Month: March 2018

Worst streak of declining retail sales since 2015, Russia-UK tensions, tumbling GDP expectations, and trade-war escalation and retaliation looming was apparently enough to kill goldilocks.

All those yummy goldilocks Dow gains from Friday’s payrolls data… gone…

 

Dow broke back below its 50% retracement level of the Fed Fiasco…

 

But The Dow remains underwater for the month (and the year)…

 

The S&P 500 fell back to its 50DMA…

 

Bank stocks have erased all their goldilocks gains…maybe Cohn matters after all

 

Tesla Tanked…

VIX rose above 17 – breaking above its 50DMA… (another mini-flash-crash today)…

 

Treasury yields are all lower than pre-payrolls (2Y unch)…

 

7, 10, and 30Y yields are all lower since the Jan CPI print…

 

Breakevens and Bond Yields tumbled the last few days – erasing the January CPI spike…

 

Notably the yield curve (in this case 2s30s) plunged back towards the lowest levels of the year… 2s30s actually closed at its lowest since October 2007…

 

The Dollar Index was down for the 4th straight day…

 

Ugly day for the Ruble…

 

Crude continues to underperform and gold clung to gains. Copper jumped after better than expected China production data…

 

Cryptos had another tough day after the Google ban and more chatter ahead of next week’s G-20 over coordinated regulatory crackdowns…

 

Gold has moved back into the lead year-to-date as The Dow drops back into the red for 2018…

We leave it to David Rosenberg ( @EconguyRosie) to conclude:

How do you spell s-t-a-g-n-a-t-i-o-n?

Core consumer prices +3.2% SAAR and real retail sales -4.4% SAAR over the past three months. Time for a hard-asset portfolio. Notice the CRB index up today with the stock market getting clobbered?

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As if the abrupt firing of Secretary of State Rex Tillerson – and countless others in recent weeks and months – wasn’t enough of a surprise, President Donald Trump on Tuesday told an incredulous group of reporters that Tillerson’s head wouldn’t be the last to roll. The moment had all the hallmarks of a paradigm shift: with his approval rating at post-election highs (according to Rasmussen), an emboldened Trump is reworking the famous phrase “let Trump be Trump” by being more assertive on policy and personnel.

And today, Vanity Fair reported that Trump is planning to fire Attorney General Jeff Sessions  – a decision that would certainly complicate Robert Mueller’s investigation (perhaps that’s the intention). According to the report, the leading candidate to replace Sessions would be EPA administrator Scott Pruitt.

Perhaps most consequential for Robert Mueller’s investigation, sources said Trump has discussed a plan to fire Attorney General Jeff Sessions. According to two Republicans in regular contact with the White House, there have been talks that Trump could replace Sessions with E.P.A. Administrator Scott Pruitt, who would not be recused from overseeing the Russia probe. Also, because Pruitt is already a Cabinet secretary, he would not have to go through another Senate confirmation hearing.

In another (perhaps expected) revelation, Sherman reports that Trump has been quietly grumbling about Jared Kushner and Ivanka Trump, telling advisors that he wished they’d move back to New York City as Kushner being stripped of his temporary security clearance has become a hindrance to performing his duties as a senior advisor to the president.

Then there is the question of Jared Kushner and Ivanka Trump’s futures. Trump has told people for months that he wants them to go back to New York. “Trump wants them out of there. He thinks they’ve been getting hit too hard,” a friend of the president said. But Javanka are digging in, sources said. “They’ve damaged us so much already. What else can they say about us?” Kushner recently said, according to a person who spoke with him. “And if we go back to New York, they’ll keep attacking. So what do we have to lose?” In recent days, the couple have argued for their continued relevance by cooperating with pieces in The New York Times and The Washington Post. Sources said that if Kelly is forced out, Jared and Ivanka will fight to stay on.

And that’s not all: Earlier this week, it was reported that Trump is preparing to also fire HR McMaster, his National Security Adviser. McMaster was appointed hastily in the aftermath of Mike Flynn’s firing, and has refused to parrot the president’s views about whether Russia interfered in the 2016 election, earning him the ire of Breitbart and most of the “alt-right.”

