“Sign, sign, everywhere a sign
Blockin’ out the scenery, breakin’ my mind
Do this, don’t do that, can’t you read the sign?” – Five Man Electrical Band
For months now I have been discussing that despite the “hopes” that this time is different, there is little chance that the U.S. can remain an island of economic prosperity in the sea of global deflation. To wit:
“While none of this analysis suggests that a domestic recession is imminent, it does suggest that the hopes that the U.S. can “decouple” from the rest of the world’s deflationary drags are likely misplaced. As shown in the chart below, the U.S. economy has historically been unable to achieve accelerating rates of economic growth when both the EuroArea and Japanese economies have been weak.”
“The implications to investors are important. The current growth in domestic profits is one of the last remaining footholds of market “bulls.” With valuations now expensive, interest rates near zero and yield spreads flattening, the risks to the markets have risen substantially. While this doesn’t seem to be the case as markets push up against all-time highs; it is worth remembering that we saw much the same in early 2000 and 2007. This time is likely no different, only the timing and catalyst will be.”
The following series of charts all suggest that current hopes of surging economic growth in the U.S., over the next several quarters, will likely be met with disappointment. I have added brief comments, but primarily you should judge for yourself.
LEI Coincident To Lagging Ratio
The coincident-to-lagging ratio is like a “book-to-bill” ratio for the economy. It is hard to suggest that the economy is “firing” on all cylinders when this ratio is languishing at levels normally indicative of a recessionary economy.
While the ISM composite survey is near the top end of its range, there are clear signs that the ratio will likely subside in the months ahead. I have mapped the normal cycles of the index in the past. It is important to remember that the ISM survey is a “sentiment” survey that tends to lag actual inputs like new orders and backlogs.
Speaking of orders, durable goods (ex-aircraft) are showing considerable signs of weakness domestically. The demand for goods has weakened significantly over the last couple of months in particular despite the hopes that falling oil and gasoline prices would buoy spending. (I wrote several articles dispelling this myth see here, here and here.)
Imports vs. Exports
The surging dollar and weak consumer demand are also being reflected in import and export activity.
The rising weakness in demand for goods and products can be clearly seen in the decline in the shipping index.
Copper, a component used in virtually every facet of manufacturing, production, and consumption, also suggests that economic demand is weakening.
National Activity vs. Economy
We can see this more clearly by looking at the major components of the Chicago Fed National Activity Index (CFNAI) as compared to the relative economic indicators.
The 5- and 10-year breakeven inflation rates continue to suggest that underlying economic strength is much weaker than headline statistics suggests.
These charts all clearly suggest that the real economy is likely weaker than currently believed. In addition, current data would likely already be printing lower growth rates had it not been for revisions a couple of years ago that added more questionably measured components such as “intellectual property.”
However, while I am not suggesting that a recession is imminent, i am suggesting that the risk to investors has risen markedly over the last few months. The rising financial instability in the Eurozone, particularly following the Greek elections, combined with the global deflationary tide puts currently extended financial markets in jeopardy.
There is little question that the markets will eventually suffer a rather nasty mean reversion. However, bull markets don’t end simply due to old age, it requires a catalyst. The problem remains that throughout history the “catalyst” that finally triggers a market reversion and coinciding economic recession are rarely identified in advance.
This is why I point to the signs. The signs are everywhere that the market is currently a “bug in search of a windshield.” It will eventually find one, and as the old saying goes, the last thing that goes through the mind of the bug is its ***.
We suggested the Greek pivot from Europe to Russia was building previously, and now, we get confirmation from Russia’s finance minister Anton Siluanov that the pivot could be mutual, who told CNBC in the interview below:
- *RUSSIA WOULD WEIGH FINANCE FOR GREECE IF ASKED, SILUANOV: CNBC
With fire and brimstone spewing from Germany over the potential for Greece to veto any and everything, it seems Russia may just have stymied Europe’s leverage over the newly democratic nation.
* * *
Recall that a German central banker warned of dire problems should the new government call the country’s aid program into question, jeopardizing funding for the banks.
