A Wobbling Stock Market

Authored by Charles Hugh Smith via OfTwoMinds blog,

A third period of heightened volatility shouldn’t surprise us.

Consider this chart of the SPX (S&P 500) over the past two years: take a look at the relative steepness of each of the red lines (rallies), the duration of each rally (purple lines), the blue boxes (volatile spots of bother) and the green line (market has gone nowhere for 19 months as every rally to new highs drops back to or below the high of January 2018).

As the saying goes, a market topping is not an event, it’s a process. There are a handful of historically useful characteristics of topping markets:

1. Declining volume / liquidity

2. Increasing volatility–major swings up and down that increase in amplitude and frequency

3. Inability to break decisively above previous resistance (i.e. make sustainable new highs in a stairstep that moves higher).

We see all these elements in the S&P 500 over the past few years. A healthy, stable advance in 2017 led to a manic blow-off top that crashed in February of 2018, setting off a period of high volatility.

This set up another stable advance that was shorter than the previous advance, and also steeper. This led to the multi-month period of instability that concluded in a panic crash in December 2018.

Since then, advances have been shorter and steeper, suggesting a more volatile era. Three advances to new highs have all dropped back to (or below) the highs of January 2018. In effect, the market has wobbled around for 18 months, becoming more volatile after every rally.

Notice how the duration of each advance is getting shorter even as each advance is steeper, i.e. more manic. Notice also that the amplitude of each volatile plummet from new highs increases.

What happens next? No one knows, but a third period of heightened volatility shouldn’t surprise us–nor should a further increase in the amplitude of the move during the next volatile spot of bother.

Recent podcasts: I was blessed to be invited to two terrific podcasts:

Parallels Between The Decline of the Roman Empire and America (46 minutes)
Host: Patrick Vierra of SilverBullion.com.sg

Market Huddle Episode 41 (guest: Charles Hugh Smith)
Hosts: Patrick and Kevin
(I am the first guest, then I get to do the last half-hour informal free-for-all.)

*  *  *

Pathfinding our Destiny: Preventing the Final Fall of Our Democratic Republic ($6.95 ebook, $12 print, $13.08 audiobook): Read the first section for free in PDF format. My new mystery The Adventures of the Consulting Philosopher: The Disappearance of Drake is a ridiculously affordable $1.29 (Kindle) or $8.95 (print); read the first chapters for free (PDF). My book Money and Work Unchained is now $6.95 for the Kindle ebook and $15 for the print edition. Read the first section for free in PDF format. If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com. New benefit for subscribers/patrons: a monthly Q&A where I respond to your questions/topics.

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China Unveils Its Own Libor: How China’s Interest Rate Reform Will Work

On August 17, China’s central bank unveiled detailed measures on its long-awaited interest rate reform by establishing a reference rate for new loans issued by banks to help steer corporate borrowing costs lower and support a slowing economy.

As a key part of the rate overhaul, the Loan Prime Rate will become the new Benchmark Reference Rate to be used by banks for lending which is aimed at supporting funding as well as lower borrowing costs for small businesses; the rate will be set monthly (20th of every month) and will be linked to the Medium-term Lending Facility rate. The current 1 year LPR stands at 4.31% vs. Benchmark Rate 4.35%, with the new LPR set to be published on August 20th, when the National Interbank Center will publish reference interest rates on loans at 9:30 am.

Somewhat similar to Libor, eighteen reference banks are asked to report to the National Interbank Center interest rates based on Open Market Operation rates (mainly MLF rates) with additional premiums before 9 am on the 20th of each month. The National Interbank Center will calculate the arithmetic mean of all reported interest rates after excluding the highest and lowest ones.

As Goldman notes, the new loan prime rate differs from the old one in terms of the following:

  • The new LPR is based on open market operation rates, mainly MLF rates, whereas the previous was based on benchmark lending rates.
  • In addition to a reference rate for 1-year lending, the reference rates will also include one rate of 5 years or above. Banks will have discretion in loan pricing for maturities of less than 1 year and within 1-5 years.
  • Apart from the original ten national quoting banks, eight additional city commercial banks, rural commercial banks, foreign banks and private-owned banks will also be included in the price quotation group. The PBOC explained that newly added banks are the medium and small banks who have relatively large impact on loan markets among peers and who serve SMEs better, which will enhance the representativeness of LPR.
  • The new LPR is reported monthly (vs. original daily), to minimize day-to-day rate volatility.

Perhaps more importantly, the PBOC will include the use of reference rates and competitive behavior in the Macro Prudential Assessment (MPA). Furthermore, banks will be required to use the new LPR as benchmark in new loans, while outstanding loans follow the original contracts. And in another similarity to Libor, Chinese banks are prohibited from coordinating to set implicit floors for loan rates, which means that this is precisely what will happen.

* * *

Some further observations: although the new system is supposed to be more market-based, there will still likely be guidance from the central bank. Under the previous system, banks were supposed to be mostly free to set deposit and lending rates, but there were still effective guidance rates from the central bank.

Furthermore, while it is geared toward boosting lending and ushering in lower rates, the new system itself doesn’t guarantee the actual lending rate will be lower. This depends on whether the OMO rates become lower, liquidity conditions and government window guidance. But given the current situation with weak activity growth, heightened trade war risks and a strong desire by the senior leadership to lower rates, Goldman does expect actual lending rates to go down.

These measures form the bulk of planned interest rate reform, though the details are most likely to fine-tuned further in the future. The main apparent leftover task is what to do with existing long-term loans, especially mortgage loans. At the moment these are based on benchmark rate, so implicitly rates will remain unchanged until that rate changes or they are shifted to LPR basis.

Appendix

The following courtesy of Reuters explains how China’s new Loan Prime Rate (LPR), a central part of the reforms, will work.

WHAT IS THE LPR?

