised rates another 0.25% the week before last.

This marks the 5th rate hike since the Fed embarked on its policy tightening in December 2015 and the fourth rate hike in the last 12 months. The Fed’s latest statement also indicates it plans on raising rates three more times in 2018.

It is easy to gloss over the significance of this, but the Fed’s actions are indeed unusual; other major Central Banks (the Swiss National Bank, Bank of Japan, European Central Bank and Bank of England) are all currently running QE programs (the BoJ, ECB and BoE) or openly printing new money to buy stocks outright (the SNB).

What precisely is the Fed doing? Why the urge to tighten when other banks are all printing new money by the billions?

The following quotes from Fed offer us clues.

Fed Monetary Policy Report, June 2017:

“Forward price-to-earnings ratios for equities have increased to a level well above their median of the past three decades,

Fed minutes, July 2017:

"Since the April assessment, vulnerabilities associated with asset valuation pressures had edged up from notable to elevated, as asset prices remained high or climbed further, risk spreads narrowed, and expected and actual volatility remained muted in a range of financial markets."

Janet Yellen response to question from IMF Panel, October 2017:

Market valuations “are at high level in historical terms” when assessed on metrics akin to price-earnings ratios,

Fed Minutes, October 2017:

"In light of elevated asset valuations and low financial market volatility, several participants expressed concerns about a potential buildup of financial imbalances,"

Janet Yellen during Fed presser December 13th, 2017:

Stock valuations are at high end of historical levels.

I want to be clear on the significance of these statements.

The Fed’s primary role is to maintain financial stability. This means that the Fed will always downplay risks in its public statements. Indeed, former Fed Chair Ben Bernanke once stated that Fed policy is “98% talk, 2% action.”

With that in mind, the above quotes are astonishing in their clarity: the Fed is explicitly stating (in Fed terms) that the markets are in a bubble. And the Fed didn’t just do this once, the Fed has been warning about asset valuations/froth in the system for six months straight.

So just how “frothy” are things that the Fed is being so explicit?

Try “1999-levels” frothy.

Perhaps the best means of measuring frothiness in stocks is the Price to Sales (P/S) multiple. Most investors prefer to use Price to Earnings (P/E), but I am wary of that method because earnings can easily be fudged via gimmicks (different methods of depreciation, write-offs, reducing loan loss reserves, tax loopholes, etc.).

Sales, on the other hand, are very hard to fudge. Either money came in the door, or it didn’t. And if a company gets caught fudging its revenues, someone goes to jail.

With that in mind, consider that the S&P 500’s current P/S multiple has surpassed its former all time peak from 1999: a period that is now widely considered to be the single largest stock bubble in history.

Put simply, stocks are extraordinarily overvalued by a reliable measure.

H/T Bill King

However, there is one main difference between 1999 and today...

Namely, that the Fed has been INTENTIONALLY creating bubbles for nearly 20 years today... and it"s out of more senior asset classes to use!

Let me explain...

The late ‘90s was the Tech Bubble.

When that burst in the mid-‘00s, the Fed created a bubble in housing.

When that burst in ’08 the Fed created a bubble in US sovereign bonds or Treasuries.

And because these bonds are the bedrock of the US financial system, the “risk-free rate” of return against which ALL risk assets are valued, when the Fed did this it created a bubble in EVERYTHING (hence our coining of the term “The Everything Bubble” and our bestselling book by the same name).

On that note, we are putting together an Executive Summary outlining all of these issues as well as what’s to come when The Everything Bubble bursts.

It will be available exclusively to our clients. If you’d like to have a copy delivered to your inbox when it’s completed, you can join the wait-list here:

https://phoenixcapitalmarketing.com/TEB.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

Is the Bond Market About to Call the Fed"s Inflationary Bluff?

Perhaps the single biggest development this year, as far as the markets were concerned, was the Fed admitting on the record that it has no idea what is going on with inflation.

This represents a kind of endgame for the Fed. Since the early ‘80s, the Fed has been actively understating inflation via a variety of gimmicks.

It first removed home prices and replaced them with “owner’s equivalent rent.” Doing that removed any sharp rise in home prices from affecting inflation data, thereby downplaying the official inflation rate.

Then in 1998, the Fed started playing around with “hedonics” (think food and energy prices). The Fed claimed that the goal was to somehow balance the deflationary forces of technology vs. the inflationary forces of hedonics items… but the reality was that this was just another gimmick to understate inflation.

Then, finally in 1999, the Fed introduced the idea of “substitutions.” Here again the Fed claimed it was trying to get an accurate read on inflation (the Fed argues here that if a consumer cannot afford steak anymore, the fact he or she can substitute hamburger indicates his or her quality of life is roughly the same as before).

