Category: zerohedge

Authored by Nomi Prions via The Daily Reckoning,

This week I’ve been in Washington, D.C. for high level meetings focused on the economy. While meeting with senior officials and members of the House and Senate, it became clear that a troubling phenomenon is building.

In the wake of recent stock market volatility and uncertainty surrounding monetary policy, it seems that political figures are starting to grow concerned.

There is growing consensus that the makings of a financial crisis of some sort is building — and could drop sooner rather than later. While there is speculation over whether it will be as big as the last one, and whether it will come in waves, the belief is that something is wrong.

With those fears, I turned to the Federal Reserve itself. While meeting at the Fed, I was given the impression that bank regulators have been routinely chastised by Wall Street bankers. What I learned is that some of the biggest playmakers in finance don’t want to disclose the true nature of their positions and money-making schemes. This confirmed my own experiences as an former investment banker.

In addition, it became clearer that Fed Chairman, Jay Powell, and Vice Chairman, Randal Quarles, will be closely studying real economic and bank data when rendering decisions about the path of interest rates. Many have speculated about such dealings, and whether they will be swayed by President Trump’s pressure.

The truth is that the leaders at the Fed have a firmer understanding of what’s really going on in the economy than they allude to publicly. Even though the Fed has been able to avoid another financial crisis the last decade, with quantitative easing (QE) policy — or what I call dark money — their “toolkit” might not render us “safe enough.” They need to grapple with this reality.

Jerome Powell, left, and Randal Quarles. AP Photo/Cliff Owen.

You see, the Fed manufacturers dark money that the markets have come to rely on. Through quantitative easing (QE) the central bank has accumulated a balance sheet that hit a high of $4.5 trillion of assets last year.

By having purchased these assets with electronically created money, the Fed was able to keep rates at the middle and longer end of the yield curve low, while they specifically set low rates for the short end of the yield curve, too.

Just to remind you, the yield curve is the difference between short- and long-term interest rates. Long-term rates are normally higher than short-term rates. When the two converge, it often means markets are anticipating low growth ahead. When the yield curve inverts, when long-term rates fall below short-term rates, it’s almost always a sign of looming recession, historically speaking.

Currently the Fed’s book of assets has been reduced by only a bit — to about $4.1 trillion — but it’s still historically large.

If the Fed continues to sell those assets (which consist of treasury and mortgage bonds) there is a risk that their value will drop too much, too quickly. If bond values drop, then rates will rise in the middle and longer end of the yield curve. This would make it more expensive for most companies to repay, or extend, their corporate debts.

The Fed knows it is currently in a catch-22. That’s why over the last two weeks, it has barely sold any of its assets as volatility in the markets picked up.

Here’s something else you might not know: Two weeks ago, it even quietly increased its book of assets. That’s the opposite of the policy of unwinding, or selling its assets through quantitative tightening (QT), which is what Chairman Powell promised he would be doing.

That’s another sign that the Fed is afraid of a possible new financial crisis. For more proof, consider that former Fed Chair, Janet Yellen, just did a 180 on her prior comments related to the possibility of another crisis. Last June, she said that she didn’t think there would be another financial crisis in her lifetime, attributing this to banking reforms made since the 2008 financial crisis.

Now, everything has changed. Last week, she told the New York Times that, “Corporate indebtedness is now quite high and I think it’s a danger that if there’s something else that causes a downturn, that high levels of corporate leverage could prolong the downturn and lead to lots of bankruptcies in the non-financial corporate sector.”

She noted that CLOs could be a real problem, as I’ve been warning for months. CLOs, or collateralized loan obligations, are a Wall Street product stuffed with corporate loans. If that sounds familiar to you, there’s a reason. Wall Street is doing exactly what they did with mortgage loans before the 2008 financial crisis, but with corporate ones.

Her timing was not random. Just because she’s no longer running the Fed doesn’t mean she has no contact with its new leader, who was her number two. The people and connections within central banks and Wall Street are always in play.

The danger in her analysis is that she’s largely mistaken that “current holders of corporate debt do not appear to be levered to excess, mitigating risk of any credit ripple effects.” The data bears this out.

Companies are holding $9.1 trillion of debt now in contrast to the $4.9 trillion in 2007 before the last financial crisis. The financial system, and those who take money from banks, are more highly levered than they were prior to the last financial crisis.

In its inaugural Financial Stability Report, the Fed stressed lurking dangers in corporate debt. Although the Fed also used the opportunity to pat itself on the back for how well capitalized banks were, just as Janet Yellen did, the trouble was still highlighted.

The Fed noted that corporate debt relative to GDP is at record highs, and that credit standards have gotten worse again. The amount of junk bonds and leveraged loans or “risky debt” has risen by 5% in the third quarter of 2018 to over $2 trillion in size.

The central bank pointed to a number of other risks facing the markets. Those include the outcome of Brexit, Italy’s finances and a slowing European economy which could lead to more dollar appreciation. If the dollar were to continue to rise in value, it would make it harder for foreign companies that took out dollar-denominated debt to repay it.

The Fed also used the report to warn that trade wars, geopolitical tensions and slowdowns in China and other emerging market economies could negatively impact the U.S. economy and markets.

All of these factors could not only impact the markets, as we’ve seen over the past several weeks, but also begin to creep in on how companies are able to repay their debts.

Today is the big Fed meeting. I don’t believe the Fed will raise rates this time, which would give markets a boost heading into the new year. If they do, the announcement will be accompanied with much more dovish language and guidance for 2019. Regardless, the problems aren’t going away and neither is volatility.

via RSS https://ift.tt/2R6C5BA Tyler Durden

FedEx shares are plunging after what Morgan Stanley called a “jarring” cut to its annual forecasts, suggesting global growth is slowing far more than most expect – in fact, the bank hinted at the possibility of a “severe recession” unfolding – and prompting expectations of an “uber-dovish hike” by the Fed.

The global logistics bellwether slashed its outlook just three months after raising the view, reflecting an unexpected and abrupt change in the company’s view of the global economy amid rising trade tensions between the U.S. and China. Not only were the cuts were deeper than the Street expected according to Morgan Stanley analyst Ravi Shanker, but everyone is pointing to the following comment from the press release: “Global trade has slowed in recent months and leading indicators point to ongoing deceleration in global trade near-term.”

Needless to say, with little in terms of warning, Morgan Stanley was shocked by the magnitude and severity of the cut, and suggested that this implies a “severe global recession” is unfolding:

“We recognize that global growth has slowed but we are very surprised by the magnitude of the headwind, which is what might be seen in a severe recession,” Shanker wrote. “We believe global growth concerns are also likely to get worse before they get better next year, which could mean more of a drag on FY20 EPS.”

Quoted by Bloomberg, Shankar also said that the Express unit is also likely to remain an overhang, Shanker said, as FedEx management didn’t provide an outlook for fiscal 2020 or its timeline for improving the cargo airline, which has been hit by worsening economic conditions in Europe.

FedEx shares tumbled 7% on Wednesday morning, the lowest intraday price in about two years and the 10th decline for FedEx in 11 days.

The silver lining: according to Bloomberg’s Arie Shapria, the fact that the guidance was slashed one day before the FOMC’s decision later today, expectations may be turning from a “dovish hike” to an “uber-dovish hike.” Alternatively, traders may be “jarringly” disappointed if the Fed refuses to prop up the market and retains its hawkish bias.

via RSS https://ift.tt/2ClUCSm Tyler Durden

Step side Russia: the new global hacking bogeyman is now officially China.