The LPR, originally introduced by the People’s Bank of China (PBOC) in October 2013, is an interest rate that commercial banks charge their best clients and was intended to better reflect market demand for funds than the benchmark the PBOC sets. However, the LPR’s moves since its launch have generally not reflected those market dynamics with lenders typically reluctant to cut into their profit margins with lower rates and was little-watched by the markets. The one-year rate, for example, is currently just below the benchmark one-year lending rate of 4.35%.

Under the reforms announced on Saturday, the new LPR will be linked to rates set during open market operations, namely the PBOC’s medium-term lending facility (MLF), which is determined by broader financial system demand for central bank liquidity. Setting the LPR slightly higher than MLF rate will in theory give borrowers access to funds at rates that better reflect funding conditions in the banking system, providing a smoother policy transmission mechanism

HOW DOES THE NEW LPR WORK?

The new LPR will be announced at 9:30 a.m. on the 20th of every month, starting this month. The rate has up until now been set using quotations from 10 contributing banks. These banks will be joined by another eight, which include two foreign institutions. Banks will submit their LPR quotations, based on what they have bid for PBOC liquidity in open market operations, to the national interbank funding center before 9am on the day. If the reporting day falls on a weekend or a holiday, the rate will be published on the following working day.

In addition to the existing one-year LPR, the central bank will also use contributing bank quotations to publish similar reference rates for benchmarks of five-years and beyond. Banks will retain discretion as to how they price rates for loans maturities of less than 1-year and within 1-5 years. The LPR will be a reference rate only for new loans issued by banks. Existing loans will still be based on the PBOC-set benchmark rate.

WHY IS PBOC READY REFORMING ITS BENCHMARK NOW?

China has a long history of using two interest rate tracks to drive its lending sector – a market-based rate and a benchmark bank rate. Although China has in recent years given commercial banks more leeway in setting lending rates, the benchmark lending rate remains a key reference for them to price loans, hampering the central bank’s bid to lower corporate funding costs. The PBOC has pledged to “merge” the two tracks and reiterated this commitment several times this year.  Beijing has vowed to lower average funding costs for small companies by 1 percentage point this year to spur growth in the economy, amid weak demand domestically and a year-long trade war with the United States.

WHAT ARE THE LIMITATIONS?

The latest move is widely interpreted by the market as an official attempt to revive growth and effectively cut financing costs in the real economy. But some analysts argue that the move could shift commercial banks to become more risk averse in their lending due to growing financial and economic risks.

“We expect the PBOC to have more incentive to lower MLF rates and other quasi-policy rates, but we believe the PBOC’s capability to reduce banks’ lending rates is quite limited due to restraints on credit growth as well as banks’ vulnerability,” said Lu Ting, chief China economist at Nomura in Hong Kong.

“In our view, the PBOC will likely have to walk a tightrope between lowering borrowing costs and maintaining financial stability,” Lu added.

Luo Yunfeng, an analyst at Merchants Securities in Beijing said the impact on corporate borrowing costs will be felt over the long-term and could be far more modest than benchmark rate cuts, which affect both new loans and the outstanding loans.

WHAT’S NEXT?

Investors now await Tuesday’s LPR publication with many market participants expecting the new rate to be cut by 10 to 15 basis points from the current level. Ming Ming, head of fixed income research at CITIC Securities in Beijing, expects the first new rate to be set lower to narrow the yield gap between LPR and interest rate on the MLF, which is now 3.3% for one-year loans. That gap is currently 101 bps.

“If the U.S. Federal Reserve continues to cut its interest rates, chances for lowering MLF to drag down borrowing costs will be relatively high,” he said.

Tommy Xie, head of Greater China research at OCBC Bank in Singapore said the move is a “half step” towards interest rate liberalization, and the link to the medium-term lending rate may only be temporary. “In the longer run, China may also need to loosen the setting of deposit rate,” Xie said.

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Stocks Climb As Ross Confirms Another 90-Day Delay On Huawei Blacklist

Late on Friday, the Trump Administration made another unexpected concession to Beijing when the Commerce Department announced it would extend a reprieve given to Huawei permitting the Chinese firm to buy supplies from US companies so that it can continue to service existing customers. Now, on Monday, in an interview with Fox Business, Commerce Secretary Wilbur Ross affirmed that Huawei will receive another 90 day reprieve to conduct business with some US businesses.

Stock futures, which had seemingly already shrugged off the carnage of last week, were already pointing toward a higher open, but moved even higher on the news.

All of this is happening after Trump announced last week that he would delay imposing the 10% on some $300BN in mostly consumer goods in what appeared to be a panicked response to the market’s vicious selloff, as well as fears that more tariffs could hurt holiday sales at a fragile time for the economy. Instead of going into effect on Sept. 1, those tariffs won’t start now until mid-December. Ross also said the Commerce Dept has added another 40 Huawei subsidiaries to its entities list.

US is giving Huawei another 90 days to conduct some business in the U.S., Commerce Sec. Wilbur Ross tells Fox Business.

Of course, as one Twitter user pointed out, Ross has continued to parrot the Trump Admin line about US consumers not paying tariffs – particularly when the Administration just moved to delay the next round of tariffs so as to avoid a “stagflation”-type scenario.

Ross also parroted Trump’s line that there will likely be a recession ‘eventually’, but that the 2s10s inversion – the latest in a string of US yield curve inversions – is hardly reason to panic.

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Futures Soar, Treasuries Slide On German Stimulus Hopes, Chinese Rate Reform

It is a sea of green out there to start the week, and we have Germany’s generous taxpayers and Chinese rate reform to thank for today’s ramp.

With central banks now almost out of ammo, every algo is attuned to even the faintest hint of fiscal stimulus, and nowhere more so than “stingy” Europe, which is why the trial balloon two weeks ago and again last week out of Spiegel, that Germany would unleash billions in stimulus spending in case of a recession will be repeated again and again, and overnight it was Bloomber’s turn to report that Germany was readying a stimulus plan as a contingency plan for a “deep recession”, helping send futures and global stocks sharply higher.