And once again the goal was to understate inflation.

I realize this is getting a bit complicated, so let’s put this in simple terms…

1)   Since the early ‘80s, the Fed has been employing various gimmicks to hide the real rate of inflation.

2)   Doing this allowed the Fed to overstate GDP growth while understating the true decline in incomes/ quality of life for most Americans.

This game worked for a while, but this year the whole scheme crashed into a wall when the various gimmicks resulted in data that made no sense what-so-ever.

At a time when the NY Fed’s UIG inflation measure and the Atlanta Fed’s “sticky inflation” measure, showed inflation at 2.8% and 2.1% respectively, the Fed’s official inflation measures (CPI and trimmed PCE) were clocking in at 1.7% and 1.4%,

The Fed’s Board of Governors had a choice here:

1)   Admit the official inflation numbers were garbage

Or…

2)   Act surprised by the official rate being so low and claim it’s an anomaly.

The Fed went with #2 in what was one of the most insane Fed statements ever. According to the Fed’s July FOMC statement…

• Most participants expect inflation to pick up over the next couple years.


• Many Fed participants think inflation will remain below 2% longer than expected.


• Many Fed participants believe that inflation measures dropped recently due to “idiosyncratic factors.”


• A few Fed participants believe the Fed’s framework for forecasting inflation is no longer valid.


• Some Fed participants noted their increase uncertainty about the outlook for inflation.

Put simply: the Fed admitted that it no longer had a clue what was going on with inflation. It has since maintained this “who knows!” shtick (I note that Fed Chair Janet Yellen, in last week’s conference stated that the Fed’s understanding of inflation is “imperfect.”)

Why does this matter?

As I explain in my bestselling book The Everything Bubble: the Endgame For Central Bank Policy, US sovereign bonds (also called Treasuries) trade based on inflation expectations.

Put simply, when inflation spikes higher, so do Treasury bond yields.

When bond yields rise, bond prices fall.

When bond prices fall, the Bond Bubble bursts.

When the Bond Bubble bursts, the EVERYTHING bubble follows.

Well, guess what? The yield on 10-Year US Treasuries is spiking, having broken above its 20-year trendline.

What"s coming will take time for this to unfold, but as I recently told clients, we"re currently in "late 2007" for the coming crisis. The time to prepare for this is NOW before the carnage hits.

On that note, we are putting together an Executive Summary outlining all of these issues as well as what’s to come when The Everything Bubble bursts.

It will be available exclusively to our clients. If you’d like to have a copy delivered to your inbox when it’s completed, you can join the wait-list here:

https://phoenixcapitalmarketing.com/TEB.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

And So Begins The Rug-Yank Phase Of Fed Policy

Authored by MN Gordon via EconomicPrism.com,

The political differences of today’s leading two parties are not over ultimate questions of principles.  Rather, they’re over opposing answers to the question of how a goal can be achieved with the least sacrifice.  For lawmakers, the goal is to promise the populace something for nothing while pretending to make good on it.

Take the latest tax bill, for instance.  The GOP wants to tax less and spend more.  The Democrat party wants to tax more and spend even more.  We don’t recall seeing any proposals to tax less, spend less, and shrink the size of the state.  And why would we?

Today’s central planners and social engineers are enlightened and progressive.  They know much more about anything and everything than the rest of us.  In particular, they share a general sense that they know how to spend your money better than you.

At best, the central planners call your money to Washington so they can then distribute it back to your friends and neighbors.  In reality, the lawmakers call your money to Washington where they distribute it to their friends and neighbors – not yours.  This is not a matter of opinion.  It’s a matter of fact.

Is it a coincidence that the top three wealthiest counties in the country are in the shadow of the Capitol in the D.C. suburbs?  What it is exactly that the residents of these counties do that’s of tangible value is unclear.  However, what is clear is that bogus government jobs in Loudoun County and Fairfax County, Virginia, pay big bucks.  But that’s not all…

Garbage In Garbage Out

Further up the eastern seaboard, Wall Street has a good thing going too.  The big bankers and brokers make big bucks extracting capital from Main Street America.  That’s a fair characterization, right?

Perhaps the big bankers and brokers really are efficiently allocating capital to its highest and best use.  Who knows?  But as far as we can tell, they’re gambling with other people’s money – and collecting fees regardless of how their coin tosses fall.  It’s always, ‘heads I win, tails you lose.’  Not a bad fugazi gig, if you can get it.

Of course, the cornerstone of it all is the Federal Reserve.  Through what they call “open market operations,” the Fed rigs the game in Washington’s and Wall Street’s favor.  Indeed, the process is really quite elegant.