Just days after the US accused Beijing of hacking hundreds of millions of Marriott accounts and extracting the private data of countless Americans, even as the ongoing diplomatic feud over Chinese “intermediation” in western communications via the likes of Huawei escalates, moments ago the EU unveiled that China was now also the new Wikileaks, accusing hacker tied to China’s People’s Liberation Army of a “huge hack” of its diplomatic cables and reviving fears about vulnerabilities in the 28-country bloc’s data systems.

According to investigators, hackers had accessed cables on a variety of geopolitical issues including terrorism, transatlantic relations, peace in the Middle East, arms control, the South China Sea and the Asia and Oceania working party.

In a campaign dating back at least to 2015, the hackers gained access to more than a hundred organisations including the EU’s Coreu electronic communication network, the FT reported citing a report due to be published on Wednesday by cyber security company Area 1 Security, that exposed the breach. According to the report, Chinese hackers used the Cypriot foreign ministry as an entry point to conduct cyber espionage over several years throughout the block. Other targets included parts of the UN and the AFL-CIO, a confederation of American unions that may have been of interest to the Chinese because it was involved in trade negotiations.

The EU Council secretariat said it was “actively investigating” allegations of a “potential leak of sensitive information”. “The Council Secretariat takes the security of its facilities, including its IT systems, extremely seriously,” it added.

The revelations come as the latest embarrassment to the EU at a time of heightened concerns about the ability of groups linked to perpetual cyberwarfare bogeyman Russia and other powers to exploit weak links in its information and financial networks.

But how do we know it’s China this time and not, say, North Korea, Moscow, or some basement dwelling supporter of Julian Assange? Well, according to Oren Falkowitz, CEO of Area 1, he had “absolute confidence” that a Chinese group was behind the attacks, because of an extensive analysis of their techniques… the same way CrowdStrike had “absolute confidence” Russia hacked the DNC server without, of course, allowing the FBI to also investigate it independent. He linked the hacks to the Strategic Support Force of the People’s Liberation Army.

In a hack surprisingly reminiscent of how “the Russians” got access to John Podesta’s email, Area 1 said the hackers initially accessed the system using unsophisticated phishing techniques, sending an email with a malicious link or attachment to people inside the ministry in Cyprus.

“It only takes access to one of the parties to expose all the other secrets,” Mr Falkowitz said. “You just break the weakest link in the diplomatic chain.”

Of course, cynics may respond that this is just another convenient arrangement meant to escalate cyberwar tensions between the west and China.

The hack is the latest to involve China, whose government reached an agreement with the Obama administration in 2015 designed to curtail corporate espionage hacking companies to steal intellectual property or data, but it did not directly address more conventional cyber espionage against governments. As a trade war escalates between the US and China, the agreement is under pressure.

The thousands of hacked documents revealed concerns in the EU “about an unpredictable [President Donald] Trump administration and struggles to deal with Russia and China and the risk that Iran would revive its nuclear programme”, according to the New York Times, which also had access to the trove.

As for Cyprus being used as the entry point, that too is hardly a coincidence: the alleged use of the Mediterranean island as the “unwitting gateway” for the hack is likely to intensify some EU states’ security focus on Nicosia, after concerns about Russian money and influence there.

As the FT notes, the bloc is grappling separately to plug weaknesses in its financial supervision revealed by revelations that €200bn of suspect cash — largely from clients in Russia and other former Soviet republics — had flowed through the Estonian branch of Denmark’s Danske Bank.

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S&P futures rose after yesterday’s volatile session ahead of today’s Fed decision, and European stocks jumped after Italy struck a crucial budget deal with the EU following a downbeat Asian session as oil tried to rebound after a furious three-day selloff that rattled global markets and sent investors scrambling into the safety of government bonds (in record numbers according to BofA).

The Stoxx Europe 600 Index gained 0.5% rising to session highs after four days of declines, with banking and healthcare stocks contributing the most to the gains, after the European Commission decided against launching a disciplinary procedure against Italy over its budget, while carmakers climbing on hopes of a breakthrough on trade.

Rome and Brussels ended their long-running feud over Italy’s 2019 budget, striking a deal on spending plans that had shocked investors and stoked tensions between the country’s populist government and the rest of the EU. Valdis Dombrovskis, the EU commission vice-president responsible for the euro, said the agreement that had been reached would lead to a budget deficit next year of precisely 2.04% of GDP and not a penny less or more compared with 2.4 per cent in Rome’s original plans.

Europe’s rebound followed a weak Asian session which saw equities mostly lower after a disappointing market debut for SoftBank Group’s Japanese telecom business and amid cautious trade ahead of the FOMC rate decision, and after the attempted rebound on Wall St. where the S&P closed little above its 2018 low. Australia’s ASX 200 (-0.2%) was pressured by oil names following the mass decline in the complex, while Nikkei 225 (-0.7%) initially traded with no firm direction amid a choppy JPY before digging deeper into losses and giving up the 21,000 handle. Sentiment across the region was also reflected by the 10% plunge in Softbank’s mobile business in its USD 24bln market debut. Elsewhere, Hang Seng (+0.2%) and Shanghai Comp. (-0.5%) were mixed as the former was supported by financial names with the four large banks in positive territory. Meanwhile, mainland gains in real estates and utilities were offset by the decline in the energy and healthcare sectors. Finally, JGB futures posted the biggest intraday gain since 2016 on growing concerns over the global economy health, at one point triggering an emergency margin call for JGB futures  after the 10Y note future spiked as it triggered stop losses.

Futures on the S&P 500 Index erased losses made in late trading on Tuesday after earnings from FedEx cast doubt on the strength of global trade, and were trading 25 points higher from session – and 2018 – lows of 2,530.95. FedEx, considered a bellwether for the world economy, slashed its 2019 forecasts, noting “ongoing deceleration” in global growth and sending S&P futures sharply lower early in the session only for market to quickly BTFD.

Even with today’s rebound, US stocks are set for their worst December since 1931, the depths of the Great Depression.

“It’s a confluence of several important factors: the market is adjusting its outlook on growth and there is a consensus we will see a slowdown. More importantly, the market is adjusting to the idea this will translate into lower earnings growth,” said Norman Villamin, chief investment officer for private banking at Union Bancaire Privee in Zurich.

“It’s being complicated by the tightening liquidity situation with the Fed expected to move today and the ECB having signaled the end of its (stimulus)”.

Crude was mixed, trading unchanged after the biggest three-day slump since 2016 on slowing demand. Oil’s spectacular fall – down almost 10% since last Thursday – and world stocks’ plunge to 19-month lows spurred speculation the U.S. Federal Reserve might be done with tightening after its policy meeting later in the day. While WTI was unchanged at just above $46 after plunging 6 percent overnight, its 35% fall since October is sending a deflationary pulse through the world just as trade and economic activity are cooling.

Looking at today’s Fed decision, Fed Fund Futures are sticking with a two-in-three chance of a rate rise on Wednesday and Villamin expects the Fed to move twice in 2019. That’s a more hawkish call than the broader market which is pricing less than one rise in 2019, down from three not long back.

“One thing I would like to see is what people are calling a dovish hike,” Ronald Temple, head of U.S. equity and co-head of multi asset at Lazard Asset Management LLC, told Bloomberg TV. “The hiatus on trade helps as well, but I’m a bit more skeptical about how long-lasting that is.”

Beyond the Fed, trade and politics remain the dominant themes. Unless Trump and Congress reach a deal, spending authority expires for a majority of the U.S. government on Friday night. Meanwhile, Treasury Secretary Steven Mnuchin said America and China are planning to hold meetings in January to negotiate a broader trade truce.

