Category: zerohedge

Despite the Saudis starting as early as February in shutting key public sites down in the kingdom, including the historically unprecedented shuttering of the pilgrimage to Mecca, it’s been reported this week that COVID-19 has hit the Saudi royal family hard. 

A source close to the royal family told The New York Times Wednesday that up to 150 members of the Saudi royal family have contracted the coronavirus.

Appropriately titled Coronavirus Invades Saudi Inner Sanctum the Times report says that even King Salman has been moved to isolation near the city of Jeddah, after his nephew and governor of Riyadh, Prince Faisal bin Bandar bin Abdulziz al Saud, tested positive. The prince is said to be in intensive care in serious condition. 

Crown Prince Mohammed bin Salman is also working isolation on the Red Sea coast, as are many of his ministers. There are thousands of princes as well as ministers close to the family across the kingdom.

The situation appears dire, from which even Saudi elites cannot escape: 

The senior Saudi prince who is governor of Riyadh is in intensive care with the coronavirus. Several dozen other members of the royal family have been sickened as well. And doctors at the elite hospital that treats Al-Saud clan members are preparing as many as 500 beds for an expected influx of other royals and those closest to them, according to an internal “high alert” sent out by hospital officials.

“Directives are to be ready for V.I.P.s from around the country,” the operators of the elite facility, the King Faisal Specialist Hospital, wrote in the alert, sent electronically Tuesday night to senior doctors. A copy was obtained by The New York Times.

“We don’t know how many cases we will get but high alert,” said the message. It directed that “all chronic patients to be moved out ASAP” and only “top urgent cases” will be accepted, according to the report.

And then there’s the fact that the princes’ high spending luxury life styles have been hampered by the outbreak: “Many of the thousands of princes in the family are believed to have brought back the virus after traveling to Europe, the newspaper reported, citing doctors and people close to the family.”

The country at this point has 41 deaths from the virus and 2,795 cases, however, health officials warn the number of cases in the weeks ahead “will range from a minimum of 10,000 to a maximum of 200,000,” according to the words of Saudi health minister Tawfiq al-Rabiah.

Thus leaders in Riyadh are expecting the kingdom’s numbers to peak in parallel with the US expected peak, now the global epicenter with over 430,000 cases. 

Submitted by Guy Haselmann, founder of FETIgroup.com

Introduction

As the pandemic dissipates, businesses open and individuals come out of hibernation, our world will be forever changed. Time at home has allowed for self-reflection. New behaviors will be adopted by individuals and businesses alike. Relationships between neighbors, employees and employers, and citizens and their governments will be transformed. Some bonds will be made stronger, but in other cases, particularly where frailties of system or leadership ineptitudes have been exposed, anger and resentment will reign.

Some shifts in relationships and personal behavior will be immediately noticeable, while others will evolve more slowly over time. High indebtedness and unfavorable demographics will be drags on economic activity and markets for decades to come, while also influencing politics and global security. A movement toward de-globalization will cultivate a lowering of international trade with destabilizing geopolitical results. At the highest level, material shifts to geopolitical considerations and away from Ricardian ones will change world order and the course of history.  These will impact every person and institution on the planet.

2020 vs. 2008

In a nutshell, 2008 was a fixable financial crisis brought on by too much debt. The 2020 crisis is a health crisis riddled with unquantifiable uncertainties that has spilled over into human psychology, politics, global economies and markets.

Comparing these crises has major flaws. In 2008, markets stopped functioning properly when interbank lending froze due to securities (e.g., CDOs) held in hidden off-balance sheet Special Purpose Vehicles (SPVs). A trillion dollars of collective SIVs made banks question the credit quality and magnitude of loses, hence the balance sheets, of counter-party banks. As bank lending seized, other markets were impacted in a classic market contagion scenario. TARP money and numerous market liquidity facilities set up by the Fed were funneled to financial markets to unclog the markets clogged plumbing.

