Month: March 2016

In recent weeks, Goldman Sachs has gained prominence by being the only bank left standing in its confidence that the Fed’s forecast of 2 rate hikes in 2016 is wrong, and instead is sticking with its hawkish prediction of at least 3 rate hikes for 2016. This also explains why Goldman has been pounding the table on long US dollar bets, which incidentally have led to major losses in the past three major central bank announcements, two from Mario Draghi and one from Yellen.

Which is why we were curious how Goldman would reconcile the latest “dovish” shocker from Yellen which has unleashed a dramatic buying spree of all risk assets (as of this moments the S&P500 is trading at a 23x LTM GAAP P/E), with Goldman’s hawkish bias.

For those strapped on time, this is the summary: stocks are currently surging because the Fed is “less confident it can normalize rates” and sees a “weaker global growth environment.”

What can one say: perfectly new normal.

Here is the full note:

Yellen Comments Emphasize Downside Risks

Bottom Line: Fed Chair Janet Yellen emphasized downside risks to the US economic outlook stemming from slower global growth in a dovish speech at the Economic Club of New York. Yellen highlighted the weaker global growth environment coupled with the FOMC’s “asymmetric” capacity to respond to economic shocks as the key reason for the Committee’s lower path for the funds rate in March. On inflation, Yellen acknowledged that that core inflation had risen “somewhat more” than she expected in December, but said it is “too early to tell if this recent faster pace will prove durable” and expressed concern about downside risks arising from lower inflation expectations.

Main Points:

1. In a speech to the Economic Club of New York, Fed Chair Janet Yellen took a positive view of recent US growth and employment gains, while emphasizing both current weakness in the US manufacturing and export sectors and downside risks to the outlook. In particular, Yellen expressed concern about the impact of the earlier tightening in financial conditions, slower growth globally and in China in particular, and uncertainty surrounding China’s exchange rate policy.

2. Yellen acknowledged that core inflation had risen “somewhat more than my expectation in December,” but said “it is too early to tell if this recent faster pace will prove durable,” in part because “earlier dollar appreciation is still expected to weigh on consumer prices in the coming months.”

3. Yellen expressed concern that “inflation expectations may have drifted down,” pointing to both the Michigan consumer survey and market-based measures of inflation compensation. Using the 1970s as an analogy, Yellen noted that stable inflation expectations cannot be taken for granted. However, she also noted that the Michigan measure has in the past responded to declines in gasoline prices and therefore might currently be “unreliable” as a guide to trend inflation. While Yellen said she views inflation expectations as still well anchored, if that view is wrong then “a more accommodative stance of monetary policy” might be required to return inflation to the target.

4. Yellen said that recent changes in economic conditions, especially developments abroad, “imply that meeting our objectives for employment and inflation will likely require a somewhat lower path for the federal funds rate than was anticipated in December.” Pushing back against the argument that the FOMC’s March projections for the funds rate represented a change in the reaction function, Yellen instead attributed the shift to the weaker pace of global growth. She emphasized the need to “proceed cautiously in adjusting policy,” noting that “caution is especially warranted” because the FOMC’s ability to respond to shocks with the funds rate close to zero is “asymmetric.”

5. Yellen noted that a number of Fed models imply that the real neutral rate is still close to zero. She attributed this in part to headwinds facing the economy, including weak foreign growth, the strong dollar, slow household formation, and weak productivity growth. While Yellen said she still expects these headwinds to “gradually fade” and for the neutral rate to rise as a result, she noted that “this assessment is only a forecast” because “no one can be certain about the pace at which economic headwinds will fade,” a somewhat less confident take on future neutral rate normalization.

6. Responding to concerns that central banks have run out of policy space, Yellen said that FOMC still has “considerable scope to provide additional accommodation” should it prove necessary. She also noted that the FOMC’s data-dependent approach “serves as an important ‘automatic stabilizer’ for the economy” because incoming data surprises tend to induce offsetting “changes in market expectations about the likely future path of policy.”

* * *

Next, we await to see how long before Goldman finally throws in the towel on its “long dollar” trade.

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While real estate is all about "location, location, location," it appears there are sometimes more prescient factors that any prospective buyer should pay attention to. Amid yet another government-fueled housing bubble, it seems in their haste to fulfil a rapacious demand for property in which to gamble their hard-grafted assets, Chinese construction companies have cut a few corners. As the following stunning video shows, a "newly constructed apartment" crumbles before the owners' eyes as the 'concrete' walls turn to sand…

LiveLeak exposes, in the following video, just how poor the standards can be of so-called “new” properties. LiveLeak footage shows two men in a supposedly “new apartment building” in China where the concrete walls crumble like sand.

China is currently in the midst of a huge property bubble…

And the country is full of “ghost cities” and new apartment blocks waiting to be filled. Which is no surprise considering that China used about 6.4 gigatons of cement during their construction boom between 2011 and 2013, which is more than what the US used during the entire 20th century. However, those housing properties in China are frequently not built to stand the test of time: In 2010, officials revealed that many homes had a lifespan of just 20 years.