That news followed another report earlier this month suggesting that Chief of Staff John Kelly and Defense Secretary James Mattis had struck a deal to push out McMaster and install one of their proteges.

To summarize: the firing of Rex Tillerson was just the first in a series of terminations planned by what now appears to be a far more confident and empowered Trump. And judging by the market’s reaction today, risk assets are finally starting to get concerned.

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Over the weekend, when we noted the ongoing blow out in the Libor-OIS spread, we asked whether a dollar funding crisis is emerging , now that this traditional indicator of monetary tightness and systemic credit stress has blown out to levels last seen during the European sovereign debt crisis of 2011.

One day later, Bank of America’s rates strategist Mark Cabana used the same chart as his “chart of the day”, noting that “the 3-month USD LIBOR-OIS spread recently widened sharply to levels not seen since the European peripheral crisis in 2011-12.”

Noting that while it is hardly indicative of “heightened bank credit concerns, but rather reflects a number of factors that have worsened the supply-demand backdrop and impacted the price of funding”, BofA then said it expects the widening in 3m LIBOR-OIS will likely get modestly worse before it gets better due to structural shifts in money markets.

We are not expecting a quick retracement due to (1) a possible acceleration in offshore corporate cash repatriation, (2) uncertainty over how quickly a new marginal buyer will emerge or issuer diversification will occur and (3) ongoing reserve draining. We expect higher overall front-end borrowing rates to persist for some time, but do not expect this tightening in conditions to materially impact the Fed’s gradual rate hiking path.

According to Bank of America, the recent 3m L-OIS spread widening to four factors, in order of priority:

• Elevated front-end supply: Following the Congressional agreement to suspend the debt limit on 8 February the US Treasury has issued a whopping net $283bn of Treasury bill supply inclusive of the settlements this week (Chart 2). For context, the amount of supply over the past five weeks has exceeded the net bill supply in 2017 by over two times. The elevated front-end supply has caused Treasury bills to cheapen notably vs OIS (Chart 3). This has supported a cheapening of other money market products and forced banks to raise their borrowing rates to attract funding, especially since financial CP outstanding recently hit the highest since MMF reform (Chart 4).
• Repatriation: As discussed here, many corporates are likely in the process of building liquidity ahead of a draw down in large cash pools overseas. One way to evidence this activity is through offshore USD MMF. AUM in offshore prime USD MMF increased from $240bn to $320bn after the 2016 election likely as expectations for repatriation built (Chart 5). As the tax law moved to completion late last year offshore USD MMF fund managers became defensive anticipating future corporate outflows (Chart 6).
• Defensive positioning: Onshore institutional prime MMF WAMs have recently declined reflecting defensive posturing amid elevated front-end supply and in anticipation of the March FOMC rate rise (Chart 7).
• Reserve draining: The Fed’s balance sheet unwind and recent build in the Treasury’s cash balance will serve to drain excess reserves and tighten funding.

Meanwhile, going back to our most recent post on the Libor-OIS spread, we noted that while the overall move wider was expected, the speed of the blow out has taken most analysts by surprise, and the result has been a scramble to explain not only the reasons behind the move, but its sharp severity. Abd while this is a simplification of the various catalysts behind the spike in Libor-OIS, here is a quick summary of what is going on – the expansion of Libor-OIS and basis swaps have been impacted by a complex array of factors, which include:

1. an increase in short-term bond (T-bill) issuance
2. rising outflow pressures on dollar deposits in the US owing to rising short-term rates
3. repatriation to cope with US Tax Cuts and Jobs Act (TCJA) and new trade policies, and concerns on dollar liquidity outside the US
4. risk premium for uncertainty of US monetary policy
5. recently elevated credit spreads (CDS) of banks
6. demand for funds in preparation for market stress

To be sure, in recent posts…

• Why US Tax Reform Will Put Even More Pressure On Dollar Funding Markets
• Libor-OIS Blowing Out On Rising Repatriation Concerns, Collapsing Front-End Funding
• Libor-OIS Contagion: As Spread Blows Out, It Starts To “Infect” Other Markets
• Libor-OIS Blows Out As Libor Rises Above 2% For The First Time In 10 Years

… we have taken a detailed look at each of these components, of which 1 thru 3 are the most widely accepted, while bullets at 4 through 6 are within the realm of increasingly troubling speculation, and suggest that not all is well with the market, in fact quite the contrary, and would imply that contrary to what BofA and various other commentators have suggested, bank credit concerns are indeed becoming a relevant issue.