The responses to 2020’s health crisis are wider and consist of global draconian measures (e.g., “stay at home” orders) that are directly impacting every economy, business and person on the planet. The virus and responses to it have happened with unprecedented speed and scope. Dusting off the 2008 alphabet soup of liquidity facilities has and will certainly help markets function better in the short term, but unlike in 2008, they do not solve today’s health crisis or broader underlying economic problems. They do little to replace lost income, fix balance sheets, prevent insolvencies, rebuild trust, or restore supply chains. 

Rightly, today’s stimulus money is mostly trying to flow more toward main street than financial markets. This is critically important and will help quell social unrest. However, when the government controls the means of income distribution, degrees of freedom for individuals and businesses will plummet. Underlying tensions will simmer and perpetually rise like the heat in a pressure cooker.

Getting money to individuals and SME’s — to where it is needed the most — is an enormous undertaking by itself and will take time. Money is desperately needed, but, unfortunately, a good deal of the fiscal stimulus is in the form of low-cost loans. Does a world already saturated in debt need new loans?

The complexities of the government going directly to Main Street means tens of millions of loans or touch points which in turn means more room for fraud, trickery and skullduggery. A “V-shaped recovery” and “business as usual” will simply not occur when the economy opens back up.

Demographics

Baby boomers are defined as those born from 1946-1964 (middle year of 1955). Looking at the average age of baby boomers during the last three major stock market declines (2001, 2008, 2020) result in dramatically different ages which should mean different reactions – all else being equal.  The average age was 46, 53, and 65 respectively. A 65-year old investor invests differently than a 46 year investor, especially when confronted with a huge wake-up call.

The developed world is aging rapidly. Age plays a part in how a person participates in society, how they vote and invest, and whether they are a net contribution or draw on the economy. The ratio of working age people relative to number of retirees matters. This is particularly true in the U.S. with an enormous amount of unfunded liabilities; $140 Trillion+ in pensions, social security and Medicaid alone. Most of the large developed world has poor demographics.

Wars, particularly the two world wars, played a significant role in the demographic make-up of many countries.  It skewed generational populations. Japan now has one of the oldest societies in the world and it also has a rapidly falling population. While the country has full-employment as a result, it has had low and limited GDP growth and zero inflation for almost 30 years. The global impact Japan is still playing out.

Germany is in equally bad shape. Germany’s boomers did not have many children and they lost 8 million men fighting the two world wars. A shortage of working age men negatively impacts a country’s means of production and level of consumption. This materially impacts Germany further due to its huge dependency on exports. A world that is de-globalizing magnifies the damage to Germany’s outlook. When demographics shift toward an extreme an entire country is destabilized.

The pandemic could not come at a worse time for the European (Dis)Union due to Germany’s financial role in keeping it together. Will Germany backstop Italian debt or that of other countries most impacted by the coronavirus and global recession? Will Germany’s own troubles lead to a two-tier EU and Euro: A North vs. South? Will the refugee problem cause Europe to close its borders, one to the other?  Will that be the vanguard of a dismantling of the EU and the Eurozone?

China’s demographics are also problematic. Since 2000, China’s GDP has expanded 4X, but over the same period its debt has expanded 24X.  Spending $6 of debt to achieve $1 of GDP growth is unsustainable. To keep the peace, particularly amongst many diverse cultures, Beijing leaders must continually improve the lives of its people. China has insufficient natural resources to be self-sufficient and lacks enough domestic demand to power its economy. A deglobalizing world has huge ramifications for China. (Japan, Germany and China are only a few examples)

Individual Behavior

The extraordinary and sudden shutting of economies and business doors have led to a plummeting of revenue and income, and skyrocketing of unemployment. These will forever change behavior and psychology. When crises occur, typically the exit is through a different door than the entrance. 

Too much complacency had settled in for investors and in people’s daily life. Too many people and businesses either recklessly forgot, didn’t have the means, or choose not to “save for a rainy day”. As a case in point, two weeks after “stay at home” orders were imposed there have been news reports of a 4-mile long car line at a food bank in Pittsburgh.  