Under the smokescreen cover of garbage in economic data, the Fed’s economists produce garbage out bar charts and line graphs.  These, in short, are fabricated depictions of the economy’s growth, consumer and producer prices, personal consumption expenditures, unemployment rate, and whatever other aggregate metrics are deemed to be of vital importance.  What’s more, these fabricated depictions serve as the basis for the Fed’s monetary policy decisions.

Do the graphs show price inflation heating up or cooling down?  What about GDP or the unemployment rate?  Is one going up while the other’s going down?  Is one going down while the other’s going up?

The Federal Open Market Committee (FOMC) deliberates over these questions about every six weeks.  Then the Fed goes to work inflating the nation’s money supply, with the occasional rug yank, for the stated purpose of getting the charts and graphs to illustrate the garbage data to their liking.  What to make of it?

The Rug Yank Phase of Fed Policy

From the outside, the Fed’s economists and planners appear to be esteemed professionals, making decisions with the intent of providing for the greater good of the country.  They even attend economic conferences and forums where they present their latest research findings on abstract topics like liquidity traps.  Some of their studies even include footnotes, as if the professional economists are building upon a concrete knowledge base of human intellect.

Yet beneath this cover of bogus science, the real sausage is made.  Capital is borrowed into existence where it is directed to Washington and Wall Street.  There, having first dibs on this phony money, Washington and Wall Street get to spend it as if it has real value.

However, the real value does not coming from the Fed’s phony money.  In fact, as this new phony money appears on the scene, it extracts incremental wealth from the workers and producers across the country that – through their time, talent, and labor – created the wealth to begin with.

At the moment, we’re in the rug yank phase of the Fed’s monetary policy.  This is where they reel back credit ever so slightly after letting it run wild over the last decade.  This tightening of credit markets has the effect of pulling the rug out from under financial markets and the economy.

Monetary policy, without question, is not an exact science.  It’s rudimentary guess work that’s based on committee interpretations of bogus data.  This week, the FOMC raised the federal funds rate by 0.25 percent to between 1.25 and 1.5 percent.  This marks the third increase this year and the fifth increase this cycle.

Incidentally, Janet Yellen also delivered her last press conference as Chair of the Federal Reserve, though she’ll likely still Chair the FOMC meeting scheduled for late January.  Then Jay “Count Dracula” Powell will take over the helm of the nation’s central bank.  The broad expectation is for Powell to continue the rate increase playbook that Yellen has laid out, which includes three quarter percent hikes in 2018.

We wish Powell the best in his endeavors.  But we suspect he’ll unwittingly pull the rug out from under financial markets and the economy before he completes his first year.  After that, the fun really begins.

2 Charts That Might Define The Fed"s Jerome Powell Era

Authored by Daniel Nevins via FFWiley.com,

In September, we proposed a theory of the Fed and suggested that the FOMC will soon worry mostly about financial imbalances without much concern for recession risks. We reached that conclusion by simply weighing the reputational pitfalls faced by the economists on the committee, but now we’ll add more meat to our argument, using financial flows data released last week.

We’ve created two charts, beginning with a look at cumulative, inflation-adjusted asset gains during the last seven business cycles:

According to the way that the Fed defines its policy approach, our first chart stamps a giant “Mission Accomplished” on the unconventional policies of recent years. Recall that policy makers explained their actions with reference to the portfolio balance channel, meaning they were deliberately enticing investors to buy riskier assets than they would otherwise hold. Policy makers hoped to push asset prices higher, and they seem to have succeeded, notwithstanding the usual debates about how much of the price gains should be attributed to central bankers. (See one of our contributions here and a couple of other papers here and here.) But whatever the impetus for assets to rise, it’s obvious that they responded. In fact, judging by the data shown in the chart, policy makers could have checked the higher-asset-prices box long ago, and with a King Size Sharpie.

Consider the measure on the vertical axis, percent of personal income. From the risky asset trough in Q1 2009 through Q3 2017, households accumulated asset gains, in real terms, equivalent to 139% of personal income. (Nominal gains were much greater, but we used the CPI to deduct the amount of purchasing power that households lost on their asset holdings. Also, we defined asset holdings as the four biggest categories that the Fed computes gains for—equities, mutual funds, real estate, and pensions.)

In other words, households are enjoying an investment windfall that amounts to nearly sixteen months of personal income, which is larger than the windfalls accrued in any other business cycle since the Fed began tracking asset gains in 1947. Not only that but the gap continues to widen—as of this writing, we’re likely approaching 145% of personal income and well clear of the previous peak of 128% from the 1991–2001 expansion.