Still, as we explained on Sunday, whatever the cause of the ongoing blow out in Libor-OIS, this move is having defined, and adverse, consequences on both dollar funding and hedging costs. This alone will have a severe impact on foreign banks, because as DB wrote recently, “the rise in dollar funding costs will damage the profitability of hedged investing and lending by [foreign] financial institutions. Most of the bond investors we have talked with shared a strong interest (and concern) in this topic.” However, the most immediate consequence is that it is now more economical for Japanese investors to buy 30Y JGBs, with their paltry nominal yields, than to purchase FX-hedged 30Y US Treasuries which as of this moment yield less than matched Japanese securities. The same logic can be applied to German Bunds, as the calculus has made it increasingly unattractive for European investors to buy FX-hedged Treasuries.

Meanwhile, in the forward space, the latest jump higher in 3-month USD Libor prompted a fresh wave of selling across Mar18 eurodollar futures…

…with the higher fix pushing FRA/OIS over 50bp for the first time since 2012.

And while Libor-OIS is moving fast, the FRA/OIS has widened even more dramatically, rising as much as 8bp above spot Libor-OIS in recent days.

Aside from reflecting expectations of a wider Libor-OIS, the FRA/OIS widening could have been driven by the fact that large traders used Eurodollars instead of fed funds futures to express views of a more aggressive Fed cycle and a higher terminal rate. An evidence of this is that FRA/OIS moved considerably wider the day after the January jobs report and also after the January CPI report.

As previously, we urge readers to keep a close eye on this sharp move wider, because whether it is due to relatively innocuous reasons such as the 4 listed by BofA, or the three far more troubling ones, namely i) the risk premium for uncertainty of US monetary policy, ii) recently elevated credit spreads (CDS) of banks and iii) demand for funds in preparation for market stress, dollar funding is becoming increasingly problematic, and absent a sharp tightening in the Libor-OIS and FRA-OIS spread, while bank credit concerns may not have been the catalyst for the sharp spike, it will be banks that are eventually impacted by what is increasingly emerging as an acute tightening in short-term funding markets and/or a global dollar shortage.

What happens next is critical. 

As BofA notes, it is difficult to imagine levels moving materially higher than 50bp due to the presence of central bank liquidity swap lines. The Fed currently maintains bilateral FX swap lines with the ECB, BoJ, and other major central banks. The price to access these swap lines has three parts: (1) OIS of borrowing tenor +50bp; (2) haircut on the posted collateral; and (3) associated stigma. As such OIS +50 should serve as a soft upper bound on how high funding costs can rise though it is certainly possible the 3m L-OIS spread could rise to 60bp after collateral haircuts and stigma concerns are taken into consideration.

As such, should either L-OIS, or FRA-OIS move notably wider beyond 50bps, and should CB swap lines remain unused, it may be time to throw away all those explanations you have read that say “don’t panic” the move is perfectly normal, and to consider the alternative.

Finally, the move in Libor alone will soon start attracting attention as it is the benchmark rate for several hundred trillions in floating-rate debt.

It is worth noting that the Fed itself is monitoring the rise in LIBOR and is trying to understand what exactly is driving it (in their most recent dealer survey the Fed specifically asked about the 3m L-OIS spread widening). The Fed is certainly aware that the around 35bp increase in 3m LIBOR-OIS since mid-November equates to roughly 1.4 hikes. However, according to BofA, the Fed is probably monitoring LIBOR in the context of broader financial conditions and is not yet sufficiently concerned by the recent tightening to adjust policy. Indeed, the Chicago Fed financial conditions index has tightened, but still shows conditions are much easier vs when the Fed started tightening policy in 2015.

The Fed would likely be much more concerned about the rise in LIBOR if it reflected heighted bank credit concerns rather than structural supply/demand dynamics at the front end of the rates curve… which may well be the case if as noted above, the blowout persists beyond 50bps.