It was all about Germany over the weekend too, with the Bloomberg news following an overnight report that Germany’s finmin and SDP leadership contender, Olaf Scholz, said in Berlin that “the last crisis cost €50bn … we can muster that [again].” However, as Mizuho wrote overnight, “we are sceptical of a sustained market impact, as it is conditional on a crisis” with the Japanese bank adding that “the point which is being missed is that said German fiscal stimulus is conditional on a recession, and existing law already allows for this. The ECB would probably restart QE before the German fiscal taps were at risk of being nudged open. We suspect the market is simply trading the headlines in a kneejerk manner and the summer liquidity is allowing for the moves to go unfaded

Mizuho is right, and while the German news is largely meaningless – especially when one considers that of the €50BN stimulus, about half or more would have to be spent to shore up Deutsche Bank (as it would only be unlocked in a “deep recession”), for now it has provided enough fuel to send global markets and US equity futures sharply higher, and to steepened the curve, sending 30Y yield back over 2.00%, especially after news from late Friday that the US treasury reached out to dealers again seeking feedback for 50Y or 100Y issuance, even though as we noted on Friday, longer issuance has been repeatedly shunned in the past, most recently 2017, citing a lack of stable demand. In 2017 this caused a 7bp round trip (up then down) in three days for 5s30s.

News of the recession-contingent German stimulus sent the EUR to session highs of 1.1114, if not for long…

… while the German 30Y yield has soared higher in the past 2 days, rising from -0.30% to as high as -0.10%.

In the US, S&P futures advanced alongside the Stoxx Europe 600, which extended its gains to a session high following the Bloomberg Germany stimulus report and amid speculation that economies would prop up stalling growth with fresh stimulus measures, easing pressure on bonds and dampening demand for perceived safe-havens such as gold.

Hopes of government action to stave off fears of recession – triggered by an inversion in the U.S. bond yield curve – grew as China’s central bank unveiled interest rate reforms expected to lower corporate borrowing costs. The prospect of Germany’s coalition government ditching its balanced budget rule to take on new debt and launch stimulus steps also helped the mood, after boosting Wall Street shares on Friday.

Over the weekend, the PBoC announced a new interest rate reform plan which will make the Loan Prime Rate the new Benchmark Reference Rate to be used by banks for lending which is aimed at supporting funding as well as lower borrowing costs for small businesses, while it is to be set monthly (20th of every month) and will be linked to the Medium-term Lending Facility rate. (Newswires) Note: current 1yr LPR stands at 4.31% vs. Benchmark Rate 4.35%. China is to publish the new LPR from August 20th.

The MSCI world equity index gained 0.3%, powered by a 0.8% gain for the Euro STOXX 600. Bourses in London, Frankfurt and Paris rose between 0.7%-0.9%. The optimism was set to spread to Wall Street, too, where futures gauges were pointing to gains of around 1%.

Earlier in the day, the People’s Bank of China’s interest rate reforms – which it is said would help steer borrowing costs lower for companies and support a slowing economy – helped stocks in Shanghai rise 2.1%. MSCI’s index of Asia-Pacific shares outside Japan gained 1.1% with shares in Hong Kong and China climing the most in Asia, where jumps across the region were helped by news of Beijing’s plan to reform its interest-rate system and cut borrowing costs. Treasury 10-year yields continued to rise from multiyear lows reached last week, while the Bloomberg dollar index ticked even higher and the pound reversed an early increase. Gold fell, hovering back around the $1,500 level.

Yet even as signs that major economies would act to support growth emboldened investors, some market players cautioned that the boost to markets from expectations of stimulus was fragile.

“You have just got a little bit of portfolio readjustment, a resetting of expectations. The big question is whether it can last,” said Michael Hewson, chief market strategist at CMC Markets. “Talking about fiscal stimulus in Germany is one thing, doing it is something else.”

As investors tiptoed back to riskier assets, gold fell 1% to $1,499.30 per ounce, with U.S. futures for the precious metal also down.

In FX, the dollar index was higher in Asia at 98.201, close to a two-week high reached on Friday, while the Bloomberg dollar index was at session highs above 1210.

The euphoria will probably not last long: with volatility jumping in August, traders’ focus will turn to Fed Chair Powell’s address planned at the Kansas Fed’s annual Jackson Hole gathering on Friday, which will be key to gauging whether U.S. policy makers will add to July’s interest-rate cut. Analysts think Powell’s remarks will be aimed at reassuring nervous markets that the Fed will keep its easing stance and set the stage for more rate cuts.

“What Powell has to say is in focus as the discrepancy remains between what he said on interest rates and what the markets have come to expect the Fed will do,” said Junichi Ishikawa, senior FX strategist at IG Securities in Tokyo.

“This week is an opportunity for, in particular, Chair Powell to straighten up the message and show that they are at one and that there is a clear view about where the economy is going,” Anne Anderson, head of fixed income in Sydney for UBS Asset Management Australia, told Bloomberg TV. “This fear needs to be arrested.”

Over the weekend, While White House economic director Larry Kudlow said recent phone calls between U.S. and Chinese trade negotiators had been “positive,” even though later in the day President Trump suggested he wasn’t ready to sign a deal and linked the discussions to Hong Kong, saying for the first time on camera that it would be harder to reach a deal if there’s a violent conclusion to the protests.

In geopolitical news, US issued a warrant to seize the Iranian oil tanker Grace 1 which was just released by Gibraltar. Subsequently, Iran has warned the US against seizing its oil tanker in open seas, said the Iranian Foreign Ministry

In commodity markets, crude oil prices rose after an attack on a Saudi oil facility by Yemeni separatists on Saturday, with traders also looking for signs that Sino-U.S. trade tensions could ease. Brent crude was up 65 cents, or about 1.1%, at $59.29 a barrel at 0805 GMT.