The expectations of a Fed pause and the equity selloff sent 10-year Treasury yields to the lowest since August at 2.799 percent down 20 bps in December – while two-year yields touched a three-month trough of 2.629 percent, sliding from November’s 2.977 percent peak. Meanwhile, as noted earlier, Italian debt surged after the European Commission was said to have decided against launching a disciplinary procedure against the country over its budget.

The yield on benchmark Japanese notes slipped to within striking distance of 0% before a rapid turnaround as the surge in demand triggered a margin call.

The Bloomberg Dollar Spot Index fell a third day as traders speculated the Fed may signal Wednesday that it’s approaching a pause in its rate-hike cycle; the greenback retreated versus most of its Group-of-10 peers. The euro advanced and Italian bonds surged to take yields to the lowest in nearly three months after the nation was said to have reached a technical agreement with EU officials over its budget. The pound was steady after U.K. inflation rate slowed to a 20-month low of 2.3% y/y, in line with estimates. The Norwegian krone led gains in G-10, rebounding from a one-year low against the euro, as oil prices stabilized

In commodities, Brent (+0.1%) and WTI (+0.1%) remain in close proximity to recent lows following from yesterdays significant losses where WTI dropped by 7.3%. Prices were mostly unreactive to the surprise 3.5mln barrel build in API crude inventories, where consensus has been for a draw of over 2mln barrels. Markets will be looking to see if EIA data later in the session confirms this build or if the crude stocks consensus of -2.475mln barrels is correct; if the build is confirmed it will be the first in 3 weeks and may generate new downward price pressure.

Gold is trading relatively flat after reaching a 5-month high of USD 1251.43/oz earlier in the session, with the yellow metal  continuing to benefit from a softer dollar ahead of the FOMC decision. Elsewhere, profit margins at Chinese steel mills has  significantly narrowed in November as the Chinese government has removed overall winter production restriction, now allowing  cities and provinces to decide output curbs based on their emissions levels.

Market Snapshot

• S&P 500 futures up 0.8% to 2,559.25
• MXAP up 0.3% to 148.27
• MXAPJ up 0.6% to 479.88
• Nikkei down 0.6% to 20,987.92
• Topix down 0.4% to 1,556.15
• Hang Seng Index up 0.2% to 25,865.39
• Shanghai Composite down 1.1% to 2,549.56
• Sensex up 0.4% to 36,506.13
• Australia S&P/ASX 200 down 0.2% to 5,580.60
• Kospi up 0.8% to 2,078.84
• STOXX Europe 600 up 0.1% to 340.95
• German 10Y yield rose 0.8 bps to 0.252%
• Euro up 0.4% to $1.1403
• Italian 10Y yield fell 2.1 bps to 2.576%
• Spanish 10Y yield fell 2.7 bps to 1.351%
• Brent Futures up 1% to $56.83/bbl
• Gold spot down 0.1% to $1,248.30
• U.S. Dollar Index down 0.2% to 96.87

Top Overnight News from Bloomberg

• The U.S. and China are planning to hold meetings in January to negotiate a broader truce in their trade war but are unlikely to have any face-to-face contact before then, according to Treasury Secretary Steven Mnuchin. READ: Xi’s defiant end to 2018 signals more U.S.-China tension ahead
• Italy’s populist government is betting the European Commission will ratify an informal budget deal on Wednesday to avoid sanctions over its spending plans
• U.K. Cabinet ministers agreed to implement “in full” plans for a no- deal break from the European Union, including 3,500 troops put on standby and 2b pounds ($2.5b) of funds made available for contingencies
• Economic jitters and surging supplies from the U.S. to Russia hammered oil again, with crude suffering its biggest decline in more than three weeks
• Japan’s exports rose 0.1% in November from a year earlier, broadly in line with estimates and reflecting a weakening pace
• Thailand’s central bank raised its benchmark interest rate for the first time since 2011, joining peers in the region in tightening monetary policy this year
• India’s rupee rallied with sovereign bonds as sliding oil prices improved the outlook for the nation’s finances and the central bank extended support via open-market debt purchases
• Citigroup Inc. faces losses of as much as $180 million on loans made to an Asian hedge fund whose foreign-exchange wagers went awry, prompting board-level discussions and a business shakeup, according to a person briefed on the matter

Asian equities were mostly lower amid cautious trade ahead of the FOMC rate decision, and after the attempted rebound
on Wall St. where the S&P closed little above its 2018 low, while the Dow Jones was supported by gains in Goldman Sachs. ASX
200 (-0.2%) was pressured by oil names following the mass decline in the complex, while Nikkei 225 (-0.7%) initially traded with no
firm direction amid a choppy JPY before digging deeper into losses and giving up the 21,000 handle. Sentiment across the region
was also reflected by the 10% plunge in Softbank’s mobile business in its USD 24bln market debut. Elsewhere, Hang Seng
(+0.2%) and Shanghai Comp. (-0.5%) were mixed as the former was supported by financial names with the four large banks in
positive territory. Meanwhile, Mainland gains in real estates and utilities were offset by the decline in the energy and healthcare
sectors. Finally, JGB futures posted the biggest intraday gain since 2016 on growing concerns over the global economy health,
while futures purchases were also exacerbated after BoJ kept 5-10yr purchases steady at JPY 430bln.

Top Asian News

• China Watchers Split on Yuan Outlook; It Comes Down to Trade
• Samsung’s 5G Network Grab Gets Boost With Huawei, ZTE Under Fire
• Third Canadian Citizen Detained in China, National Post Says
• Stocks Edge Up Before Fed Decision; Bonds Steady: Markets Wrap

Major European indices are in the green (Euro Stoxx 50 +0.5%(, with some outperformance seen in the FTSE MIB (+1.6%) with banking names such as UBI Banca (+4.0%) and Intesa Sanpaolo (+3.7%) benefitting from reports that the EU commission has accepted Italy’s 2019 budget deficit at 2.04%. Sectors are mixed with some outperformance seen in the telecom and consumer discretionary sector. Other notable movers include GlaxoSmithKline (+6.6%) in the green as they are to create a new healthcare joint venture with Pfizer estimated combined sales of GBP 9.bln. With Fresenius SE (+3.0%) following an upgraded to buy at Goldman Sachs. Whilst Natixis (-6.5%) are at the bottom of the Stoxx 600 after reporting Q4 revenue will be 10% lower than the previous year. Whilst postal names such as Royal Mail (-2.6%) and Deutsche Post (-4.5%) are down after FedEx cut their guidance.

Top European News

• Europe Loses Taste for Punishing Russia as U.S. Toughens Stance
• Italian Markets Rally as Budget Agreement Seen Reached With EU
• U.K. Unveils Post-Brexit Migrant Plan for Skilled Workers
• Electronics Retailer Ceconomy Latest Victim of Retail Crisis

In FX, the Dollar remains depressed in the run-up to the FOMC in anticipation of a dovish hike if not quite one more and done as a growing number of pundits look for the accompanying statement and guidance to be tweaked via the dot plots and/or removal of further gradual tightening. The index has duly retreated from another 97.000+ test and is holding just above recent lows ahead of 96.500, with the December base so far around 96.360 and ytd peak circa 97.710-715 the obvious bearish and bullish targets depending on the tone of the Fed.

