Thursday 30 November 2017

US economy growing 5.5% vs 1.25% Fed funds?

The BEA Q3 GDP release today had the US economy growing 5.5% in USD/ nominal terms, albeit with non-financial profits going sideways since 2013. 

Only in Janet Yellen's mind could there be uncertainty as to whether interest rates should be 1.5% or not. The market has to look for 4 hikes next year, which would take Fed funds to 2.25-2.5%. 

Question is what the 10 year does. With balance sheet reduction I think that should put selling presure on it, however if people sell HY and buy bonds that would offset it. 

So far it looks like the curve has been trying to flatten. If the spread went to 50bps, it would imply a 10 year in a years time at 2.75-3%. With recession/ inflation scares that might give a trading range of 2.5-3.5%. 

Versus perhaps 6% nominal GDP growth its still massively negative in real terms however. So the quesiton would be whether the Fed can hike enough to curtail a wage inflation cycle and risk a recession, or if they stay permanently behind the curve. 

The financial economy is likely to act like its a recession far earlier than the real economy, aggregate asset prices have to fall as QE sees a fall in liquidity and rate hikes push up discount rates.

This Fed being trapped behind the curve vs triggering a real economy recession debte doesnt seem to be a focal point right now. Kashkari yesterday even said they should be able to tolerate 5 years of inflation above target given they have had 5 years below. The problem would be is inflation starts to push to 3 or 3.5% on full employment,  but we definitely need more wage growth in the areas of strength for that to happen and its unlikely to be an issue in the next six months. 

US oil imports and exports

With US domestic oil production growing 1MMbpd YoY and expected by analysts like Goldman to keep growing at this rate for several years, the US net imports of oil have dropped to the 3-4MMbpd range, from 12.5mmbpd pre-shale. With some reduction in demand due to EVs and energy efficiency perhaps in the next 2 years the US can go to being a net exporter. Nevertheless, the global market is tightening.

Tuesday 28 November 2017

Credit growth and asset values

Often one of the hardest things to fathom in finance is the lack of lateral thinking or common sense from finance professionals. 
At the moment the US yield curve vs equity bull markets are puzzling them. 

Casting aside the fact the Fed has manuulated yield curves via QE, the overall answer could be as prosaic as this. ~90% of the actual money supply is debt, so as debt grows faster than GDP there is more money available vs the amount of assets. 

Therefore average valuations rise, hence higher equity and bond prices. Until the credit cycle stops or there is a dash for cash. 

To put it in context from the end of 2008 the US GDP has increased approximately $5Tn, while total US non-financial debt has increased approximately $15Tn, a ratio of 3:1.

So watch out for increasingly narrow bull markets, Fed driven shocks (rates or balance sheet), European banks liquidaing their $600bn Treasury xccy carry trade, or a slowing of the credit cycle.

Finally I am of the view the policy response when there is a recession will be such that the recession is shallow but the outcome wage inflationary; that will be the true end of the 35 asset bubble super cycle we have seen driven by credit.

Monday 27 November 2017

More Fed BS (balance sheet)

Fed managed to buy assets in the week to 22nd Nov (as part of its supposed $50bn a month balance sheet reduction); USD weakened and risky assets like JNK and EMLI bounced. But this week has started off weaker.

Tuesday 21 November 2017

Wages as a % of GDP

Wages as a % of GDP going back to post-war levels would entail almost a 20% rise. Corp profits, FIRE economy size and overall debt levels would have to fall a lot and the CA/ double deficit would need to go to a surplus. The only way to smooth the process will be a Fed staying a long way behind the curve and letting a wage-inflation cycle develop. Wages currently look to be growing 3-3.5% against a tightening labour market. Which comes back to having an inexperienced LBO guy in the Fed.

Monday 20 November 2017

The Fed starts to shrink the balance sheet

As mentioned or aluded to elsewhere in this blog, I think we are on the cusp of many turning points in the political economy, which will open the door to the so called fourth turnign phase. The Fed shrinking their balance sheet is one of the key ones. 