No major economic data are expected. Estee Lauder and Baidu are among companies reporting earnings.

Market Snapshot

  • S&P 500 futures up 0.7% to 2,923.50
  • STOXX Europe 600 up 0.7% to 372.13
  • German 10Y yield rose 4.3 bps to -0.642%
  • Euro up 0.1% to $1.1104
  • Italian 10Y yield rose 6.1 bps to 1.046%
  • Spanish 10Y yield rose 4.8 bps to 0.129%
  • Brent futures up 1% to $59.21/bbl
  • Gold spot down 0.8% to $1,501.21
  • U.S. Dollar Index little changed at 98.20
  • MXAP up 0.8% to 151.93
  • MXAPJ up 1.1% to 493.02
  • Nikkei up 0.7% to 20,563.16
  • Topix up 0.6% to 1,494.33
  • Hang Seng Index up 2.2% to 26,291.84
  • Shanghai Composite up 2.1% to 2,883.10
  • Sensex up 0.7% to 37,595.10
  • Australia S&P/ASX 200 up 1% to 6,467.44
  • Kospi up 0.7% to 1,939.90

Top Overnight News

  • Finance Minister Olaf Scholz suggested Germany could muster 50 billion euros ($55 billion) of extra spending in an economic crisis, putting a number on a possible fiscal stimulus for the first time
  • President Trump said the U.S. is “doing very well with China, and talking!” but suggested he wasn’t ready to sign a trade deal, hours after his top economic adviser laid out a potential timeline for the resumption of substantive discussions with Beijing
  • U.K. opposition leader Jeremy Corbyn will promise to do “everything necessary” to prevent a no-deal Brexit. Prime Minister Boris Johnson will travel to Germany and France this week to make clear that Britain is leaving the European Union on Oct. 31 with or without a deal
  • China’s central bank said it’ll start releasing a new reference rate for bank loans, a further step in a long-awaited reform to interest rates that’s set to bring lower borrowing costs to the economy
  • Italy’s anti- establishment Five Star Movement said Sunday that its coalition partner the League — and its leadership — is “no longer a credible interlocutor,” setting the stage for a full-blown split that could realign the nation’s politics
  • Hong Kong protesters turned out in force through heavy rain to march for an 11th straight weekend, as more moderate leaders sought to reset the movement after violent scenes at the airport last week threatened to sap support among the public
  • The Iranian supertanker detained last month on suspicion of hauling oil to Syria in violation of European sanctions set sail from Gibraltar waters after being released by the British territory
  • Deputy Premier Matteo Salvini’s push for power in Italy looks to be running into trouble, with the strongest indication yet that his rivals may be able to forge an alliance to thwart him
  • Trump’s trade policy could be one of the many topics Fed Chairman Powell could talk about in the annual Jackson Hole symposium Friday. Powell is likely to use the gathering to suggest the Fed is ready to cut interest rates
  • Iran warned the U.S. against targeting a supertanker carrying the Middle East country’s oil as the vessel departed Gibraltar after being seized last month by U.K. forces and held in the British territory
  • The 1.1 trillion euro ($1.2 trillion) global pool of negative-yielding corporate debt is failing to entice European companies to borrow at ultra-cheap levels. It shows the uphill battle the ECB faces to revive the region’s economy

Asian equity markets were higher across the board as the region took impetus from last Friday’s firm gains on Wall Street and as composure returns to the market following the recent turmoil. ASX 200 (+1.0%) and Nikkei 225 (+0.7%) were positive in which the tech and energy sectors led the advances and with firm gains seen in the likes of Beach Energy and Lend Lease post-earnings despite a decline in the latter’s profits, as it stressed the strong position of its core business and confirmed several parties are conducting due diligence on its engineering unit. Tokyo sentiment also found relief from the latest Japanese trade figures which showed Exports and Imports continued to contract, albeit at a slower pace than what the market feared. Hang Seng (+2.0%) and Shanghai Comp. (+2.1%) conformed to the positive tone after the PBoC continued its liquidity efforts and announced interest rate reforms in which it will make the new Loan Prime Rate the benchmark rate for bank loans which is aimed at lowering borrowing costs. Furthermore, Hong Kong outperformed despite the continuation of mass protests over the weekend which were of a peaceful nature, while participants await the US decision on Huawei as reports suggested the Trump administration will grant an additional 90-day extension to the licence which allows the Chinese tech firm to conduct some business with US customers. Finally, 10yr JGBs were slightly lower amid the heightened risk appetite but with downside also stemmed by the BoJ’s presence in the market for a total JPY 760bln in 1yr-5yr JGBs.

Top Asian news

  • China Lines Up Lower Borrowing Costs with Revamped Rate System
  • Rebound in China, Hong Kong Stocks Accelerates on Policy Support
  • Huawei’s Three Closest Chinese Rivals Form Rare Partnership
  • Thailand Says Producers Leaving China Offer Hope for its Economy

European equities are higher across the board [Eurostoxx 50 +0.9%] following on from a stellar Asia-Pac handover in which Hang Seng and Shanghai Comp. closed higher by 2%. Sectors are all in the green with underperformance seen in some defensive sectors amid the overall risk appetite. Meanwhile, material and energy names outperform amid price action in the base metal and oil complexes; while the European Banking Index has experienced a turnaround from last weeks poor performance as reports around the size of potential fiscal stimulus for Germany (USD 55bln according to Finance Minister Scholz) have provided the first figures to the possible package. As such, the likes of Deutsche Bank (+2.5%) and Commerzbank (+2.4%) are notably firmer this morning. Looking at individual movers, Bpost (-1.5%) shares fell towards the bottom of the Stoxx 600 as its CEO is to reportedly step down in 2020. At the other end of the index, CNH Industrial (+3.2%) rose amid a broker upgrade at Morgan Stanley. Finally, BASF (+1.5%) is among the top DAX performers as its CEO reaffirmed the Co’s intent to steadily increase dividend.  