• EUR/AUD/NZD – All vying for top G10 spot and biggest gainer vs the flagging Greenback, but with the single getting an extra lift or rather relief bid on the back of Italy and EU agreement on the 2019 budget that is likely to be officially announced by Italian PM
• Conte shortly. Eur/Usd has subsequently revisited 1.1400+ terrain, albeit just, while Aud/Usd has had another go at 0.7200 and the Kiwi is pivoting 0.6850 even though NZ current account data for Q3 was somewhat disappointing overnight. Note, decent option expiry interest may act as a drag on Eur/Usd with 1 bn at 1.1375 and the same amount between 1.1355-60 rolling off, while there  is strong chart resistance ahead of 1.1450 at 1.1442 (earlier December peak) and 1.1445 (Fib).
• JPY/GBP – Also firmer vs the Usd, with the former just off a marginal new mtd high, but perhaps restricted to an extent by option related flow as 1.2 bn resides between 112.00-05 and 1.5 bn sits from 112.40-50, while for the Yen there is also the BoJ’s final policy meeting of 2018 to consider just after tonight’s FOMC. Meanwhile, Brexit continues to put a brake on the Pound, or at least temper Sterling gains as Cable crests 1.2650 and Eur/Gbp hovers around 0.9000 with little reaction to broadly in line UK inflation data or a modest beat on CBI trends that seems to have been released early.
• CAD/CHF – The marginal underperformers, with the Loonie still blighted by crude’s slump and diplomatic strains with China, but just off new ytd lows a fraction above 1.3500 ahead of Canadian CPI data, while the Franc meanders between 0.9910-35 and  around 1.1300 vs the Eur.

In commodities, Brent (+0.1%) and WTI (+0.1%) remain in close proximity to recent lows, as global equity markets have begun  stabilising, following on from yesterdays significant losses where WTI dropped by 7.3%. Prices were mostly unreactive to the  surprise 3.5mln barrel build in API crude inventories, where consensus has been for a draw of over 2mln barrels. Markets will be  looking to see if EIA data later in the session confirms this build or if the crude stocks consensus of -2.475mln barrels is correct; if  the build is confirmed it will be the first in 3 weeks and may generate new downward price pressure.

Gold is trading relatively flat after reaching a 5-month high of USD 1251.43/oz earlier in the session, with the yellow metal continuing to benefit from a softer dollar ahead of the FOMC decision. Elsewhere, profit margins at Chinese steel mills has significantly narrowed in November as the Chinese government has removed overall winter production restriction, now allowing cities and provinces to decide output curbs based on their emissions levels. Saudi Finance Minister says the 2019 budget allocation to the energy industry, mining and logistics is over 3 times higher than in the previous budget.

US Event Calendar

• 7am: MBA Mortgage Applications, prior 1.6%
• 8:30am: Current Account Balance, est. $125b deficit, prior $101.5b deficit
• 10am: Existing Home Sales, est. 5.2m, prior 5.22m; Existing Home Sales MoM, est. -0.38%, prior 1.4%
• 2pm: FOMC Rate Decision; Interest Rate on Excess Reserves, est. 2.4%, prior 2.2%

DB’s Jim Reid concludes the overnight wrap

Ahead of the Fed meeting conclusion today, yesterday had looked like we’d finally get a dull pre-Xmas session. However a sharp decline in oil prices late in the European session put pay to this. Indeed WTI and Brent tumbled -5.54% and -7.36%, respectively, sending WTI to $46.21/bbl and the lowest since August 2017. The price is also down almost 40% from the October highs just seven weeks ago. Despite the energy sector struggling (-2.35%), the S&P 500 ultimately closed flat, albeit that was after volatile intraday moves of +1.10% and -0.68%. Yesterday’s flat session at least snaps a losing streak of -3.95% over the previous two sessions, but leaving the S&P 500 still on track for its worst December since 1931. Europe struggled but in fairness was still playing catch up (or down) to the US with the STOXX 600 closing -0.82%. US HY underperformed yesterday with spreads +12bps wider. That means they are now +146bps wide of the October tights, and +88bps wider YTD. As recently as November 9th, spreads were still tighter than where they started this year.

The immediate catalyst for the oil move was the publication of Saudi Arabia’s budget plan, which included ambitious oil revenue targets of $177 billion for next year. To reach that number, the Kingdom is either assuming very unrealistic oil prices of around $80 per barrel, or they plan to pump more than the 10.2 million barrels per day target agreed earlier this month.Since the $80 per barrel figure is around 30% more than consensus estimates, the latter scenario looks more probable, which would equate to a significant increase in global supply and would end up being more bearish for prices.

Now to the Fed which starts a run of three central bank meeting outcomes over the next couple of days. Our US economists expect the Fed to raise rates for the fourth time this year (and a 20bp increase to the IOER) – which is in line with the consensus and market pricing. The more important question for our economists is what signal will the Committee send about its policy path in the coming years. They expect the message to be that the Fed remains upbeat on the outlook and expects to raise rates further in coming quarters, but that the pace of normalization is likely to slow next year from its recent quarterly rate as the Fed becomes more data dependent. Reflecting this, our colleagues expect the statement to modify the forward guidance language by noting that gradual increases remain appropriate in the “near term”. Also worth keeping an eye on is the 2019 median dot which our team expect to fall from three hikes to two. This wouldn’t impact our house view for three hikes for next year and, in fact, if the Fed signals some flexibility around the pace of hikes, while maintaining the overall trajectory for the terminal rate, it could help to ease financial conditions which in turn makes three hikes more likely next year. We’ll know more tonight with the meeting outcome due at 7pm GMT and Powell’s press conference shortly after.

Interestingly, in our yield curve note from last week (link here ) we showed how 2s10s has inverted ahead of each of the last 9 recession. However there was one false positive ahead of the 1970 recession where this measure inverted 48 months before the recession. In our view the main reason for a false positive was due to the Fed easing policy via cutting rates in late 1966/early 1967. This was despite the fact that core inflation was on the rise and accelerated more as the fed funds rate declined, and ultimately therefore can be viewed as a policy mistake given that this uptick in inflation continued into the early 1970s. Curves subsequently steepened again in 1967 once the Fed cut rates, however they inverted once more in 1968 as tightening resumed and the Fed corrected its earlier error. The recession then eventually materialised in 1970 after the second inverted YC signal worked with a more normal time lag. We mention this as there could be parallels to today if the Fed responds dovishly to the recent wobbles in markets and recent softness in inflation. This could delay a slowdown (and curve inversion) but at the expense of exacerbating pressures in the labour market and generating higher inflation further down the line. So food for thought as we hit more challenging times for the Fed.

Ahead of today’s meeting, President Trump reiterated his view that the Fed shouldn’t hike, tweeting yesterday that “I hope the people over at the Fed will read today’s Wall Street Journal Editorial before they make yet another mistake. Also don’t let the market become any more illiquid than it already is. Stop with the 50 B’s”. The “50 B’s” reference apparently referred to the balance sheet roll off caps. That tweet did little to move Treasuries with yields lower across the curve – more reflecting the oil move. 10y yields ended -3.4bps lower and the 2s10s curve finished slightly steeper at 16.8bps. It had been a similar story for Europe too where bond yields were broadly 1bp to 2bps lower. Gilts were the exception with yields up 1.6bps however there didn’t appear to be any material new Brexit newsflow from yesterday’s Cabinet meeting.

Also on the cards today is the European Commission meeting to discuss Italy’s budget. Press reports (Bloomberg) suggested that the two sides have reached an informal agreement to avoid a launch of the excessive deficit procedure. Apparently, the deal will include delays to some of the newly planned social spending and a reduction in the size of other programs. Overall the new deficit is reported to be around 2.04% and includes EUR 4bn in cuts versus the original proposal. In an effort to prove their seriousness, the government will also cut their 2019 growth forecasts to 0.9-1.0% from 1.5%. This follows news (Corriere della Sera) that the Commission was still not satisfied by the latest plan presented by the government with the sticking point being that the Commission does not see a sufficient enough reduction in the structural deficit – the important condition to avoiding an EDP. We will find out more today as to whether both sides have indeed reached an agreement.