Getting back to policy priorities, the chart seems to tell us that asset prices no longer need boosting. The Fed’s pooh-bahs proved they could boss the investment markets, and they’ve almost certainly moved on to new endeavors.

Bull, bear, or donkey?

But record asset gains are just one of the reasons the Fed’s priorities are likely to be changing. To describe another reason, we’ll first show that policy makers may wield a King Size Sharpie but that it’s not a Permanent Marker:

As you can see, our second chart looks like the first, except that we pinned the tails on the asset price donkeys.

We tacked on the down halves of each cycle, showing that the portfolio balance channel has a reverse mode.

So what should we make of the result that asset price cycles, adjusted for inflation, have ended with busts that reverse a large portion and often the entirety of the prior booms?

According to our beliefs about how investment markets work, the up and down phases of asset cycles are closely connected. Also, monetary stimulus influences both phases at the same time. It helped fuel the giant gains of recent expansions, but it also helped create the imbalances that led to giant losses. And after the accelerated advances of 2016-17, it’s fair to wonder if today’s imbalances are approaching the extremes of 2000 and 2007. Even some FOMC members are gently acknowledging that risk.

But we think the committee members are even more concerned than you would know by just reading their meeting minutes. We expect financial imbalances to become their biggest worry, bigger than the risk of recession, which should matter less and less to the central bankers’ reputations as the business cycle expansion continues to lengthen. In fact, a garden variety recession would barely affect their legacies at all by mid-2019, when the expansion, if still intact, would become the longest ever. By that time, the FOMC’s greatest reputational threat would be another financial market debacle, which would suggest that manipulating asset prices maybe wasn’t such a good idea, after all. In other words, the committee’s reputational calculus will change significantly during Jerome Powell’s first few years as chairperson.

All that said, Powell probably wants a recession-free economy in, say, his first year or two in the position. Moreover, he’ll certainly stress continuity with his predecessors’ policies. But once he becomes comfortable in the job, the Fed’s priorities will look nothing like they did under Janet Yellen and Ben Bernanke. Instead of fueling asset gains, Powell’s biggest challenge will be containing imbalances connected to prior gains. He and his peers will aim to avoid pinning another oversized tail on the donkey—or at least to manage the fallout from said tail—and that’s a challenge that could very well define his regime.

The Fed is Arranging Deck Chairs on the Titanic (the Iceberg Comes in 2018).

The Fed concludes its final FOMC meeting of the year today.

The entire financial world expects the Fed to raise rates a final time. This will mark the fifth rate hike since December 2015, and the fourth of the last 12 months.

Throughout this time period, the Fed has routinely stated that it is confused as to why inflation is “too low.”

Inflation is not too low. The method the Fed uses to measure inflation is intentionally incorrect. As a result, the official inflation numbers reflect whatever the Fed wants, as opposed to reality.

Alan Greenspan devised this entire gimmick back in the 1990s. At that point, the amount of debt in the US financial had already become a systemic issue.

So Greenspan opted to “paper over” this fact via inflation… hoping that by aggressively devaluing the US Dollar he could keep this game going.

The only problem as far as the Fed was concerned was that the inflation numbers would reveal the Fed’s strategy. So Greenspan started tinkering with how the Fed measured inflation, removing various components (food and energy) and tweaking things so the Fed would no longer measure the cost of maintaining the same quality of life.

Greenspan hoped understating inflation publicly he would give him the cover he needed to pursue an aggressive devaluation of the US Dollar. The flip side of this was that the Fed would begin intentionally creating asset bubbles by maintaining loose monetary policy ad infinitum.

The late ‘90s was the Tech Bubble.

When that burst in the mid-‘00s, the Fed created a bubble in housing.

When that burst in ’08 the Fed created a bubble in US sovereign bonds or Treasuries.

And because these bonds are the bedrock of the US financial system, the “risk-free rate” of return against which ALL risk assets are valued, when the Fed did this it created a bubble in EVERYTHING.

That bubble is now beginning to burst. And ironically it is inflation (which the Fed claims is too low) that will do it.

It will take time for this to unfold, but as I recently told clients, we"re currently in "late 2007" for the coming crisis.

The time to prepare for this is NOW before the carnage hits.

On that note, we are putting together an Executive Summary outlining all of these issues as well as what’s to come when The Everything Bubble bursts.

It will be available exclusively to our clients. If you’d like to have a copy delivered to your inbox when it’s completed, you can join the wait-list here:

https://phoenixcapitalmarketing.com/TEB.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

How Will The Market Absorb Trillions Of US Treasury Bonds to Replace The Feds Balance Sheet Wind Down?