Top European News

  • Welder Shortage Threatens Boris Johnson’s U.K. Nuclear Revival
  • Salvini’s Rivals Are Threatening to Derail Italian Power Grab
  • SNB Sight Deposits Surge, Suggesting Interventions to Curb Franc
  • Thomas Cook Shares Jump as Bailout Partner Swings to Profit

In FX, the Dollar remains firm vs most G10 counterparts and EM currencies, but the index has lost some momentum after reaching 98.341 on Friday and has eased back towards 98.000 within a 98.242-134 range. In truth, trade has been rather muted overall at the start of a week that is relatively light on data/events until Wednesday when FOMC minutes are due and are followed by preliminary PMIs, ECB minutes and the Jackson Hole Symposium.

  • JPY/GBP/NZD/SEK – The major ‘underperformers’ as the Yen extends is retreat from recent lows to 106.65 and close to Fib resistance ahead of DMAs either side of 107.00 amidst a further rebound in US Treasury yields and Japanese trade data showing shallower than forecast declines in both imports and exports. Meanwhile, UK political/no deal Brexit jitters have scuppered Sterling’s revival on the back of last week’s better than expected run of data, with Cable slipping back towards 1.2100 and Eur/Gbp back up over 0.9150 vs sub-0.9100 at one stage. Note, comments from BoE Governor playing down NIRP and any change in the 2% inflation target have not really impacted, though Gilts and 3 month futures are weaker and the curve is steeper. Elsewhere, the Kiwi is lagging down under after recent downbeat NZ macro releases, like the sub-50 manufacturing PMI, with Nzd/Usd hovering just above 0.6400 and AUD/Nzd firm within a 1.0550-70 range as Aud/Usd holds up better between 0.6800-70 parameters. Back to the cross, MS advocates a long position around current levels for 1.1100 and with a 1.0280 stop based on diverging RBNZ/RBA policy outlooks in wake of the latest Aussie jobs report that revealed a bigger rise in headline payrolls and mostly due to full-time hiring. Similarly, the Sek is struggling to keep pace with its Scandi peer on relative Riksbank vs Norges Bank rate guidance and with the Nok also propped up by firm oil prices. Indeed, Eur/Sek is hovering around 10.7400 whereas Eur/Nok has pulled back from circa 10.0000.
  • EUR/CAD – The single currency is also benefiting from a retracement in Eurozone debt yields amidst more German Government reports about fiscal spending to offset recession, and as the Bundesbank warns that the economy may have shrunk further through the summer. Hence, Eur/Usd is resilient either side of 1.1100 even though final Eurozone CPI was revised a bit lower and ECB’s Muller expresses concern about inflation being too soft, with a decision about more stimulus likely to come next month. As noted above, crude has firmed up again and the Loonie is also drawing some support as Usd/Cad sits closer to the base of a tight 1.3277-57 band.
  • EM – Broad losses vs the Greenback, but the Argentine Peso may be in for additional investor angst given a double dose of credit rating punishment from S&P and Fitch late on Friday. Note, Usd/Ars closed at 54.8340.

In commodities,the energy complex is currently benefitting from the overall risk appetite in the market which sees WTI futures above the 55/bbl mark whilst Brent futures remain north of 59/bbl. Prices may also be deriving some support from reports of a drone attack at Saudi’s 1mln BPD Shaybah oilfield, albeit the fire was extinguished at a gas processing plant and there has been no reported impact on production. Looking at the complex from a technical perspective, WTI sees a golden cross forming with its 200 and 50 DMAs both around 56.15. Elsewhere, gold prices are subdued amid the overall risk appetite with the yellow metal back at the 1500/oz level, session low of USD 1497/oz thus far. Meanwhile, the risk tone has provided supported to copper prices as the red metal reclaims 2.60/lb to the upside.

US Event Calendar

  • Nothing major scheduled

DB’s Craig Nicol concludes the overnight wrap

So, August is clearly proving to be anything but the quiet, sleepy, non-eventful month that most were hoping for. If you were lucky enough to be on holiday last week then all you missed were four daily moves of at least 1% for US equities, the 10y treasury briefly dipping below 1.50% and the 2s10s curve at one stage inverting intraday which started a chorus of recession debates. That was compounded by soft China data and a negative Q2 GDP print for Germany, and one which our economists believe will be followed by another negative reading in Q3 and thus sending the economy into recession (see their update here ).

That’s one way to set the scene for the Fed then and specifically to see if Powell can right the ship with the Fed’s annual Jackson Hole symposium due for the end of the week. The event officially kicks off on Thursday however we won’t hear from Fed Chair Powell until the Friday at 10am EST/3pm BST. The theme for this year’s conference is the sufficiently vague “Challenges for Monetary Policy” however expect the market to be leaning on every word Powell says especially given that there’s been relatively muted Fedspeak in the wake of the July FOMC meeting. Obviously since then we’ve had a ratcheting up in the trade war, slowing global growth and the massive focus on the inversion of the yield curve last week. We’re still pricing in around two and a half more rate cuts this year so the bar for Powell to be dovish is clearly fairly high. All that to look forward to.

We’ll also get the FOMC meeting minutes from the July meeting on Wednesday evening however that could look a little stale now in light of developments since then. That said our economists noted they may provide an important benchmark for Fed officials’ outlooks prior to the escalation of trade tension. For example, if the minutes indicate officials’ existing economic views were largely predicated on a flare-up in trade tensions, as St. Louis Fed President Bullard (dove/voter) mentioned last week, this would be relatively hawkish as it would imply officials think they do not need to do much more easing than they have already foreshadowed. However, if trade tensions returning to a boil a day after the July meeting was actually a surprise, which would be implied by Powell saying they had “returned to a simmer” in his prepared remarks to open the press conference, this would be consistent with our economists’ call that more monetary policy easing than was built into the June dot plot is to be expected.