EM is losing money almost every day and the Fed has only just started shrinking its balance sheet, so far a lot less than $50bn a month.

Some other markets showing topping signs. I think EMBI and US high yield total return so far the credit spread widening has been masked by a bond rally.
The floating rate ETFs yield little. 

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Friday 10 November 2017

Impact of Fed balance sheet normalisation

Yellen starts selling Treasuries to bank billions of profits for US taxpayers on QE and tighten policy. 

High beta assets like HY and EM sell off, which causes Treasuries to rally. 

Real money which has been forced into high beta assets is left holding the bag. Sovereign and regulated money is left holding a low yield portfolio exposed to duration losses next year. 

I guess it should hold until the market focusses on wage inflation and the back end starts to sell off, but that might be a 2018 story.

Wednesday 8 November 2017

What shoud London finance focus on post Brexit?

Using the concept of individual countries having national competetive advantages what does post-Brexit offer London.

Lots of comments about European banks moving jobs away from UK. My 2c is we need to push the high leverage, low margin, commoditized, systemically risky activities to France/ Germany.

Germany for the lending as they dont get finance anyway and their stock of savings gives them an advantage in commoditised lending. And in post-debt bubble environments its probably not the best business to be 15x leveraged in.

France for the derivatives. You cant compete with an army of engineering PhDs using sovereign backstoped bank balance sheets anyway. 

As luck would have it they seem to be trying to get the business anyway via regulatory measures. 
In my view London needs to reemerge as a merchant banking/ entrepreneurial hub. A nexus of deals and 'at risk' capital. Particularly in credit, there seems to be a lot of opportunities for merchant banking or flexible private credit investments given comemrcial bank retrenchement from anything involved. 

EM always needs funding and is where most of the stable medium term growth and capital formation is.

A mix of merchant banks with access to cheap offshore funding and closed end or other flxible funds/ pooled structures is the most appropriate way to achieve this. 

If we are going to have a wage-inflation-cpaex led cycle over the next 10 years this is especially important.

An update on the Royal Borough

House prices in west London was actually one of the first blog posts post Brexit. Took a while for the new direction to take shape and indeed in the zone 2+ residential boroughs house prices seem to be going sideways or up due to the chronic shortage.  A few rate hikes should put an end to that though.

Over half of todays 38 ads are price reductions. Im even getting email alerts in Surrey where over half the emil is price reductions.

Mouseprice, which is not comprehensive or 100% accurate, has 55 pages of reductions on 122 pages of 15 ads per page in the Royal Borough.

Here is a good example for a 3 bed flat in a period block:

20 Jul 17:   Asking price reduced 9% to £2,950,000
17 Mar 17:   Asking price reduced 6% to £3,250,000
03 Mar 17:   Asking price reduced 10% to £3,450,000
28 Jul 16:   Asking price reduced 9% to £3,850,000
25 Feb 16:   Marketed at £4,250,000

2000sq ft

The same property is listed with at least 5 agents on rigthmove, with one using the innovative sales angle of 'viewing advised'

The property previously sold but with a lease extension the valuation cant be compared. 

Saturday 4 November 2017

Why put an LBO guy in as Fed chair?

My view on LBOs is a large part of the payoff is just the arb between debt costs and nominal GDP growing over time. If GDP grows 5% a year then most companies will have revenue growth of about 5%, so if you hold the LBO for 5, 6, 7 or so years then sales and profits are up big wihtout any value added. And the cheaper the debt is then the bigger the arb....

With US nominal GDP growing 5-6% or so, and Fed funds at 1.25%, its a pretty big subsidy to business/ real asset owning borrowers. Such as LBOs guys or real estate developers...

Last time U6 was 7.9% (Dec 06) Fed funds were 5.25%. 


Financial conditions are very easy. 