Just like buying worthless companies in the stock market bubble ended very badly, it appears buying 'worthless' homes is set for the same outcome…

Quick everyone back into stocks!!

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While it remains unclear how far, if anywhere, the lawsuit against Trump campaign manager Corey Lewandowski will go, who as reported earlier was charged with battery of former Breitbart reporter Michelle Fields during an altercation in early March, one thing is clear: he will remain in his post. According to The Hill, citing campaign spokeswoman Katrina Pierson, the Trump campaign “will stand by campaign manager Corey Lewandowski.”

“The allegation is that he grabbed her aggressively, nearly throwing her to the ground,” Pierson said. “That did not happen, its not on the video, and Mr. Lewandowski will be cleared of all charges.” When CNN host Wolf Blitzer asked whether Lewandowski would remain in his position if he did not “beat” the charge, Pierson said he would.

“Yes, absolutely. Mr Lewandowski is an integral part of this team, the camp wholeheartedly supports him and will see him through the entire ordeal,” she said.

She added that it’s common for people to be “jostled or moved or hit” in media scrums both by campaign officials and members of the media, and compared the altercation to when she received a cut on her arm from a news camera during a scrum, and floated the possibility of restricting access to the press in response. 

“You could start suing networks now for slashing your arm with a camera, which happened in my case. This is absurd, it is ridiculous and it will be beat,” she said. “If anything, perhaps campaigns, particularly presidential campaigns, should begin to change the rules of the type of access the press gets from here on.”

Meanwhile, The Hill also reported that a lawyer representing Lewandowski resigned from his post as a U.S. attorney in 1996 after he allegedly bit a stripper at a Miami nightclub.

Kendall Coffey, who was appointed by President Clinton in 1993, stepped down after the Justice Department concluded an investigation into the nightclub incident, according to reports from the time. Coffey, a founding partner of the law firm Coffey Burlington, then returned to private practice. 

He was involved in the high-profile custody battle of Elian Gonzalez in 2000.

Additionally, Coffey’s law firm is representing Trump in a suit he brought against Doral, Fla., residents living near one of his golf courses. Trump is accusing the residents of chopping down trees on the course’s property.

All this assures that the media circus surrounding what is already the most entertaining presidential race in decades, is not going anywhere.

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From ISIS marches in Germany to refugees “doing normal manly things” to women in Sweden, UKIP leader Nigel Farage confronts Angela Merkel and her peers in the European parliament over their dreadfully misguided immigration policies.

“Europe is burning,” he exclaims, adding that – just like the central-bankers of the world – their solution is insanely simple-minded: “Europe isn’t working, so we must have more Europe.” The only hope lies, he adds, in the British referendum showing the rest of Europe it is possible to take back control of its own borders.

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Submitted by Dwayne Purvis via OilPrice.com,

Props to Saudi Arabia. Unlike other producers, including U.S. shale producers, it maintained financial strength and flexibility during the last boom. When it began to shift the paradigm of global supply, the kingdom was explicit about its goal – market share – even if it didn’t always trumpet the proactive steps it was taking towards that goal. The now-evident objective of low prices, having been achieved and sustained, begs the question of why Saudi Arabia defended its market share.

The position of Saudi Arabia among producers in 2014 resembled the position of Germany in the European Union in prior years. Both had maintained financial strength despite the prodigal habits of other members, and both were called upon to make unique sacrifices to rescue their neighbors. Germany had closer ties to its partners and seemed to see the ultimate benefit of helping. Perhaps because it didn’t have such ties, Saudi seems to have weighed the benefits differently. Indeed, Saudi had no moral obligation or economic need to sacrifice itself in order to redirect wealth to other producers.

Their actions suggest that they intended to drive prices toward a basement price—stepping supply up when prices reached the $60s, slowly tuning it down when prices hit the $40s and below, and increasing its capacity for production even as prices fell. The recent address of Saudi Oil Minister Ali Al-Naimi in Houston was straightforward and polite, but it might be crudely paraphrased as, ”Get used to the low prices. Adapt or die.”

The possibility of his bluffing is belied by historical actions. As recently as Monday, the OPEC report on monthly volumes showed the kingdom continuing to produce more than half a million barrels a day above its rates in late 2014. Saudi Arabia has had the will and means to drive prices, giving market forces some push.

As oil has been its only resource and industry of value, the kingdom has treated the business as the treasure that it is. The centuries-long fate of the royal family and its kingdom depends upon how they manage themselves during the era of oil, particularly the epoch of increasing demand. Surely, the highly intelligent, disciplined and motivated planners knew the short-term consequences of the actions which the rest of the world is just beginning to appreciate fully. And even last month, Minister Al-Naimi professed the acceptability of $20 oil.

Normally the benefit of market share is obvious—increased revenue and increased performance. This assumes, however, stable prices and economies of scale. If one maintains market share, or even gains a few percent, but prices drop by 50 or 70 percent, then revenue drops to half or a third of what it had been. Said differently, the Saudis could have absorbed all of the increasing production from the rest of the world, dropped their production by half to about 5 million barrels per day (mb/d) and still have had the same or more revenue than they have enjoyed during this transition. Market share is not its own reward. Evidently Saudi Arabia has some strategic plan that results in its making more money in the long run than it is losing in the short run.