First, the facts:

At Powell"s Nov 28th 2017 testimony to Congress, Powell said that as the Fed allows its 4 trillion dollar balance sheet to wind down, the US Treasury would issue new bonds to the market to replace them (so, technically, US notional debt will neither increase nor decrease as a result of QE).

Recall that QE is a sterile operation (this is why we don"t have hyper-inflation).  What does that mean?  Sterile means that the US public debt will neither increase or decrease as a result of QE, and neither will the money supply.  Another way to say this is that QE is a cash neutral operation.  Where cash is pushed into the system at one point, it must be drained someplace else (in our case, the Fed offers interest to banks to store their cash at the Fed...mostly with IOER - interest on excess reserves..and all the banks have indeed been doing this).  This is also why banks are not over-excited to lend you money...they get risk free money to deposit their cash at the Fed.  QE simply took US debt off the markets balance sheet, and placed onto the Fed"s (yes, the Fed printed digital fiat currency to make this happen...but the unwind will reverse  this "money" creation).  So, the Fed bought 10yr notes with funny money..will hold them to maturity...and then when those 10yr notes mature, the US Treasury will auction new bonds into the market to repay the Fed, making the funny money disapear like magic.  This whole process together "sterilizes" the Feds money printing...but in the meatime, the market pushed that money into other assets (mostly stocks).

Here is the simplified flow of money:
Fed QE --> bond market --> stock market --> bank accounts --> Fed accounts(IOER)

Such that total dollars in circulation didn"t change much...they ended up back at the Fed (with a nice uptick in asset prices as an inbetween step).
There was a nice side effect to this...while the Fed holds a large balance sheet...the US Treasury doesn"t have to pay interest on its debt (because the Fed remits all its profits back to the Treasury...and interest income is considered profit).  When the Fed winds down its balance sheet, the Treasury will have to start paying interest on that debt again.

The interesting question is thus:  When the US Treasury tries to sell 1-2 Trillion dollars of long term debt back into the market...what happens to interest rates and the stock market?  Recall #1 that after the Trump election, 10 year interest rates moved from 1.80% to now 2.40% (expectation of Trump borrowing lots of long term money to finance his infrastructure and deregulation projects).  But that hasn"t even happend yet (analysis of the Republican tax plan cost estimates an additional 1 Trillion US long term debt).  Recall #2 that the Fed is currently holding a lot of that debt...which minimized the need to liquidate bad long positions in the post Trump bond market selloff.  US Treasury debt is "high quality" and so the market will buy it...but at what price?  This is the big question.  Will the market sell stocks to make room to buy up all this new debt (reverse QE)?  Does this cause the next stock market crash?  (hint hint - probably)

 

The piper must be paid eventualy.  However, just like in Cyprus...the banks will have a heads up...and their assets will be safe.  What will happen to yours?

QE Unwind is Really Happening: Fed Assets Drop To Lowest Level In Over Three Years

Submitted by Wolf Richter of Wolf Street

The Fed’s balance sheet for the week ending December 6, completes the second month of the QE-unwind. Total assets initially zigzagged within a tight range to end October where it started, at $4,456 billion. But in November, holdings drifted lower, and by December 6 were at $4,437 billion, the lowest since September 17, 2014:

“Balance sheet normalization?” Well, in baby steps. But the devil is in the details.

The Fed’s announced plan is to shrink the balance sheet by $10 billion a month in October, November, and December, then accelerate the pace every three months. By October 2018, the Fed would reduce its holdings by up to $50 billion a month (= $600 billion a year) and continue at that rate until it deems the level of its holdings “normal” – the new normal, whatever that may turn out to be.

Still, the decline so far, given the gargantuan size of the balance sheet, barely shows up:

The Fed is unloading its Treasuries alright.

As part of the $10-billion-a-month unwind from October through December, the Fed is supposed to unload $6 billion in Treasury securities a month plus $4 billion in mortgage-backed securities (MBS) a month.

The Fed doesn’t actually sell Treasury securities outright. Instead, it allows some of them, when they mature, to “roll off” the balance sheet without replacement. When the securities mature, the Treasury Department pays the holder the face value. But the Fed, instead of reinvesting the money in new Treasuries, destroys the money – the opposite process of QE, when the Fed created the money to buy securities.

This happens only on dates when Treasuries that the Fed holds mature, usually once or twice a month.

In October, the big day was October 31, when $8.5 billion of Treasuries on the Fed’s books matured. The Fed reinvested $2.5 billion and let $6 billion “roll off.” Hence, the amount of Treasuries fell by about $6 billion from an all-time record $2,465.7 billion on October 25 to $2,459.8 billion on November 1.

In November, there were two big maturity dates:

• November 15, about $11 billion in Treasuries matured. The Fed allowed $3.4 billion to “roll off” without replacement.