With Trump, a bankruptcy artist, in the White House and an LBO guy in the Fed, we might not see 5.25% for a while though. I mean why would we? What incentive do they have to get to a neutral rate for the real economy in a country where non financial debt is hundreds of % of GDP. The problem will be when the Fed breaches its 2% inflation mandate on a consistent basis. At that point after a rate shock I think we see Fed mandate drift which I believe would need legislation.  
They have also cut corporate taxes to help facilitate the final transfer of the wealth through debt eroding inflation.

As Michael Hudson has said, we have had the asset pump, next comes the inflation that wipes out the debt and middle class savings which in turn forces baby boomers to live off their Gen X children. 

I also think Powell in the Fed and a Fed under Trump's orders is another sign that we are soon to transition from the third to the fourth turning, ie the politics and societal changes are happening now which will trigger it during this Presidential term.

Wednesday 1 November 2017

USD readies to break out?

USD bounced off the 50% retracement of the bull market. The good US data is starting to suggest that the Fed's financial conditions model is not broken, conditions significantly eased this year supported by a flat curve and narrow credit spreads, and the Fed is further and further behind the curve. 

Yellen will hand over a firmly wrapped up pin to her sucessor, I guess it will be Powell now.

Im sure Powell wont be in any rush to aggressively tighten but he will be underpressure to step up the pace as part of his dual mandate as Core PCE rebounds as the drag from manufacturing, retail and durable goods passes and the headline number better reflects where US wage inflation is.
I think there is a good chance the USD index sees highs. Aginst the Yen I dont think that is a problem and Im bearish GBP as well. Question is the Euro. I think for the Euro to see a new low, say parity, we need policial risks to rear their head again as at 1.06 earlier this year the equivalanet of the Deutsche Mark and the French Franc were more or less at all time lows, as previously discussed on this blog. I dont think Catalonia is done and dusted as some market particiapants think. 

China upgrades its vendor financing model via Belt and Road

China is upgrading its vendor financing model from trinkets for Americans to heavy industry and infrastructure for Belt and Road recipients. 

Question is what basic goods will the recipients produce for China? If the answer is more or less zippo, the history of imperial economics is one of eventual default by the borrowers and control by the lenders. 

Its a brilliant geopolitical move by the CCP in my view. And one the China bears usually fail to understand. 

The following was posted on social media by someone to prove that point:

"In September 2016, the Indus Water treaty was threatened by India that would have essentially created food and water riots in Pakistan. Sensing the sensitivity, Pakistan responded by a) calling it as an "act of war" and b) essentially added "water security" to the "national security" scrolls.  

Under President Xi's Belt and Road Initiative (BRI), we have seen barrage of dams being constructed - large, medium and small sized. A $50bn commitment from China's Three Gorges Corporation would finance the dams worth generating 22,300 MW of clean energy. Pakistan's current water storage capacity is 30 days and availability per capita has dwindled to border line 1000 cubic meter per person.  In light of such transformation, the work has commenced on Diamer-Bhasha Dam (4500MW), Dasu (4230MW), Suki Kinari (870MW) and Karot (720MW). Expected to come online within 3-7 years, they would not only reduce the water shortage but would also bring the overall cost of electricity down in Pakistan thereby giving a competitive edge to the industries.  

Amidst the topsy-turvy nature of the equity investors over political uncertainty and widening Current Account Deficit (CAD) in Fiscal Year 2018, what we are seeing is good dividends in years after that!" 

US heading towards oil self sufficiency

Interesting weekly EIA numbers. 

US demand is down YoY, domestic supply up, exports up, net imports collapsed. YoY US inventories down 5%. 2MMbpd more of shale supply would more or less make the US self sufficient if oil demand continues to shrink. 

But globally its the opposite picture with ongoing demand growth and supply slightly less than demand as the capex cutbacks since 2014 dont seem to really have been felt yet in non-OPEC, non-shale production.  

Nevertheless Brent is over $60, more or less doubling from the bottom last year.

A few years ago who would ever have thought that a new technology, combined with demand weakness would almost make the US oil self suffient?!?