Perhaps the Saudis view ‘market share’ not just in terms of oil production but in terms of total energy use. By 2014 shale oil had posted an acute rise in supply, and other high-cost sources like oil sands were building momentum. Natural gas and renewables were tracking their own, chronic ascent. Moreover, the high cost of oil created incentives toward alternatives, both unconventional oil and non-oil forms, and global demand growth for liquid oil was forecast to grow below historical trends due to conservation and lesser economic activity. Minister Al-Naimi has said that oil demand would peak long before supply. Before the current price crash, that peak demand was within sight, perhaps 2040 give or take a decade. High prices were slowly killing the goose that lays the golden eggs.

If the strategic focus on market share does not involve increased revenue or efficiencies, then the market power is the only compelling explanation for the strategy. With power they can perhaps maximize their own decades-long revenue stream rather than passively treat their national treasure as a cash cow, perhaps exerting some control over their own destiny rather than ceding to less economically rational sources.

The new paradigm of supply/demand balance seems to have at least two major tenants: Price should be low enough to discourage run-away supply and perhaps to encourage the use of oil. Saudi Arabia may cooperate but will not unilaterally support prices. Around these pillars are two routes back to prices which can sustain long-term supply: slow rebalancing as supply slides and demand creeps, with cooperation for widespread cuts. Or prices could recover by a challenge to the new paradigm, namely conflict to threaten or to interrupt even a small portion of supply.

A freeze in production growth as headlined in the last month would be a mostly irrelevant step on the first route or a minor step towards the second route. The large majority of OPEC production comes from countries not able or not inclined to increase production. With Iran still adamantly and publicly opposed, the idea of a freeze in supply growth is more publicity than policy change. Perhaps the most important take-away is that Saudi Arabia has signaled that its floor price is somewhere above $30.

Even if cooperation cannot be achieved, the rest of the world may not remain a hapless victim of Arabian pricing power. Oil consumers may appreciate the drop, but countries like Russia and Iran do not. They also have motives and objectives similar to those of Saudi Arabia; they desperately need oil revenue. Only they have different forms of power at their disposal to influence oil price.

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Yesterday’s 2 Year auction was ugly, and while it stopped through the When Issued its internals were ugly. Moments ago the Treasury sold $34 billion in 5 Year paper (Cusip Q37), which was just as, if not uglier. The high yield printed at 1.335% (28.08% allotted at high), stopping 0.5 bps through the 1.330% When Issued.

The Bid to Cover, just like yesterday, slid again, dropping to 2.38, down from 2.44 in February, and below the 12 month trailing average of 2.45. The good news: the BTC collapse did not match yesterday tumble in bid-side demand, where the BIT dropped to a level last seen in December 2008.

And, just like yesterday, Indirect bidders took down just 53.9%, far below below the record 67.3% in February, and below the LTM average of 58.5%. Directs were left holding 7.2% while Dealers were allotted 38.9% of the paper, the highest since August 2015.

It is worth noting that there were mitigating circumstances: just like yesterday European buyers were off on holiday, so today the auction took place during Yellen’s critical Economic Club speech, when few were willing to take the risk with some major hawkish surprise coming out of Yellen’s mouth. Now that just the opposite has happened, we expect the auction of tomorrow’s 7Y auction to be far “smoother sailing” compared to the stormy issuance of 2 and 5 Year paper so far this week.

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Remember when the central bank of the United States worried about development in the, well, United States? Those days are gone. Presenting: China. From page 8 of Yellen’s speech on “The Outlook, Uncertainty, and Monetary Policy“:

There is a consensus that China’s economy will slow in the coming years as it transitions away from investment toward consumption and from exports toward domestic sources of growth. There is much uncertainty, however, about how smoothly this transition will proceed and about the policy framework in place to manage any financial disruptions that might accompany it. These uncertainties were heightened by market confusion earlier this year over China’s exchange rate policy.

Confusion, that is to say, which was the direct result of the US Dollar soaring to multi-year highs, which forced China, whose currency is peg to said dollar, to aggressively devalue its own currency.

The rest is history.

And it’s not just China: it’s every country which, as we warned in November 2014, is reliant on the viability of the Petrodollar, and more importantly, keeping the USD low. Here is Yellen explicitly addressing the impact of collapsing oil prices on oil exporters.

A second concern relates to the prospects for commodity prices, particularly oil. For the United States, low oil prices, on net, likely will boost spending and economic activity over the next few years because we are still a major oil importer. But the apparent negative reaction of financial markets to recent declines in oil prices may in part reflect market concern that the price of oil was nearing a financial tipping point for some countries and energy firms. In the case of countries reliant on oil exports, the result might be a sharp cutback in government spending; for energy-related firms, it could entail significant financial strains and increased layoffs. In the event oil prices were to fall again, either development could have adverse spillover effects to the rest of the global economy.

In other words, as John “Idiot?” Williams said yesterday, it is no longer about the US: the Fed’s so-called “reaction function” can be summarized with just one word: China. (and maybe one more word: oil, which the Fed just realized needs a low USD to rise…)

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