This morning in Asia markets are continuing to trade mixed with the Nikkei (-0.57%) and Shanghai Comp (-0.25%) trading lower while the Hang Seng (+0.16%) and Kospi (+0.69%) are trading up. In overnight news, the US Treasury Secretary Steven Mnuchin said that the US and China are planning to hold meetings in January to negotiate a broader truce in their trade wars but are unlikely to have any face-to-face contact before then. It’s also worth noting that the three-day annual economic policy-setting meeting of Chinese leaders kicks off today. This could have important policy implications for 2019 and beyond so watch for any headlines. Elsewhere, futures on the S&P 500 are up +0.57% despite FedEx’s stock price being down -5.55% in aftermarket trade as the company slashed its profit forecast for the current fiscal year and decided to pare its international air-freight capacity on account of a darkening view of demand for shipping services outside the US. Interestingly, FedEx has made a U-turn on its guidance just three months after raising it, reflecting an abrupt change in FedEx’s view of the global economy and indicating that the global macroeconomic headwinds are rising.

Meanwhile, yesterday’s data didn’t add a whole lot to the growth debate. The volatile housing starts and building permits series surprised to the upside in November with the former rising +3.2% mom (vs. 0.0% expected) and the latter +5.0% mom (vs. -0.4% expected). However, the rise was concentrated in the south of the US and represented some pay-back from weakness over the last few months, as hurricanes depressed regional activity. In Germany, there was some slight disappointment in the December IFO survey with the business climate reading down 1pt to 101.0 (vs. 101.7 expected) largely due to a drop in the expectations component of 1.4pts to 97.3 (vs. 98.4 expected). That is actually the lowest expectations reading since November 2014 and it appears that the IFO survey is now finally catching up with the slide in the Germany PMIs in recent months.

Looking at the day ahead, the highlight will no doubt be the Fed this evening however prior to that this morning we get November PPI in Germany and the November inflation data docket in the UK. The December CBI trends orders and selling prices survey for the UK is also out just before lunch while in the US we get the Q3 current account balance reading and November existing home sales data. The ECB’s Hansson is also slated to speak today while the other potentially important event to note is the aforementioned European Commission meeting to discuss Italy’s budget and the potential for enforcing the excessive deficit procedure.

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The market-rattling game of chicken between Rome and Brussels has ended in a draw.

EU officials confirmed Wednesday that after a meeting in Brussels with leaders from Rome, the two sides have struck a deal on the Italian budget deficit that will allow Italy to move forward with its plans to expand welfare benefits and tax cuts while avoiding the threat of billions of euros in fines. 

EU commission vice-president Valdis Dombrovskis said the agreement that had been reached would lead to an expected budget deficit next year of 2.04% – a number of redundantly laughable precision – of GDP compared with 2.4% in Rome’s original plans.

The euro climbed, European bank stocks rallied and Italian bond yields moved lower after EU officials, who had been meeting with Italian Prime Minister Giuseppe Conti and other government officials in Brussels on Wednesday, confirmed that they would abandon their plans for an “excessive debt proceeding” against Italy, the process for officially punishing an EU member found to be in violation of the bloc’s stringent budget rules.

The FTSE MIB rallied over 1%, driven by rising shares of domestic banks (+2.9%). BTP futures surged higher, while the curve bull steepened with yields initially falling by 12bps in 2s and 5s. The euro rallied as anxieties about an ‘Italeave’ scenario faded.

However, these moves started to fade after EU bureaucrats made clear that they still have some reservations about the Italians’ spending plans. The ECB’s Ewald Nowotny said the Italian budget “is not sustainable”, and European Commission Vice President Valdis Dombrovskis said Italy’s proposed 2019 budget “still raises concerns” and that the Italians “structural” budget adjust for 2019 will effectively be ‘zero’ (presumably due to the government’s decision to lower its growth forecasts from 1.5% to 1% as growth falters). Because of the country’s precarious debt burden, there is an ‘urgent’ need to set Italy on the path toward fiscal responsibility.

After the EU rejected the Italians proposed budget last month in what was an unprecedented decision that rattled the country’s markets, Italy’s ruling populist coalition decided that it would be willing to work toward a negotiated solution despite earlier claims that it would never kowtow to bureaucrats in Brussels. Earlier this month, reports suggested that the Italians would accept a deficit of 2.04% instead of 2.4% in return for the EU dropping its pursuit of financial sanctions that might have led to a banking crisis – or worse – in Europe’s third-largest economy. Dombrovskis confirmed that these were the parameters agreed to on Wednesday during a meeting of EU leaders and leaders from Rome.

Dombrovskis said he hopes that the budget will be “the basis for balanced budgetary and economic policies in Italy,” though he added that the agreement “is not ideal.” Italy “urgently needs to restore confidence in its economy to ease financial conditions and support investment.”

While the Italians have insisted that the stimulus is essential for reviving Italy’s moribund economy, Brussels has warned that the additional debt burden would only add to the country’s woes, and that Italy was “sleepwalking into instability.” Brussels said it will continue to “monitor” developments in Rome. Wednesday had initially been the deadline for Italy to either amend its budget proposal or face the formal beginning of the EDP, which would have handed Italy deadlines to either mend its finances or face fines, according to the Financial Times.

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That didn’t take long.

Three days after warning Canada about “escalation” and “grave consequences” amid a worsening diplomatic crisis, China has arrested a third Canadian national, according to Canada’s National Post, which cited a spokesman for Global Affairs Canada, the international arm of the Canadian government. No further details were provided, other than saying the Canadian government was “aware of a Canadian citizen” being detained.

Global Affairs diplomatically refused to connect this third arrest to the arrest of Huawei CFO Meng Wanzhou in Vancouver earlier this month. The executive, the daughter of one of China’s most successful businessmen, was released on bail last week.

According to the Straits Times, when asked about the arrest at a press briefing on Wednesday, Chinese foreign ministry spokesperson Hua Chunying said: “I have not heard about this.”

Former diplomat Michael Kovrig and businessman Michael Spavor are both being held by Chinese authorities for “threatening National Security.”

The National Post noted that China and Chinese media have lashed out at Canada over the arrest of Meng. It also confirmed that the captured Canadian isn’t a diplomat or an entrepreneur.

The arrest of a third Canadian citizen could cloud relations between the two countries, which has been marred amid an ongoing trade dispute between the United States and China.

The National Post could not confirm the identity of the detained citizen. But third-party sources who said they spoke to the family of the person suggest the person is not a diplomatic official, nor an entrepreneur operating in China.

Meng has since been released on bail and is to return to court early next year for what could be an extended legal proceeding.

The Chinese govnerment and state-run media have lashed out against Canada for the arrest, which could dampen Prime Minster Justin Trudeau’s ambitions to launch free trade talks with the country.

The Canadian government hasn’t learned much about the whereabouts or the circumstances of the detention of Kovrig and Spavor, as Beijing has refused to elaborate on the charges facing the two men (beyond threatening national security, presumably by being Canadian) and hasn’t released any information about where they are being held. But if they haven’t gotten the message already, any Canadians lingering on the Mainland should probably take the hint: Get out.

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Belgium is back to doing what it does best: running without a government.

Following in the footsteps of the political chaos that has gripped much of Europe, on Tuesday Belgian Prime Minister Charles Michel became the latest political figure to fall after he tendered the resignation of his government when his liberal-led coalition lost its parliamentary majority and an appeal to lawmakers in Parliament failed to garner backing for a minority administration.

Belgium’s royal palace said in a tweet that the country’s king holds his decision on whether to accept the resignation “in abeyance.” The king could still keep Michel as premier in a caretaker government until a deal on a new coalition is brokered or elections are held.