They will also likely become concerned with financial conditions only if it spills over into broader corporate  borrowing/investment activity or begins to wane on consumer or business confidence. Overall, consensus believes that the rise in LIBOR is not yet sufficient to derail the Fed from their “gradual tightening cycle”, but they will likely be more attuned to financial conditions given the recent rise.

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Authored by Michael Lebowitz via RealInvestmentAdvice.com,

“Stability breeds instability.” – Hyman Minsky

The answer to the title of this article, the polite version of which is “Buy The Dip or Sell The Rally”, may well be the most important question facing stock investors this year and possibly for years to come. The bull market, now almost ten years old, has been supported by a number of technical pillars. Of these, three of the more significant ones are the “BTFD” mentality, shorting volatility (often referred to as vol), and corporate share buybacks. We are strongly of the opinion that when these technical pillars fail, the stock market will as well. It is important to note that while we wait on technical indicators for price guidance, there is a preponderance of fundamental warnings that should also be considered.

Expanding on Minsky’s theory, former Federal Reserve governor Laurence Meyer clarified the concept stating that “a period of stability induces behavioral responses that erode margins of safety, reduce liquidity, raise cash flow commitments relative to income and profits, and raise the price of risky relative to safe assets–all combining to weaken the ability of the economy to withstand even modest adverse shocks.”

Short Volatility

Over the last ten years, volatility has been transformed from a purely quantitative barometer of perceived future stability and a key input for options pricing to a full-fledged investment vehicle. It has gone from an obscure gauge of price movements, like the tachometer on the dashboard of your car, used mainly by sophisticated investors to one of the pistons in the engine helping propel markets. Since the financial crisis, investors and traders have learned that shorting volatility can provide significant and durable returns to help supplement low yields in traditional asset classes. The recent spike in volatility from all-time lows instantly put an end to this myth.

Many of those shorting vol, via a plethora of exchanged-traded funds and notes (ETF’s and ETN’s) that were designed to profit as market volatility dropped, were badly uninformed about how vol is computed or its longer-term history. The graph below charts the steady price increase in XIV, a short volatility ETN, since 2016 and the rapid evaporation of gains that occurred over just a few days.

A majority of short volatility ETF/ETN holders were of the mindset that the Fed, through its extraordinary interest rate and QE policies and its implicit statements supporting the market, would never let the markets fall again. They erroneously believed the Fed had once-and-for-all ushered in an unprecedented era of stability. There is no question that a lack of volatility, or perceived market stability, in recent years was unlike any other historical period. Given this prevailing mindset, why not short fear and go long stability?

This is exactly what many investors did. As more money chased the easy profits of short volatility strategies, investors were indirectly and unknowingly propelling the market higher in a self-reinforcing fashion. Ironically, as investors went “long stability” (short vol) they were making the markets inherently less stable. These poorly constructed securities came to a punishing end during the first week of February when the VIX index increased by over 100% on February 5th and wiped out or severely impaired those short volatility. XIV has since been delisted closing out at a final observed price of $6.04 per share.

This important technical pillar of equity strength has been permanently damaged and will likely provide much less support going forward.

Buybacks

Another major pillar of support for equity prices is corporate buybacks. The graph below shows the correlation between buybacks and the S&P 500 since 2000 (note that 2018 is an estimate).

Further support for this theory comes from Goldman Sachs who claims that corporations have been the biggest class of buyer of equities since 2010 easily surpassing ETF’s, foreign investors, mutual funds, households and pension funds.

There is currently nothing that leads us to believe that corporations will stop buying their shares back, and if anything the recent tax reform further supports this trend. While buybacks currently show no signs of slowing, the recent increase in interest rates may make buybacks more difficult to conduct as debt has been a main source of funds for buybacks as shown below. Furthermore, higher interest rates may cause the credit rating agencies to downgrade companies who have accumulated large debt loads which would add to the cost of issuing debt and make buybacks more challenging. While this pillar of the bull market is still standing tall, it is worth following.

BTFD

Since the lows of 2009, BTFD or “buy-the-dip” has gone from a catchy acronym to a most trusted investment strategy.  Those that have followed this advice and bought when the market has shown temporary weakness are batting 1,000%.