“That would have fatal consequences for Greece’s financial system. Greek banks would then lose their access to central bank money,” Bundesbank board member Joachim Nagel told Handelsblatt newspaper.
Unless of course Greece finds a new, alternative source of funding, one that has nothing to do with the establishmentarian IMF, whose “bailouts” are merely a smokescreen to implement pro-western policies and to allow the rapid liquidation of any “bailed out” society.
An alternative such as the BRIC Bank for example. Recall that the “BRICS Announce $100 Billion Reserve To Bypass Fed, Developed World Central Banks
* * *
It appears, in Russia, Greece has found another possible friend…
Siluanov: “if such a petition [for financial aid] is submitted to The Russian Government, we will definitely consider it”
So once again, it appears as if all the leverage is. much to the shock and humiliation of Brussels, back in Tsipras’ hands.
It would appear Gazprom has once again come knocking for payment – or else. As Bloomberg reports, Ukraine is pressing the Obama administration to provide political support, as much as $3b in financial aid and “non-lethal weapons,” with the goal of some progress by the end of February, Ukrainian Deputy Foreign Minister Vadym Prystaiko says. Of course, given Europe’s agreement to further sanction Russia (asEU agrees more “punitive” steps are now possible) President Obama will be happy to lend Ukraine more American taxpayer money (despite the market’s perception that Ukraine’s default probability is over 80% – six year highs).
What Ukraine wants…
Top priorities are political and financial aid, then military support Prystaiko says during meeting with Bloomberg editors and reporters in Washington
Ukraine seeking U.S. assistance for weapons radar, armored vehicles, access to surveillance drones
“We are ready to buy,” says Prystaiko; also asking France, Germany, U.K. for military support
“We would like to have these radars to be able to tell us” when attack is coming
* * *
- *EU TO PREPARE FURTHER ECONOMIC MEASURES ON RUSSIA: LINKEVICIUS
- *EU TO ADD NAMES TO RUSSIA-LINKED BLACKLIST BY FEB. 9
- *EU DECISION ON RUSSIA SANCTIONS WAS UNANIMOUS, MOGHERINI SAYS
- *EU AGREES MORE ‘PUNITIVE’ STEPS POSSIBLE ON RUSSIA: MOGHERINI
- *EU FOREIGN POLICY CHIEF MOGHERINI COMMENTS IN BRUSSELS
After the delayed 5 Year auction took place 90 minutes ago, and priced strongly well through the When Issued, it was the turn of the last for this week auction of $29 billion in 7 Year paper, which just concluded and, somewhat surprisingly, was the worst of all auctions this week: not only did it tail modestly, pricing at 1.59%, a 0.4 bps tail wider than the 1.586% WI, but the Bid To Cover also was just modestly anove last month’s 2.388, at 2.499, below the TTM average of 2.56. To be sure, a key factor for this superficial weakness was that the high yield of 1.59% was the lowest since May of 2013, as a result all those who have booked major profits in last month’s auction pricing at 2.13 likely had far less of an incentive to get involved here.
The internals were also in line, with Directs taking down 14.9%, Indirects at 56%, above the 50% TTM, and Dealers left holding 29.04% of the auction, slightly less than the 35% average, which also is to be expected in a world in which banks can no longer turn around the flip the paper to the Fed if need be.
And with that this week’s treasury issuance calendar is now complete.
What America got right…
“Perfection is achieved, not when there is nothing more to add, but when there is nothing left to take away.”
Antoine de Saint-Exupéry
Via Scotiabank’s Guy Haselmann,
Following the ECB meeting last week, news headlines summarized the initial market response with titles such as, ‘Markets rally as ECB bond buying plan exceeds all expectations’. Such characterization judged the plan only on its size and schedule and failed to fully appreciate the deeper flaws buried in the details. My judgment is that Mr. Draghi secured the best compromise he could, yet it is one that is far from “whatever it takes”. It is a plan that cleverly masks shortcomings in its complexities.