As for other things to watch, the data calendar is sparse with the exception of the global flash PMIs for August on Thursday. A reminder that the data for Europe in July confirmed a reversal of the improvement seen in June with the composite reading for the Euro Area dropping back to 51.5. The consensus expects a further modest deterioration to 51.2 with the manufacturing reading expected to fall further into contractionary territory at 46.2.

All that to look forward to then. In the meantime the main news flow from the weekend has focused on what appear to be mostly positive comments on trade and the US economy from the US administration. President Trump tweeted yesterday that “we are doing very well with China, and talking”. Prior to that White House National Economic Council Director Kudlow told Fox News that talks with China had been “positive” and that if deputies meetings pan out then the plan is still to have China come to the White House and continue negotiations, without expanding on any time frame. Kudlow also downplayed recession fears while adding to upbeat commentary was Trump’s trade adviser, Navarro, who told ABC that he expected “a strong economy through 2020 and beyond”.

Those comments combined with the strong close on Wall Street on Friday have seen markets in Asia kick off the week on the front foot. The Nikkei (+0.67%), Hang Seng (+1.87%), Shanghai Comp (1.47%) and Kospi (+0.67%) are all up. Elsewhere, futures on the S&P 500 are up +0.50% this morning while the yield on the 10y treasury is up +2.8bps. WTI crude oil prices are up +0.89% after a drone attack on a Saudi Arabian oil field kept geopolitical risks into focus. Meanwhile, the CNY is little changed overnight. It’s worth noting that the PBoC has announced that it will start releasing a new reference rate for bank loans as a further step in a long-awaited reform to interest rates.

Elsewhere, the euro is flat this morning following comments yesterday from Germany’s Finance Minister Olaf Scholz about Germany potentially increasing spending to an equivalent of that during the financial crisis which “cost us 50 billion euros”. Scholz said “we have to be able to muster that and we can muster that,” but, “the biggest problem is uncertainty, including that caused by the Chinese-U.S. trade war.”

Quickly recapping Friday’s action now, where equity markets pared their losses and bonds surrendered a bit of their rally from earlier in the week. The S&P 500 still ended the week -1.02% lower (+1.44% Friday), while the DOW and NASDAQ had similar moves of -1.53% and -0.79% (+1.20% and +1.67% Friday). Semiconductors outperformed, gaining +1.02% (+2.78% Friday), while bank stocks dropped -3.07% as interest rates collapsed (+2.61% Friday). Treasury yields rallied for the third consecutive week, with 10-year yields down -19.1bps (+2.7bps Friday), taking the 2y10y yield curve to 7.9bps after briefly dipping below zero earlier in the week. That small selloff on Friday was driven by new reports that Germany could consider running a fiscal deficit to address a downturn, in contrast to the current policy for a “black zero” of fiscal surpluses. Our economists are sceptical that the story means anything beyond normal automatic stabilizers, but bunds still instinctively sold off +2.7bps, paring their weekly decline to -10.9bps. Peripheral bonds outperformed, with BTPs rallying -41.1bps (+5.9bps Friday).

In other markets, the STOXX 600 somewhat mirrored moves in the S&P 500, retreating -0.52% (+1.24% Friday), though bank stocks performed better in Europe, down only -0.78% (+3.09% Friday). The euro weakened -0.98% (-0.15% Friday) as the dollar broadly rallied +0.72% (0.00% Friday). EMs currencies weakened -0.79% (+0.29% Friday), with the clear weak spot coming from Argentina, which saw the peso weaken -17.49% (+4.28% Friday) after the poor election result for incumbent President Macri. Commodities were fairly tame, with Brent crude advancing +0.29% (+0.81%), while gold rose +1.10% (-0.65% Friday) to touch its highest levels in six years. Credit markets were weaker, as HY spreads widened +21bps and +13bps in the US and Europe (-2.5bps and +3.0bps Friday), respectively.

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Germany Prepares Stimulus In Case Of “Deep Recession”

Nearly two weeks after Der Spiegel sent its first trial balloon about the prospects that the German government might crank up its fiscal stimulus if Europe’s largest economy slides into recession (which, as we explained last week, is already on the cusp of doing), the trial balloons have crossed the Atlantic. 

Bloomberg reported on Monday that the German government is preparing to embrace new fiscal stimulus measures should its economy stumble into a deep recession, “citing two people with direct knowledge of the matter.”

Last time around, when the German economy succumbed to the global financial panic during the great financial crisis, the German government similarly doled out bonuses to prod Germans to buy new cars. Now, the government is studying incentives to improve energy efficiency of homes, promote short-term hiring and boost income through social welfare.

Berlin could inject 50 billion euros ($55 billion) of extra spending, Finance Minister Olaf Scholz said on Sunday, adding that Germany has the fiscal strength to counter any future economic crisis “with full force.”

Strategists at Mizuho have pointed out that these reports are probably over-hyped, and that the ECB would likely re-launch QE before Germany turns on the fiscal taps.

The point which is being missed is that said German fiscal stimulus is conditional on a recession, and existing law already allows for this. The ECB would probably restart QE before the German fiscal taps were at risk of being nudged open. We suspect the market is simply trading the headlines in a kneejerk manner and the summer liquidity is allowing for the moves to go unfaded. As the Bund swap spread is now tighter than it was in the QE regime, this seems to be once again inconsistent with market expectations of an ECB monetary easing “package.”

One strategist for CMC markets questioned whether this jawboning will continue to have an impact.

“You have just got a little bit of portfolio readjustment, a resetting of expectations. The big question is whether it can last,” said Michael Hewson, chief market strategist at CMC Markets. “Talking about fiscal stimulus in Germany is one thing, doing it is something else.”

As a reminder, under the German constitution, net federal debt can increase by only 0.35% of output if there is GDP growth, but since the rules can be relaxed during recession.

But the news sent the 30-year bund yield higher, at a time when the entire German yield curve remains below zero (i.e. the market is effectively begging the government to borrow more).