• November 30, about $7.9 billion matured. The Fed allowed $2.5 billion to roll off without replacement.

For all of November, the balance of Treasuries fell by $5.3 billion to $2,454.5 billion, in line with the plan, and the lowest level since October 8, 2014:

Mortgage-backed securities are a different animal.

As part of QE, the Fed acquired residential MBS guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae. Now, as part of its $10-billion-a-month QE-unwind, the Fed is supposed to shed up to $4 billion a month in these MBS. And?

At the beginning of October, the Fed held $1,768.2 billion in MBS. The balances then jumped up and down on a weekly basis and ended October at $1,770.6 billion, or $2.4 billion higher than at the beginning of the QE-unwind.

Same scenario in November, though they have started to edge down overall just a tiny bit to $1,767 billion, the lowest by a smidgen since March 8, 2017:

Residential MBS differ from bonds. Fannie Mae et al. regularly pass through principal payments to MBS holders as underlying mortgages get paid down or get paid off. Thus, the principal shrinks until the remainder is redeemed at maturity.

To keep the MBS balance steady, the Fed, via the New York Fed’s Open Market Operations (OMO), buys MBS in the “to-be-announced market,” or “TBA market.” This is a trade where the actual MBS is not designated at the time of the trade but will be announced 48 hours before the established settlement date, which can be two to three months later.

But the Fed books its MBS holdings on a settlement-date basis. So there is a mismatch between the date the Fed receives principal payments and the date reinvestment trades settle. Hence the jagged line in the chart above.

So when will the $4-billion-a-month in MBS reductions show up on the Fed’s balance sheet?

The first MBS reinvestment trades under the QE-unwind plan were conducted in October. Given the lag to settlement date of two to three months, the first visible impact on the balance sheet would start no earlier than December. This is where we are now, on the verge of seeing it.

The line in the MBS chart will always bounce up and down due to the mismatch between the date the Fed receives principal payments and the date reinvestment trades settle. But the line should start trending down, with noticeably lower lows and lower highs.

For the first three months, the QE unwind only removes about $10 billion a month, a negligible amount, given the vast markets and excess liquidity. But it picks up steam every three months. By October 2018, if the plan is still on, the QE unwind will remove $50 billion a month from the markets. This process will do the opposite of what QE had done: it will gradually destroy some of the $3.6 trillion that the Fed had created during QE. And by that time the broader effects of QE – asset price inflation – should also start to reverse.

Worhsipping At The Altar Of FOMO

Authored by Sven Henrich via NorthmanTrader.com,

Retail investors are worshipping at the altar of FOMO (fear of missing out). It may prove to be a painful experience.

Never before has retail gotten this aggressively exposed to stocks.

Just in time when central banks and buybacks are pulling back. I talked a bit about this in the recent The Carrot Top, but I want to expand a bit on this to issue a general warning for retail: The boat is fully loaded in one direction. Be aware.

Wall Street will not warn retail, they’ll keep pushing the envelope until the very bitter end. It’s actually quite easy to be a bull. Keep raising targets, always be optimistic, and when something breaks shrug your shoulders and say: Hey what are you gonna do? Stuff happens. The Fed will come to the rescue.

And the cycle begins anew.

You know the drill:

Just remember, Wall Street will never tell you to sell.#2008forecasts pic.twitter.com/c664pSO1No

— Sven Henrich (@NorthmanTrader) July 14, 2017

Remember the primary job of Wall Street is to get retail to invest, and to be fair, they are doing a fabulous job.

And so every December we see the same annual ritual. Here’s the message sent to retail, we can only go higher. $SPX targets for 2018:

Here’s a visual from BAML:

The primary argument: Wall Street is not yet euphoric:

Really? What’s this:

$DJIA futures weekly RSI 86.78.
Pedal to the metal till it melts. pic.twitter.com/NYLFODHht7

— Sven Henrich (@NorthmanTrader) December 4, 2017

Not euphoric? Let’s dig in a bit deeper into the data.

 

You may have seen my Rydex chart indicating record bullish allocations in The Carrot Top:

Last night Jesse Felder sent me some more data points confirming the same:

More data:

The American Association of Individual Investors’ asset-allocation poll shows members’ exposure to stocks are as heavy as it was near the 2000 peak. Cash allocations fell 1.2 percentage points to 13.9%. Cash allocations were last lower in December 1999 (12.0%).

Also:

TD Ameritrade’s Investor Movement Index of retail activity “saw its largest single-month increase ever in November, increasing over 15% to hit an all-time high of 8.53. TD Ameritrade clients were net buyers for the tenth consecutive month.”