When individuals, financial institutions, corporations, and even some central banks have a “can’t lose” strategy, sustainable market support is generated. The initially tentative investor response of BTFD has become emboldened over time and eventually turned in to a muscle memory-like reaction.

We believe it will take a series of market dips followed by rallies that do not quite get back to recent highs to erode confidence in the BTFD strategy. A period of such price action, sequential lower highs and lower lows, will cause “easy” profits to turn in to losses. As doubt and anxiety rise with losses mounting, it will challenge investor beliefs and with it remove critical support underlying the bull market.

Beginning in late January, the S&P 500 fell about ten percent and subsequently recovered about 75% of it. If the equity market fails to reclaim the January highs, then this would begin to look like a textbook technical topping formation. It is not unusual for a topping process to develop at a time of extreme optimism as is currently being experienced.

If, however, the market pushes to record highs, the BTFD’ers will have again been rewarded. Investor confidence reinforced, and the timeline for a major correction would be extended into the future.

When BTFD fails, we suspect investors will slowly gravitate to an STFR (Sell the Rally) mentality. Contrary to BTFD, they will sell or establish short positions when the market rallies. That transition, however, will only occur after much pain has been felt by those whose optimism gradually gives way to the reality of having incurred a series of losses.

Summary

Despite fundamental warnings and the collapse of the short volatility trade, we must give the bull market trend and its two remaining key pillars the benefit of the doubt. We believe it is reasonable to maintain long positions but only while remaining cautious and nimble. Watch closely for signs of lower highs and lower lows as well as indications that buybacks may be slowing down.

This bull market, like all others that have preceded it, will eventually fail and years of gains will be erased. Those focused on building wealth will once again face tough choices. Do you continue to trust in the crumbling pillars of the bull market or do you exhibit prudence and protect what you have and wait for the future when prices are much lower and valuations far more reasonable?

We leave you with a few words from Lance Roberts

“The Fed has not put an “end” to bear markets.  In fact, they have likely only succeeded in ensuring the next bear market will be larger than the last.”

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London Mayor Sadiq Kahn read a list of half-dozen racist tweets about himself to a crowd at the annual SXSW festival in Austin, TX Monday.

“I say kill the mayor of London and you’ll be rid of one Muslim terrorist,” Khan quoted to the audience. “I’d pay for someone to execute Sadiq Khan.“

Kahn, the first Muslim mayor of a Western capital, implored tech companies to censor “hate speech,” – which has recently become a catchall from everything from death threats to opposing longstanding symbols of actual oppression, such as hijabs. 

The London mayor said he didn’t want to be “portrayed as a victim” or “ask for sympathy.” Instead, he wants to tech companies to police people’s feelings by going further in “making the internet free of hate speech.” 

“But ask yourself this: What happens when young boys and girls from minority backgrounds see this kind of thing on their timelines or experience this themselves?” said Khan.

Khan said that tweets like the ones addressed to him send a message to these children that if they don’t look a certain way or subscribe to the same establishment beliefs, they will grow up thinking there’s no path for them in high-profile careers.

“We simply must do more to protect people online,” Khan said.

Khan urged companies like Facebook and Twitter to show “a stronger duty of care” so that “social-media platforms can live up to their promises to connect, unify, and democratize the sharing of information and be places where everyone feels welcomed and valued.” –Business Insider

Too bad for those offended by mass censorship in the name of creating an all-encompassing safe space. European officials, meanwhile continue to turn a blind eye as migrants to rape, pillage and plunder with near impunity due to “cultural differences” (not hate). 

Germany began enforcing strict “hate speech” laws on January 1, giving companies such as Facebook, Twitter and YouTube 24 hours after a complaint to remove postings containing hate speech. Failure to remove the offending posts in time so will expose the platforms to fines of up to 50 million euros ($60 million USD).

The new law was passed last June and went into effect in October – however social media companies were given until January 1 to prepare to maintain an “effective and transparent procedure for dealing with complaints” which users can submit freely. Upon receiving a complaint, social media companies have 24 hours to block or remove “obviously illegal content” – and up to a week in “complex cases.”