 

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Canceling Student Debt Would Hurt US Economy: Survey

Bernie Sanders and Elizabeth Warren have been leading the pack of some two dozen Democratic primary contenders on a range of progressive issues. But here’s one survey they probably don’t want to see.

According to a survey from the National Association of Business Economists, canceling Americans’ student debt, one of the most pressing domestic issues for 2020, would actually have an adverse impact on the US economy – instead of unleashing the millennial generation’s consumption power, allowing them to settle down, buy homes and start procreating again (remember, the US birth-rate fell to its lowest level in more than a decade this year).

On the contrary, 64% of respondents (most of whom are business economists) believe forgiving most or all of student debt in the country – as both Sanders’ and Warren’s plans would do – would be a net negative for the economy.

Americans owe about $1.6 trillion in student loans. That pile of debt is so huge, thousands of Americans will die before paying off their student loans. Progressives have argued that millions of students were pushed by their parents and, well, society in general, into taking out high interest loans to finance degrees at fancy private colleges that gave them little additional earning power while saddling them with six-figure loan balances.

Then again, it’s hard to defend the decision to get an undergraduate degree in women’s studies followed by a master’s degree in gender theory. Anybody in this situation who is complaining about loans (assuming their family isn’t secretly paying off their loans) is being disingenuous.

The progressive argument for cancelling debt, once again, is that it would help Americans reduce wealth inequality. The counter-argument is that, if students know they won’t need to pay back the debt for their education, they might make more expensive, and more reckless decisions. 

The survey included responses from 226 National Association for Business Economics members and took place July 14 to Aug. 1.

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Man Accused Of Placing Fake Subway Rice Cooker Bombs Held On $200,000 Bail

The West Virginia man who allegedly intentionally created a bomb scare on the NYC subway – one of the busiest, and poorest functioning mass transit hubs in the country – will be held on $200,000 bond following his arrest and Sunday arraignment, the NY Post reports.

Larry Griffin II, 26, is suspected of placing a pair of rice cookers in the Fulton Street subway station Friday. The incident occurred  at a time of heightened tensions, following a weekend of mass shootings,  and a motorcycle backfire in Times Square that nearly set off a panic.

Griffin was charged with two felonies: making a false bomb and placing of a false bomb for the incident, which led NYPD to temporarily shut down the busy Fulton Street subway station Friday, one of the hubs of transportation in lower Manhattan. He was also charged as a fugitive: Though the Manhattan DA didn’t answer questions about  this.

Police later realized they weren’t bombs.

The NYPD said it had no details about that case, and the FBI did not immediately respond to inquiries.

Griffin has an ongoing criminal case in West Virginia for allegedly sending a bestiality video to a minor. His lawyer didn’t comment about that to the New York press.

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The Rent Is Too Damn High—and It’s Going To Stay That Way

The phrase made famous in 2009 by longshot New York City mayoral candidate Jimmy McMillan is now a reality for millions of tenants across the United States.

According to the U.S. Bureau of Labor Statistics, inflation has pushed overall consumer prices up by 154 percent since 1984. During the same period, urban rents increased by 227 percent. The website Apartment List finds that the percentage of renters nationwide who are cost-burdened—meaning more than 30 percent of their income goes to rent—rose from 24 percent in 1960 to 49 percent in 2014.

These numbers reflect a regional problem, says Emily Hamilton, a researcher with George Mason University’s Mercatus Center. “It’s not really a nationwide phenomenon,” she explains. Rather, “it’s driven by land use regulations in the most expensive markets that make it nearly impossible to add enough to the housing supply to accommodate the number of people who would like to live there.”

According to data from Zillow, a real estate website, monthly rent for a median-priced one-bedroom apartment in San Francisco is $3,500, up from $2,060 in 2011. Seattle’s median monthly rent for a one-bedroom apartment nearly doubled in the same period to $2,035. In Los Angeles, the price rose from $1,275 in late 2010 to $2,350 today.

What explains the steady climb in rental prices and all the affordability challenges that come with them? Rising demand and stagnating supply.

Experts say cities should add one unit of new housing for every two new jobs that come to town. America’s boom cities are nowhere close to that. The San Francisco metro area has added 6.8 jobs for every new housing permit issued between 2010 and 2015. In Los Angeles, the ratio was 4.7 jobs for every housing permit. In New York, it was three jobs for every new housing permit issued.

Cities can’t keep up with the inflow of new residents because they’ve made it as difficult as possible to add additional units, accomplishing this with restrictive zoning codes that limit how much new housing can be built and lengthy approval processes that ensure whatever new residential developments are permitted then take years to complete.

In addition, many states have established urban growth boundaries that prevent housing being built on rural or agricultural land at the fringes of urban areas. The idea behind these policies is to protect natural environments. The effect has been to stop the development of affordable suburban housing that would take the pressure off city centers and give workers more choices.

San Francisco, to take the most egregious example, puts strict limits on density, ensuring much of the city’s land is reserved for single-family housing. According to a report from the city Planning Department, single-family homes make up 27 percent of the city’s units while occupying 62 percent of its residential territory.

Should you find a slice of land in San Francisco appropriately zoned for apartments, chances are you’ll spend years (and potentially millions of dollars) getting permission to build on it. An apartment building larger than 10 units takes, on average, more than six years to construct. Nearly four of those years are spent getting all the necessary permits and then fighting to protect them from local NIMBYs claiming your new building will cast too many shadows.

Sometimes, even local governments’ housing schemes are tripped up by their rules. In Los Angeles, Metro—the area’s transit agency—has spent over a decade trying to develop land it owns into supportive housing for the formerly homeless. Neighboring businesses have managed to delay the effort with administrative appeals and lawsuits alleging insufficient environmental review.

For each project that’s delayed, an unknown number of developers are deterred altogether. As a result, there’s just not enough housing to go around.