For the Eurozone to truly maintain a currency union, it needs to have political, fiscal, and banking unions. All of these have been elusive and slow to develop. The ECB QE plan now exposes the cracks of their monetary union. If the EU truly possessed a monetary union then the ECB should have guaranteed or assumed the potential losses from the purchases of those assets. Forcing the national central banks to assume the risks, recognizes the non-zero possibility of default or EU break up.
Choosing to purchase assets through the national central banks is anti-integration. Unlike other ‘bail-outs’, this structure is a step backwards. It is anti-union.
- As I wrote in my Jan 16th note: “Movement towards, or away from, being a union is what has driven the binary aspects of EU sovereign debt spreads for many years. In other words, debt spreads are binary in that they will either converge (union) of diverge (anti-union). Therefore the structure of ECB QE will ultimately prove much more important than the size of the program.”
Since individual countries no longer have the ability to print money themselves, various types of credit risk exists. Hung Tran of the IIF argues that the debt structure is more similar to that of a US municipality than that of a sovereign nation. A municipality’s ability to honor its liabilities is limited to its taxing authority, or ability to legally implement revenue-generating reforms. Could, or should, the debt of, say, the State of Georgia trade through the debt of the US government?
I point this out since BBB rated Spanish 10-year bonds traded 55 basis points below AAA-rated US 10-year Treasuries (after the ECB announcement). I believe this spread will move during the year from the ‘negative 50 area’ to a spread that is positive by hundreds of basis points. I believe this will be one of the best trades of 2015. (The Spain/Bund spread fell below 100 bps; I obviously expect it to widen significantly as well)
ECB debt purchases will be made in line with the individual countries’ share of ECB equity, so the benefit to the EU periphery’s debt is restricted. About one-third of all purchases will be in German and French debt. Spain’s equity contribution is only 8%.
The ECB’s single mandate is to maintain price stability (not to spur economic growth or employment). The plan’s mechanism that helps to achieve such a goal is a weakening of the Euro. The ECB has had great success in this regard over the past 7 months simply by promising a QE program (i.e., Euro from 1.35 to 1.15). The announced program is designed to weaken it further and ‘buy more time’ by hinting at the open-ended nature of the QE program should it not reach its inflation objectives by the end date of September ’16.
Adding such conditionality is a powerful tool today that maximizes ECB flexibility, while limiting the market’s desire to fight its resolve. However, in reality there are two reasons why it is highly unlikely the program is ever extended beyond the announced end-date of September 2016. If the ECB’s inflation goal has not worked by September of 2016, then it is likely to be viewed as being ineffective, increasing the likelihood that those who were reluctant supporters in the first place will want to abandon it. On the other hand, if the inflation rate begins to creep back up in the ‘preferred direction’, then the ECB would want to end the program and may even wish to do so early.
The ECB has cleverly set the timetable in a way to almost ensure that it will be successful in terms of improvement on the inflation front by September 2016. The reason is due to the year-over-year effects that the price of oil will have on inflation indicators. The price elasticity of oil makes it likely that oil may bottom near current levels between $40-$50 dollars. Should that occur, oil will stop being a drag on inflation indicators beginning in twelve months’ time.
The market rate for EUR 5-year inflation beginning in 5 years, initially rose from around 1.55% to 1.80% on the ECB announcement, but quickly reversed back to 1.55%.
The 10 year German Bund fell in yield from above 0.50% to below 0.35% and has stayed there. This shows me that fixed income markets remain skeptical of the ability of central banks to lift growth or inflation.
Demand for money to invest in the real economy does not pick up when unusually low rates are lowered modestly lower, particularly when debt levels are already quite elevated. The plummeting velocity of money is a symptom of extreme indebtedness. Imposing a negative yield of 0.20% on the excess reserves of EU banks is a tax intended to boost lending, but there are many consequences to imposing such financial repression with little evidence that the intended goal will come to fruition.
Lowering rates from already low levels hurts the lender because margins usually fall as well. Lenders have a disincentive to lend when they believe that their compensation for the loan is inadequate. Moreover, promises that rates will remain low for a period of time damages confidence that economic activity is improving.