Combine it with sentiment:

Via Reuters:

“52 percent said they believed the stock market could sustain continued growth for five years without a downturn of 10 percent or more.”

Confident much?

It’s actually the perfectly logical conclusion of what central bank interventions have wrought:

The BOJ balance sheet is now at 121% of GDP the ECB’s at 41% of GDP.

The result of course is we haven’t corrected at all. We are now in the longest market period without even a 5% correction. Ever:

We haven’t had a single down month in 2017 which historically has never happened either:

And the rush into long equity funds has been unprecedented:

Get us into stocks. We can’t go down, we can only go up. FOMO.

So when I say central banks have created a monster I really mean it.

And so it’s no surprise that central bank policy is viewed by some as the greatest risk to asset prices in 2018:

Mohammed El-Erian:

“The biggest risk to asset prices and the global economy would be if the biggest institutions reduce their monetary stimulus at the same time. Rather than reflecting the prospects of individual institutions, the greatest monetary policy uncertainty facing the global economy is what would happen if all these central banks, along with the People’s Bank of China, were to decide to reduce their monetary stimulus at the same time. When it comes to central banks, this is the biggest source of risk to asset prices and the global economy, and it would call for high-frequency policy monitoring and close international consultations.”

Asset prices are a central bank planned construct that has resulted in retail being completely long and fully exposed to equities.

And I have not even addressed the trillions of dollars exposure all being long short $VIX products:

BAML has a phrase for this: “Yield starvation forces selling volatility for yield”. “Forces” being the operative word:

Note the center piece: “Unprecedented central bank policy & low growth recovery”.

By the way I’m not picking on BAML here, not at all.

But I’m highlighting that 2017 has seen an unprecedented rush by retail into the most highly valued stock market since 1900 according to Goldman, a market that remains entirely uncorrected.

But nobody is issuing any risk warnings here. Keep going long my friends we can only go higher and if there’s a dip buy it. And no doubt this strategy has worked.

My perspective remains a variant one: This singularly oriented market construct is at extreme high risk that some trigger will pop all of this.

In a world where nothing has mattered and corrections have disappeared altogether it may be a fair question to ask what such a trigger may be. I’ll leave that for a future post, but I will say this: Triggers are often the excuse to assign cause after the fact. But it is the construct itself that seeds the depth of the ultimate unwind.

Worshippers at the altar of FOMO have come accustomed to no dip ever lasting. Will they find themselves slow to react when one does?

Markets Are Unprepared For A Government Shutdown

Authored by James Rickards via The Daily Reckoning,

Will Republicans and Democrats agree on a budget, and avoid a government shutdown after midnight Friday?

I’d say the odds are 50/50. Actually, I put the odds of a shutdown at about 55%. There’s certainly enough substance here to be wary.

The government could shut down because of disagreements over defense spending, funding for Trump’s wall with Mexico, deportation of illegal immigrants brought to the U.S. as children (the “Dreamer Act” also referred to as “DACA”), funding for Planned Parenthood, funding for Obamacare (called “SCHIP”), disaster relief and more.

There’s not much middle ground between Democrats and Republicans on many of these hot button issues.

How would a shutdown affect the Fed’s plans to raise rates on the 13th?

If an agreement can’t be reached and the government does shut down, it’s very difficult to imagine that the Fed would go forward with its planned interest rate hike on Dec 13.

Meanwhile, markets are almost certain the Fed will raise rates. It’s already “baked into the cake.”

The euro, yen, gold and Treasury notes are all fully priced for rate hike. If it happens, those instruments won’t change much because the event is priced.

But we could see a violent market reaction if Janet Yellen stays put and doesn’t raise rates.

If the Fed doesn’t raise rates, gold could soar as the Fed passes on its best chance to raise rates and markets perceive that easy money is here to stay. Euros, yen and Treasury notes will also soar.

Of course, saying the government could shut down is different than saying the government will shut down. Again, I give it about a 55% chance at this point.

And there are lots of ways for things to go wrong.

Late last week the Commerce Department released the October PCE core inflation data. This is important because that’s the number the Fed watches. There are plenty of other inflation readings out there (CPI, PPI, core, non-core, trimmed mean, etc), but PCE Core year-over-year is the one the Fed uses to benchmark their performance in terms of their inflation goal.

The Fed’s target for PCE Core is 2%. The October reading was 1.4%. For weeks I’d been saying that a 1.3% reading would put the rate hike on hold, and a 1.6% reading would make the rate hike a done deal. So, the actual reading of 1.4% was in the mushy middle of that easy-to-forecast range.

What’s interesting is that the prior month was also 1.4%, so the new number is unchanged from September. That’s not what the Fed wants to see. They want to see progress toward their 2% goal.