Not surprisingly, the reason for the government’s fall was the same one much of Europe’s political establishment finds itself reeling three years after Angela Merkel unleashed the greatest threat to European politics in generations: mass migration.

Specifically, the fall of the Belgian government was the latest in a series of crises triggered over a non-binding United Nations-brokered accord on migration. Governments from Slovakia, to Estonia and Chile, have faced backlashes over a document that the UN says doesn’t encourage illegal immigration, nor does it force countries to change their admission policies, according to Bloomberg.

Similar to the UK, where migration was among the main reasons for Brexit and the political fiasco that has followed over two years later, Tuesday’s announcement in Brussels followed the submission of a no-confidence motion against Michel’s government by opposition parties, including Socialists and the Greens. Earlier in the day, Michel had vowed to press on with his minority government, calling for a “coalition of the willing” in Parliament.

In the end, the unwilling were a majority.

Michel’s administration earlier this month lost the support of right-wing New-Flemish Alliance (N-VA), its biggest Flemish partner, after the N-VA opposed the government’s backing of the UN’s so-called Global Compact on migration. The departure stripped Michel of his majority six months before a general election which was expected to be held at the end of May.

Luckily, Belgium is quite the veteran when operating without a government and is no stranger to political crises amid persistent divisions between its Flemish and French-speaking communities. After an inconclusive election in 2010, the country muddled through for 589 days without an elected government. In that period, the country recorded its highest economic growth of the decade.

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Authored by Michael Klare via TomDispatch.com,

There could be no more consequential decision than launching atomic weapons and possibly triggering a nuclear holocaust. President John F. Kennedy faced just such a moment during the Cuban Missile Crisis of 1962 and, after envisioning the catastrophic outcome of a U.S.-Soviet nuclear exchange, he came to the conclusion that the atomic powers should impose tough barriers on the precipitous use of such weaponry. Among the measures he and other global leaders adopted were guidelines requiring that senior officials, not just military personnel, have a role in any nuclear-launch decision.

That was then, of course, and this is now. And what a now it is! With artificial intelligence, or AI, soon to play an ever-increasing role in military affairs, as in virtually everything else in our lives, the role of humans, even in nuclear decision-making, is likely to be progressively diminished. In fact, in some future AI-saturated world, it could disappear entirely, leaving machines to determine humanity’s fate.

This isn’t idle conjecture based on science fiction movies or dystopian novels. It’s all too real, all too here and now, or at least here and soon to be. As the Pentagon and the military commands of the other great powers look to the future, what they see is a highly contested battlefield — some have called it a “hyperwar” environment — where vast swarms of AI-guided robotic weapons will fight each other at speeds far exceeding the ability of human commanders to follow the course of a battle. At such a time, it is thought, commanders might increasingly be forced to rely on ever more intelligent machines to make decisions on what weaponry to employ when and where. At first, this may not extend to nuclear weapons, but as the speed of battle increases and the “firebreak” between them and conventional weaponry shrinks, it may prove impossible to prevent the creeping automatization of even nuclear-launch decision-making.

Such an outcome can only grow more likely as the U.S. military completes a top-to-bottom realignment intended to transform it from a fundamentally small-war, counter-terrorist organization back into one focused on peer-against-peer combat with China and Russia. This shift was mandated by the Department of Defense in its December 2017 National Security Strategy. Rather than focusing mainly on weaponry and tactics aimed at combating poorly armed insurgents in never-ending small-scale conflicts, the American military is now being redesigned to fight increasingly well-equipped Chinese and Russian forces in multi-dimensional (air, sea, land, space, cyberspace) engagements involving multiple attack systems (tanks, planes, missiles, rockets) operating with minimal human oversight.

“The major effect/result of all these capabilities coming together will be an innovation warfare has never seen before: the minimization of human decision-making in the vast majority of processes traditionally required to wage war,” observed retired Marine General John Allen and AI entrepreneur Amir Hussain.

“In this coming age of hyperwar, we will see humans providing broad, high-level inputs while machines do the planning, executing, and adapting to the reality of the mission and take on the burden of thousands of individual decisions with no additional input.”

That “minimization of human decision-making” will have profound implications for the future of combat. Ordinarily, national leaders seek to control the pace and direction of battle to ensure the best possible outcome, even if that means halting the fighting to avoid greater losses or prevent humanitarian disaster. Machines, even very smart machines, are unlikely to be capable of assessing the social and political context of combat, so activating them might well lead to situations of uncontrolled escalation.

It may be years, possibly decades, before machines replace humans in critical military decision-making roles, but that time is on the horizon. When it comes to controlling AI-enabled weapons systems, as Secretary of Defense Jim Mattis put it in a recent interview, “For the near future, there’s going to be a significant human element. Maybe for 10 years, maybe for 15. But not for 100.”

Why AI?

Even five years ago, there were few in the military establishment who gave much thought to the role of AI or robotics when it came to major combat operations. Yes, remotely piloted aircraft (RPA), or drones, have been widely used in Africa and the Greater Middle East to hunt down enemy combatants, but those are largely ancillary (and sometimes CIA) operations, intended to relieve pressure on U.S. commandos and allied forces facing scattered bands of violent extremists. In addition, today’s RPAs are still controlled by human operators, even if from remote locations, and make little use, as yet, of AI-powered target-identification and attack systems. In the future, however, such systems are expected to populate much of any battlespace, replacing humans in many or even most combat functions.

To speed this transformation, the Department of Defense is already spending hundreds of millions of dollars on AI-related research.

“We cannot expect success fighting tomorrow’s conflicts with yesterday’s thinking, weapons, or equipment,” Mattis told Congress in April.

To ensure continued military supremacy, he added, the Pentagon would have to focus more “investment in technological innovation to increase lethality, including research into advanced autonomous systems, artificial intelligence, and hypersonics.”

Why the sudden emphasis on AI and robotics? It begins, of course, with the astonishing progress made by the tech community — much of it based in Silicon Valley, California — in enhancing AI and applying it to a multitude of functions, including image identification and voice recognition. One of those applications, Alexa Voice Services, is the computer system behind Amazon’s smart speaker that not only can use the Internet to do your bidding but interpret your commands. (“Alexa, play classical music.” “Alexa, tell me today’s weather.” “Alexa, turn the lights on.”) Another is the kind of self-driving vehicle technology that is expected to revolutionize transportation.

Artificial Intelligence is an “omni-use” technology, explain analysts at the Congressional Research Service, a non-partisan information agency, “as it has the potential to be integrated into virtually everything.” It’s also a “dual-use” technology in that it can be applied as aptly to military as civilian purposes. Self-driving cars, for instance, rely on specialized algorithms to process data from an array of sensors monitoring traffic conditions and so decide which routes to take, when to change lanes, and so on. The same technology and reconfigured versions of the same algorithms will one day be applied to self-driving tanks set loose on future battlefields. Similarly, someday drone aircraft — without human operators in distant locales — will be capable of scouring a battlefield for designated targets (tanks, radar systems, combatants), determining that something it “sees” is indeed on its target list, and “deciding” to launch a missile at it.

It doesn’t take a particularly nimble brain to realize why Pentagon officials would seek to harness such technology: they think it will give them a significant advantage in future wars. Any full-scale conflict between the U.S. and China or Russia (or both) would, to say the least, be extraordinarily violent, with possibly hundreds of warships and many thousands of aircraft and armored vehicles all focused in densely packed battlespaces. In such an environment, speed in decision-making, deployment, and engagement will undoubtedly prove a critical asset. Given future super-smart, precision-guided weaponry, whoever fires first will have a better chance of success, or even survival, than a slower-firing adversary. Humans can move swiftly in such situations when forced to do so, but future machines will act far more swiftly, while keeping track of more battlefield variables.