That’s bad for more than just rental prices. Wealthier residents, unable to move into condos that were never built, outbid longtime residents for formerly affordable apartments, hastening gentrification. Those down the income ladder find themselves competing for an inadequate supply of public housing or moving farther and farther away from work and family.

Cities in 21st century America offer a cornucopia of cultural, social, and economic opportunities that Americans living just a century ago likely could not have imagined. But the more governments try to regulate what these cities should look like, the more exclusive and less dynamic they’ll become.

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The Rent Is Too Damn High—and It’s Going To Stay That Way

The phrase made famous in 2009 by longshot New York City mayoral candidate Jimmy McMillan is now a reality for millions of tenants across the United States.

According to the U.S. Bureau of Labor Statistics, inflation has pushed overall consumer prices up by 154 percent since 1984. During the same period, urban rents increased by 227 percent. The website Apartment List finds that the percentage of renters nationwide who are cost-burdened—meaning more than 30 percent of their income goes to rent—rose from 24 percent in 1960 to 49 percent in 2014.

These numbers reflect a regional problem, says Emily Hamilton, a researcher with George Mason University’s Mercatus Center. “It’s not really a nationwide phenomenon,” she explains. Rather, “it’s driven by land use regulations in the most expensive markets that make it nearly impossible to add enough to the housing supply to accommodate the number of people who would like to live there.”

According to data from Zillow, a real estate website, monthly rent for a median-priced one-bedroom apartment in San Francisco is $3,500, up from $2,060 in 2011. Seattle’s median monthly rent for a one-bedroom apartment nearly doubled in the same period to $2,035. In Los Angeles, the price rose from $1,275 in late 2010 to $2,350 today.

What explains the steady climb in rental prices and all the affordability challenges that come with them? Rising demand and stagnating supply.

Experts say cities should add one unit of new housing for every two new jobs that come to town. America’s boom cities are nowhere close to that. The San Francisco metro area has added 6.8 jobs for every new housing permit issued between 2010 and 2015. In Los Angeles, the ratio was 4.7 jobs for every housing permit. In New York, it was three jobs for every new housing permit issued.

Cities can’t keep up with the inflow of new residents because they’ve made it as difficult as possible to add additional units, accomplishing this with restrictive zoning codes that limit how much new housing can be built and lengthy approval processes that ensure whatever new residential developments are permitted then take years to complete.

In addition, many states have established urban growth boundaries that prevent housing being built on rural or agricultural land at the fringes of urban areas. The idea behind these policies is to protect natural environments. The effect has been to stop the development of affordable suburban housing that would take the pressure off city centers and give workers more choices.

San Francisco, to take the most egregious example, puts strict limits on density, ensuring much of the city’s land is reserved for single-family housing. According to a report from the city Planning Department, single-family homes make up 27 percent of the city’s units while occupying 62 percent of its residential territory.

Should you find a slice of land in San Francisco appropriately zoned for apartments, chances are you’ll spend years (and potentially millions of dollars) getting permission to build on it. An apartment building larger than 10 units takes, on average, more than six years to construct. Nearly four of those years are spent getting all the necessary permits and then fighting to protect them from local NIMBYs claiming your new building will cast too many shadows.

Sometimes, even local governments’ housing schemes are tripped up by their rules. In Los Angeles, Metro—the area’s transit agency—has spent over a decade trying to develop land it owns into supportive housing for the formerly homeless. Neighboring businesses have managed to delay the effort with administrative appeals and lawsuits alleging insufficient environmental review.

For each project that’s delayed, an unknown number of developers are deterred altogether. As a result, there’s just not enough housing to go around.

That’s bad for more than just rental prices. Wealthier residents, unable to move into condos that were never built, outbid longtime residents for formerly affordable apartments, hastening gentrification. Those down the income ladder find themselves competing for an inadequate supply of public housing or moving farther and farther away from work and family.

Cities in 21st century America offer a cornucopia of cultural, social, and economic opportunities that Americans living just a century ago likely could not have imagined. But the more governments try to regulate what these cities should look like, the more exclusive and less dynamic they’ll become.

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US Sanctions Backfire, Lead To Boost In Russian Oil Exports

Authored by Irina Slav via Oilprice.com,

U.S. sanctions against Venezuela and Iran have had an unplanned side effect: they have increased exports of heavy, sour crude from Russia, Bloomberg reports, adding that calculations have shown Russian oil companies raked in an additional US$905 million at least from these sales between November and July.

The Urals blend is the big winner of the U.S. sanctions, according to Bloomberg’s calculations. Venezuela is one of the main global suppliers of heavy crude, but U.S. sanctions have shrunk its exports significantly. Iran also produces heavy, which has now become less readily available to foreign buyers, freeing up space for Urals. Finally, OPEC members prioritized cutting their heavy crude production as part of their December 2018 agreement and that added to the strain on heavy crude supply.

Like heavy crude in general, Urals normally trades at a discount to Brent. However, like other heavy blends, the Russian one has narrowed the gap since November, when U.S. sanctions against Iran snapped back, despite the waivers granted to eight importing countries. Eventually, it swung to a premium, especially in the Mediterranean, where a lot of Iranian oil used to go.

Right now, Urals is trading at a discount of more than $2 per barrel to Brent crude but at a premium to West Texas Intermediate. It has swung to a premium to Brent several times this year. Meanwhile, according to information from oil data analytics firm OilX, Russia’s overall production is also on the rise, after a temporary decline. As of August, this climbed back above 11.3 million bpd, after dropping below 11.2 million bpd in July.

U.S. sanctions are definitely changing production and price patterns in heavy crude and so is U.S. production.

Italy’s Eni said in its latest World Oil Review report recently that last year that the portion of heavier sour crude grades had fallen below 40 percent of the total for the first time ever. At the same time, thanks to the U.S. shale revolution, the share of light, sweet crude increased to more than 20 percent. This, too, has had an effect on the price difference between lighter and heavier crudes.

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