The new law isn’t just for the big three (Facebook, YouTube and Twitter) either: 

Social platform giants such as Facebook, YouTube and Twitter were couched as the initial targets for the law, but Spiegal Online suggests the government is looking to apply the law more widely — including to content on networks such as Reddit, Tumblr, Flickr, Vimeo, VK and Gab. –TechCrunch

German lawmaker Beatrix von Storch’s Twitter account was blocked in January after she lashed out at New Year’s greetings sent by Cologne police in Arabic.

“What the hell is happening in this country? Why does an official police site tweet in Arabic,” wrote the Alternative for Germany (AfD) conservative party member. 

As we wrote in January, Social media giants face a gigantic task – which some might say is impossible. It is estimated that around 38.1 million Germans alone will use social media in 2018.

Now, consider that every single flagged post from millions of users must be evaluated before the post is removed or blocked. This will require Artificial Intelligence (AI) or some other sort of algo. And as algos begin to identify and remove “hate speech,” people will adapt to the filters and begin to find ways around it – changing terms, spellings, and using coded language to communicate.

What if – bear with us – parents taught their children that sometimes mean people say mean things, and one simply needs to have the internal fortitude to overcome offensive statements instead of employing mass censorship?

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While Elon Musk is more concerned with what music will be played inside the night clubs of his Martian colony, Tesla’s top executives continue to flee his all too terrestrial company, and in just the last few days the electric automaker- which continues to burn unprecedented amounts of cash – lost its two top financial executives.

According to Bloomberg Tesla’s corporate treasurer and vice president of finance, Susan Repo, quit to become the CFO of another company, just days after Chief Accounting Officer Eric Branderiz parted ways for personal reasons last week, the company disclosed.

Bloomberg’s attempts to reach Repo, who joined Tesla in 2013 according to her LinkedIn profile, were not successful, while the person who confirmed her departure wasn’t authorized to speak publicly and asked not to be named.

In addition Repo and Branderiz, Jon McNeill, Tesla’s president of global sales and service, also left the company to become the COO of Lyft in February. Musk said at the time that McNeill’s department would report directly to him and that there were no plans to search for a replacement.

The departure of Tesla’s former CFO Jason Wheeler in April of last year launched an avalanche of executive departures from car company. Since then, other prominent management departures reported by Bloomberg and others have included Lyndonand Peter Rive, Musk’s cousins who had joined him in co-founding SolarCity Corp.; Chris Lattner, an Apple Inc. hire who left after leading Tesla’s Autopilot engineering team for less than six months; Kurt Kelty, a longtime battery executive; and Diarmuid O’Connell, vice president of business development.

The following list is a summary of the publicly disclosed departures in the past several years.

The departures come at a sensitive time for Tesla, which is expected to report production and deliveries early next month that will be closely watched for whether the company hit a target to make 2,500 Model 3 sedans a week by the end of the first quarter (down from 5,000 previously). Elon Musk has delayed manufacturing goals several times for the car that Tesla has spent billions on to reach more mass market consumers.

“Elon Musk has to be careful to stabilize his company” amid reports of quality issues with the Model 3, a recent production pause for the car and the spate of management changes, said Ferdinand Dudenhoeffer, the director of the University of Duisburg-Essen’s Center for Automotive Research. “That doesn’t look very comfortable.”

And speaking of Elon Musk, it is perhaps no wonder why he is hiring “Onion” staffers – he needs more distractions… fast.

Hot on the heels of news of even more executive departures, CNBC reported that Tesla employees have warned the company is manufacturing “a high ratio of flawed parts and vehicles” that need rework and repairs. The electrical vehicle maker has had to ship some flawed parts to remanufacturing facilities to avoid scrapping them, rather than fixing them in-line, according to CNBC sources.

One current Tesla engineer estimated that 40 percent of the parts made or received at its Fremont factory require rework. The need for reviews of parts coming off the line, and rework, has contributed to Model 3 delays, the engineer said.

Another current employee from Tesla’s Fremont factory said the company’s defect rate is so high that it’s hard to hit production targets. Inability to hit the numbers is in turn hurting employee morale.

While TSLA was already sliding in today’s session, it extended its losses on the news, and was down over 3% on the day.

 

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