The Fed has boxed itself into a corner as it has attempted to prepare the markets for a rate hike around June. If it does not raise rates in June, or thereabouts, then it must have an exceptionally good reason. The reason would have to be a significant and material deterioration in the economy or a highly troubling worsening of the geopolitical environment.
Regardless, risk assets are likely to suffer mightily in the near future under either scenario. Risk assets will either have to endure a Fed hike or worsening conditions. The high for the year for the S&P could already be in place. Either way, the biggest beneficiary will remain the back end of the Treasury curve. I remain a bond bull.
Extreme central bank policies over the past 5 years have ballooned asset prices, fueled speculation and moral hazard, and exhausted interest rate tools of central banks. The Swiss National Bank reminded markets just how fleeting promises can be. And now, central bank’s under-delivering on growth and inflation promises are now further concerning risked-up markets; such could not come at a worse time.
It appears markets are on the verge of learning just how damaging the unintended consequences will be from multiple years of extreme central bank promises now that the Fed has run out of the ammunition to keep the utopian market façade alive. The structure of the ECB QE and the Greek situation make the backdrop considerably more troubling and difficult.
“Can you tell a green field from a cold steel rail? / A smile from a veil? / Do you think you can tell?” – Pink Floyd
Because nothing says dump gold and silver like an aggressively escalating currency war…
Once again the US-Europe crossover period is the witching hours for Precious Metals…
But as soon as Europe closed,. gold and USDJPY decoupled dramatically as the pair-trade-that-nobody-talks-about rolls on…
As it seems losses escalated after the European close… and as Oil flushed below $44
Margin calls? Or maybe the status-quo just cannot stand the outperformance…
Earlier, we laid out a very reasonable explanation by none other than Europe’s largest insurer AXA why the ECB’s QE will fail. The ECB did not like ththis, so it decided to reply. This is how the ECB just “crushed” AXA’s logic.
- COEURE SAYS QE WILL WORK BECAUSE IT IS BIG
What else is there to add?
Speaking in May 2014 (ahead of Ukraine’s elections) new Greek Prime Minister Alexis Tsipras made very clear why he is now against Germany’s push for further sanctions against Russia.
[The SYRIZA] party believes that the new government in Ukraine came to power as a result of a coup, and call it a junta.
“We should not accept or recognize the government of neo-Nazis in Ukraine,” the Athens News Agency quotes Tsipras who believes that the Ukrainian people should decide their future themselves.
Speaking about different peoples’ movements for self-determination, Tsipras said that the European left respected the right to self-determination, but nationalism and clashes could not lead to positive results.
“We in the EU should not give preference to changing borders, but must respect the position of the peoples, who have decided to create a Federation within the state,” said the SYRIZA leader.
the EU must change in order to survive; the EU lacks democracy, and citizens do not believe that their vote can change policy.
* * *
As we previously noted, yesterday’s 2 Year auction was an absolute blockbuster and accurately guessed the general direction of the bond market following yesterday’s FOMC announcement. Moments ago, the US Treasury sold $35 billion in 5 Year paper, the first of two Note auctions, with the 7 Year due at 1pm today, and like yesterday it too was a very strong auction, with the High Yield tumbling from 1.739% last month, when most were assuming a rate hike is imminent to just 1.288%, stopping through the 1.295% When Issued, and suggesting that the relentless collateral shortage of the past 2 years simply refuses to go away. This was also the lowest closing yield of a 5 Year auction since May 2013.
The Bid to Cover rose modestly from 2.39 to 2.49 (below the 2.72 TTM) but it was a far cry from the BTC surge during yesterday’s 2 Year issuance. However, the real action was in the internals where just like yesterday the Directs remained under 10%, allowing the Indirect take down to surge to 63.1%, leaving only 27.4% for the dealers.
Altogether, a strong showing for the first left of the belly auction for today, and if this is any indication expect a 7 Year auction in 90 minutes to also price stopping well through whatever the When Issued is trading at around 1pm.