On the other hand, the 1.4% from September was a revised number. It was earlier reported at 1.3% (the same number as August).

You can read this two ways. If you see the August 1.3% as a low, then you can say the 1.4% readings for September and October were progress toward the Fed’s 2% target. It’s a thin reed, but Yellen could use this to justify her view that the year-long weakness in PCE Core is “transitory.”

On the other hand, these 0.1% moves month-to-month are really statistical noise and may even be due to rounding. The bigger picture is that PCE Core is weak and nowhere near the Fed’s target. Another rate hike in December could be a huge blunder if it slows the economy further and leads to more weakness in PCE Core.

On balance, the PCE Core number is probably just enough (barely) to justify a rate hike. I’ve raised my probability of a December rate hike from 30% to just over 50% — 55%. That’s what analysts are supposed to do; they update forecasts continually based on new data. You can’t be stubborn about your analysis.

I’m not trying to be “in consensus” or “out-of-consensus.” I just want to get it right, and that means sometimes I’ll be in consensus. Other times, I won’t be.

But you should forget how the market is pricing the outcome. The Fed funds futures market has been off by orders of magnitude before. In mid-February 2017, the futures markets gave the odds of a rate hike in March at 30%.

I was giving 80% odds.

Within three trading days at the end of February, the market odds shifted from 30% to 80% before converging at 100% by the March meeting.

That does not mean I’ve got it right this time. But it does illustrate that the futures market does not always get this right — not even close.

And markets are being set up for a fall.

Bull markets in stocks seem unstoppable right up until the moment they stop. Then comes a rapid crash-and-burn phase.

Is there ever any warning that a collapse is about to happen?

Of course there is. Analysts warn about it all the time and provide mountains of data and historical evidence to back up their analysis. The problem is that everyone ignores them.

You can talk about the dangers represented by CAPE ratios, margin levels, computerized trading, persistent low volatility and complacency all you want, but nothing seems to slow down this bull market.

Yet there is one thing that can stop a bull market in its tracks, and that’s corporate earnings.

The simplest form of stock market valuation is to project earnings, apply a multiple and, voilà, you have a valuation. Multiples are already near record highs, so there’s not much room for expansion there.

The only variable left is projected earnings and that’s where Wall Street analysts are having a field day ramping up stock prices. Earnings did grow significantly in 2017 on a year-over-year basis, but that’s mainly because earnings were weak in 2016, so the year-over-year growth was relatively easy.

Now comes the hard part.

How do you expand earnings again in 2018 when 2017 was such a strong year? Wall Street just uses a simple extrapolation and says next year will be like this year, only better! But there is every reason to doubt that extrapolation.

Earnings are likely to fall short of expectations, which can lead to a correction. Once that happens, multiples can shrink as well. Soon you’re in a full-scale bear market with stock prices down 20% or more.

That’s without even considering a war with North Korea and all of the dangers others have already mentioned. This may be your last clear chance to lighten up on listed equity exposure before the bubble bursts.

Markets are creatures of manipulation by Fed policy changes, statements, forward guidance and the other prestidigitation of modern central banks. That’s what you get after 10 years of ZIRP, QE, tapering, QT, forward guidance, currency wars and musings about NIRP.

Shutdown or no shutdown, the Fed has painted itself into a corner and there’s no way to escape the room. That’s the larger story to keep in mind as Dec. 13 approaches.

Tune out the current sideshow and keep that in mind.

Meanwhile... The Yield Curve Is Crashing-er

Remember Monday when stocks jumped and the yield curve steepened and every talking head and their pet rabbit said the bond market is about to explode... well the yield curve is now imploding again with 5s30s crashing almost 10bps to 64bps - the lowest since Oct 2007.

False start...

 

The trend is jnot The Fed"s friend...

 

This morning Fed"s Bullard warned that more rate-hikes could invert the yield curve (which has signal 7 of the last 7 recessions).

“There is a material risk of yield curve inversion over the forecast horizon if the FOMC continues on its present course of increases in the policy rate," Bullard, who doesn’t vote on the policy-setting Federal Open Market Committee until 2019, said on Friday in Arkansas.

 

“Yield curve inversion is a naturally bearish signal for the economy. This deserves market and policy maker attention.’’

Hoever, last night Cleveland Fed President Loretta Mester on Thursday played down concerns about the yield curve, instead advocating continued gradual increases in the federal funds rate.

“Long rates are going to go up given where we are in the economy and given where we see the economy going,” she said in an interview.

 

“But this is another reason why we need to keep raising up the short rate. These financial conditions are accommodative.”

So Bullard rightly worried, Mester - it"s different this time.