As General Paul Selva, vice chairman of the Joint Chiefs of Staff, toldCongress in 2017,

“It is very compelling when one looks at the capabilities that artificial intelligence can bring to the speed and accuracy of command and control and the capabilities that advanced robotics might bring to a complex battlespace, particularly machine-to-machine interaction in space and cyberspace, where speed is of the essence.”

Aside from aiming to exploit AI in the development of its own weaponry, U.S. military officials are intensely aware that their principal adversaries are also pushing ahead in the weaponization of AI and robotics, seeking novel ways to overcome America’s advantages in conventional weaponry. According to the Congressional Research Service, for instance, China is investing heavily in the development of artificial intelligence and its application to military purposes. Though lacking the tech base of either China or the United States, Russia is similarly rushing the development of AI and robotics. Any significant Chinese or Russian lead in such emerging technologies that might threaten this country’s military superiority would be intolerable to the Pentagon.

Not surprisingly then, in the fashion of past arms races (from the pre-World War I development of battleships to Cold War nuclear weaponry), an “arms race in AI” is now underway, with the U.S., China, Russia, and other nations (including Britain, Israel, and South Korea) seeking to gain a critical advantage in the weaponization of artificial intelligence and robotics. Pentagon officials regularly cite Chinese advances in AI when seeking congressional funding for their projects, just as Chinese and Russian military officials undoubtedly cite American ones to fund their own pet projects. In true arms race fashion, this dynamic is already accelerating the pace of development and deployment of AI-empowered systems and ensuring their future prominence in warfare.

Command and Control

As this arms race unfolds, artificial intelligence will be applied to every aspect of warfare, from logistics and surveillance to target identification and battle management. Robotic vehicles will accompany troops on the battlefield, carrying supplies and firing on enemy positions; swarms of armed drones will attack enemy tanks, radars, and command centers; unmanned undersea vehicles, or UUVs, will pursue both enemy submarines and surface ships. At the outset of combat, all these instruments of war will undoubtedly be controlled by humans. As the fighting intensifies, however, communications between headquarters and the front lines may well be lost and such systems will, according to military scenarios already being written, be on their own, empowered to take lethal action without further human intervention.

Most of the debate over the application of AI and its future battlefield autonomy has been focused on the morality of empowering fully autonomous weapons — sometimes called “killer robots” — with a capacity to make life-and-death decisions on their own, or on whether the use of such systems would violate the laws of war and international humanitarian law. Such statutes require that war-makers be able to distinguish between combatants and civilians on the battlefield and spare the latter from harm to the greatest extent possible. Advocates of the new technology claim that machines will indeed become smart enough to sort out such distinctions for themselves, while opponents insist that they will never prove capable of making critical distinctions of that sort in the heat of battle and would be unable to show compassion when appropriate. A number of human rights and humanitarian organizations have even launched the Campaign to Stop Killer Robots with the goal of adopting an international ban on the development and deployment of fully autonomous weapons systems.

In the meantime, a perhaps even more consequential debate is emerging in the military realm over the application of AI to command-and-control (C2) systems — that is, to ways senior officers will communicate key orders to their troops. Generals and admirals always seek to maximize the reliability of C2 systems to ensure that their strategic intentions will be fulfilled as thoroughly as possible. In the current era, such systems are deeply reliant on secure radio and satellite communications systems that extend from headquarters to the front lines. However, strategists worry that, in a future hyperwar environment, such systems could be jammed or degraded just as the speed of the fighting begins to exceed the ability of commanders to receive battlefield reports, process the data, and dispatch timely orders. Consider this a functional definition of the infamous fog of war multiplied by artificial intelligence — with defeat a likely outcome. The answer to such a dilemma for many military officials: let the machines take over these systems, too. As a report from the Congressional Research Service puts it, in the future “AI algorithms may provide commanders with viable courses of action based on real-time analysis of the battle-space, which would enable faster adaptation to unfolding events.”

And someday, of course, it’s possible to imagine that the minds behind such decision-making would cease to be human ones. Incoming data from battlefield information systems would instead be channeled to AI processors focused on assessing imminent threats and, given the time constraints involved, executing what they deemed the best options without human instructions.

Pentagon officials deny that any of this is the intent of their AI-related research. They acknowledge, however, that they can at least imagine a future in which other countries delegate decision-making to machines and the U.S. sees no choice but to follow suit, lest it lose the strategic high ground. “We will not delegate lethal authority for a machine to make a decision,” then-Deputy Secretary of Defense Robert Work told Paul Scharre of the Center for a New American Security in a 2016 interview. But he added the usual caveat: in the future, “we might be going up against a competitor that is more willing to delegate authority to machines than we are and as that competition unfolds, we’ll have to make decisions about how to compete.”

The Doomsday Decision

The assumption in most of these scenarios is that the U.S. and its allies will be engaged in a conventional war with China and/or Russia. Keep in mind, then, that the very nature of such a future AI-driven hyperwar will only increase the risk that conventional conflicts could cross a threshold that’s never been crossed before: an actual nuclear war between two nuclear states. And should that happen, those AI-empowered C2 systems could, sooner or later, find themselves in a position to launch atomic weapons.

Such a danger arises from the convergence of multiple advances in technology: not just AI and robotics, but the development of conventional strike capabilities like hypersonic missiles capable of flying at five or more times the speed of sound, electromagnetic rail guns, and high-energy lasers. Such weaponry, though non-nuclear, when combined with AI surveillance and target-identification systems, could even attack an enemy’s mobile retaliatory weapons and so threaten to eliminate its ability to launch a response to any nuclear attack. Given such a “use ’em or lose ’em” scenario, any power might be inclined not to wait but to launch its nukes at the first sign of possible attack, or even, fearing loss of control in an uncertain, fast-paced engagement, delegate launch authority to its machines. And once that occurred, it could prove almost impossible to prevent further escalation.

The question then arises: Would machines make better decisions than humans in such a situation? They certainly are capable of processing vast amounts of information over brief periods of time and weighing the pros and cons of alternative actions in a thoroughly unemotional manner. But machines also make military mistakes and, above all, they lack the ability to reflect on a situation and conclude: Stop this madness. No battle advantage is worth global human annihilation.

As Paul Scharre put it in Army of None, a new book on AI and warfare,

“Humans are not perfect, but they can empathize with their opponents and see the bigger picture. Unlike humans, autonomous weapons would have no ability to understand the consequences of their actions, no ability to step back from the brink of war.”

So maybe we should think twice about giving some future militarized version of Alexa the power to launch a machine-made Armageddon.

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“Just because you put on a seat belt, doesn’t mean you have to crash the car.”

That’s the metaphor offered by Cabinet Secretary of State for Work and Pensions (and prominent remainer) Amber Rudd during Tuesday’s cabinet meeting, where Theresa May and her senior ministers decided to pull out all of the “Project Fear” stops to try to browbeat MPs into accepting that they have three choices: Either they pass May’s deal, opt for a no deal Brexit, or scrap the whole thing (which May, according to May, isn’t really an option, though Parliament does have the legal authority to disregard the will of the people and unilaterally decide what’s best for the UK).

And if their intention was to spook both the markets and the British people, May and her cabinet likely succeeded. Because as part of their Brexit planning, May and her ministers are calling for the reservation of ferry space for emergency supplies of food and medicine, as well as putting 3,500 armed soldiers on standby to prevent “any disruptions” when all hell breaks loose, according to the Guardian.

Much to May’s chagrin, ‘No Deal’ has become Whitehall’s “central planning assumption.’

No 10 confirmed on Tuesday that ministers would “ramp up” no-deal planning, and that the departments would be expected to make it their main priority.

Downing Street said it would send advice on preparing for no-deal to all UK businesses and suggested they should begin implementing their own contingency plans as they saw fit.

Theresa May’s spokesman said the cabinet “agreed that delivering the deal that the prime minister agreed with Brussels remains the government’s top priority and our best no-deal mitigation.”

The spokesman said it was the government’s “continued duty to prepare for every eventuality, including a no-deal situation”. Ministers acknowledged the steps that had already been taken, No 10 said, including 320 “no-deal workstreams” across all departments and 106 no-deal technical notices.

“Cabinet agreed that with just over three months from our exit from the EU, we have now reached the point where we need to ramp up these preparations. This means we will now set in motion the remaining elements of our no-deal plans. Cabinet also agreed to recommend businesses ensure they are similarly prepared enacting their own no-deal plans.”

If it comes to this, citizens will be instructed on how to prepare for Brexit prepare through a “range of channels” including advertisements on TV and social media, while two billion pounds will be allocated from a contingency fund to government departments like the Home Office and the Department for Environment, Food and Rural Affairs.

Offering another colorful metaphor, Justice Secretary David Gauke, who has said that he would rather resign than support ‘no deal’, told the meeting that a “managed no-deal is not a viable option.”

“It’s not on offer from the EU and the responsibility of cabinet ministers is not to propagate unicorns but to slay them,” he said, according to a cabinet source.

Fortunately for ministers who have been pushing for May to accept that her deal has no chance of ever winning passage – and that Brexiteers would rather crash out of the EU without a deal than countenance the risk of transforming the UK into a vassal state permanently bound to the EU Customs Union – May is reportedly considering holding votes on alternatives.

In what has become a hallmark of the Brexit trainwreck, while May continued to publicly oppose holding a series of informal ‘indicative’ votes to gauge what kind of Brexit would be politically feasible, the BBC  reported shortly after the end of the meeting that the prime minister is, in fact, planning on holding an indicative vote during the second or third week in January (around the time of May’s planned Jan. 14 vote on her deal), which would be big…if true (of course, we’ve heard this before).

But if the BBC report is accurate, May might be setting herself up for another major political miscalculation: She’s hoping that by holding the vote, MPs will realize that no one proposal has a strong plurality of support…and therefore accept the fact that her deal is the most plausible option.

The prime minister does not believe any of the factions criticising her plan have enough support to get their own version of Brexit through Parliament.

By allowing them to put forward their proposals and vote on them, she is hoping they will be defeated and her plan will emerge by a process of elimination as the best and only alternative to leaving without a deal.

The danger for Mrs May, says the BBC’s deputy political editor John Pienaar, is that none of the alternatives, including her own, can command a majority.

The upshot of the meeting: May is going all-in on “Project Fear”, hoping that charts like the one below and graphic warnings about supply shortages will eventually scare MPs into passing her deal at the last minute.

We now take you live to the floor of the Commons where May is putting on her ‘no deal seatbelt’, so the speak…

 

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Authored by Tom Luongo,

I continue to wonder who Bank of Russia President Elvira Nabuillina works for.  Seriously.  On Friday, in response to solid growth in Russian economic statistics over the past few months, Nabuillina again raised interest rates 0.25%. 

She still adheres to idiotic IMF-style ‘inflation targeting’ dogma.

Price inflation in Russia finally got off the roughly 2.5% mat in August steadily rising to 3.8% in November.  This prompted Nabuillina to raise rates again, stifling growth which itself was stifled by her overly-cautious rate cutting earlier in the cycle.

The recovery in Russia after the Ruble crisis of 2014/15 was exasperated by her holding interest rates too high for too long.  The Russian bond market took way to long to normalize because of this lack of liquidity.

In 2017 and early 2018, every time the Bank of Russia cut rates the Ruble would strengthen, that’s how high demand was for them.  The Russian yield curve was approaching normalcy.

And Nabuillina is now, again, undermining it by trying to control price inflation as opposed to letting the market regulate itself.  

The short-term Russian bond market is screaming for some relief and the Bank of Russia won’t accomodate.  Remember, inflation in Russia is running just 3.8%, so we’re talking a positive real yield on overnight money of 4%.  This is not making it easy to liquefy a growing economy.  Real yields of 4% on 3 to 5 year money?  Ok. 

But overnight?   I’m all for a cautious central bank that does not inflate massive bubbles but I’m also not for a central bank to do the bidding of a country’s adversaries either by undermining growth with needless austerity.

Central Bank Fallacies

Inflation targeting is not the role of the central bank, if it has one at all.  The central bank, at best, should simply exist as a lender of last resort when the banking system is illiquid and needs a temporary backstop to clear interbank markets during times of stress.

The issues we face today in the West evolved directly out of The Fed abandoning that role and becoming an active participant in the market.  On this I agree with Martin Armstrong, who has strenuously argued for a return to that original central bank model. 

I disagree with him about the need for a central bank in the first place. All they do is introduce moral hazard into the banking system. Banks use the backstop to lever up too far during booms and implode that much more quickly during busts.

Welcome to Austrian Business Cycle Theory 101, folks.

Central banks are truly solutions in search of a problem.   In fact, like all government interventions, they foment the very chaos they were designed to assist in controlling.

But, back to the point about who Nabuillina actually works for.  

Undermining Russia

Because here’s the problem for Russia.  They are under attack from all angles by the West, but especially financially.  Being slow to react to an improving economy in 2016/17 kept Rubles expensive domestically versus zero-bound rates for euros and dollars.  

With Putin actively pursuing a de-dollarization policy, the central bank through interest rate arbitrage discouraged de-dollarization of the Russian economy.

Now, sanctions, a stronger dollar and lower oil prices putting upward pressure on the ruble. Nabuillina is combating incipient inflation from a higher ruble by raising rates before the real recovery gained traction.

Wage Growth has fallen all year, disposable income is still flat, so consumer spending growth is sluggish.  These are all signs of a recovery stifled by too high a cost of domestic capital.  

And U.S. sanctions are making it difficult for Russian small businesses to get access to relatively cheap funds.  It’s one thing when your adversaries are screwing you over, it’s another when your central bank is doing the same thing.  

What she’s responding to now is continued weakness in the Russian Treasury’s ability to raise funds through bond auctions. Again, something that is not the Bank of Russia’s problem.

Because of U.S. pressure and uncertainty demand for Russian sovereign debt is lower than it should be.  It has nothing to do with an overheating economy that needs growth slowed down.  

But, the central bank has no control over the long-end of the yield curve.  That’s the markets function.  

Had she lowered rates to 6.5% or even 6% earlier this year, the yield curve wouldn’t still be broken, the demand for rubles domestically would be higher mitigating the effects of a weaker ruble.

This is not to say Russia is vulnerable to capital flight relative to the rest of the world.  It isn’t.  Despite Nabuillina’s mistakes Russia is in a very good position to accept inflows of foreign safe-haven capital in 2019 on political unrest in Europe. 

But, by keeping interest rates too high she is encouraging that capital inflow at rates which are far more expensive than they should be. This is especially true looking ahead to a global slowdown in 2019 which will be bad for oil prices.

IMF-style austerity is not a benefit to emerging markets like Russia.  It is a destructive dogma that overestimates the central bank’s ability to improve the economy through manipulating interest rates.  

Nabuillina should have cut rates to 7% and backed away.  She should do so now and stop tinkering with rates to please foreign ratings agencies that will downplay Russia’s fiscal position anyway for political purposes.  

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