In the future, individual savings will be higher and consumption will be lower. Due to regulatory reasons and reputational perceptions, businesses will think twice about issuing debt or using free cash flow, in order to buyback shares.

As the economy opens again for business, will people travel as much by air, or vacation on cruise ships? Will people work from home more often? Will they frequent restaurants as often? Will they go to theaters as frequently or watch streamed entertainment at home instead? Are people more likely to cook at home or cook pre-assembled delivered meals ? The list of questions here are endless and important. The answers will frame the future.

De-Globalization

The benefits of globalization over the past 30 years are too vast to list or quantify. Yet, the extent of globalization likely peaked a few years ago. Last year, as a matter of fact, was only the third time in 40 years that total global trade fell. Nationalism is on the rise; refugee populations continue to increase and so does impulses toward protectionism. Geopolitics are ascendant. As countries contend with record high debt levels and challenges to economic growth, they will drift further toward placing their own needs above that of global cooperation. It may even be every country for itself, and damn globalization.

Globalization has been about economic efficiencies driven by the (proven) Ricardian ‘Theory of Comparative Advantage’. Yet, the coronavirus dramatically damaged the complex web of interconnected global supply chains. The extend of this was outlined in my paper, “Coronavirus: A Catalyst for System Failure”. It was further damaged by demand destruction from global “stay at home order”.

As economies come back on-line, a whole new recalibration will occur as priorities and preferences become reconfigured. Mining, production and manufacturing for critical goods will take precedence over cost efficiencies. A few examples:

• N95 mask production moved almost exclusively to China when they could be produced there for 2 cents or 50% less than the cost elsewhere.
• Mines in Nevada that harvested rare earths were closed when China could produce them cheaper. 
  • Rare earths are used in electronics like flat-screen TVs and heavily by our military.  Should the US military be dependent on China for rare earths just as China itself is becoming more militaristic?
• Several key pharmaceutical drugs and other critical product will likely move from overseas production to US shores.

Bottom Line: The Coronavirus exposed many vulnerabilities. Going forward, governments and businesses will rethink the means of production and global trade. The choice will be less about economic efficiencies and more about resilience. National and geopolitical imperatives will dominate economic imperatives.

Fed “Unlimited”

The Fed was acting like a Finance Ministry well before the coronavirus struct. The newest blurred lines between the Treasury and Fed, and between monetary and fiscal policy, has emboldened the Fed even further. The old Fed term “forward guidance” was a way for the Fed to manipulate markets and investor psychology without taking direct action. Today the Fed uses the word “unlimited” to try to scare investors and risk assets higher. They both believe that due to the Fed’s unique accounting standard and the Treasuries printing press that “unlimited” is a choice.  It is not!

Certainly the US enjoys a unique and enormous privilege by having the world’s reserve currency. Valery Giscard d’Estaing called it “an exorbitant privilege”. Yet, abusing this privilege via an overheating dollar printing press has consequences. Supply and demand matter – just ask Weimar Republic, Venezuela, and Zimbabwe.

In March 2019, I wrote a paper called, “Dangers of Dollar Debasement” that took a deeper dive into this topic and calls for MMT (Modern Monetary Theory). I wrote about the ‘Triffin Dilemma’ outlined by economist Robert Triffin in the 1960’s.  The dilemma suggests that a reserve currency faces two simultaneous but opposite incentives of running a balance of payments deficit and surplus at the same time.  A deficit is necessary to provide liquidity to other countries for world trade and for other countries in need of foreign exchange reserves. However, a chronic deficit, in turn, undermines confidence in the USD, so a surplus is warranted.

The US today has to print enough dollars to help both domestic money shortages and US financial markets, and enough for the rest of the world as well. This is important because foreigners issued enormous amounts of debt denominated in USD in recent years. There is over $15 Trillion in USD denominated corporate debt maturing in the next 3 years; 25%+ of this total in 2020. The dollar today is at a record high against all other fiat currencies (the only exceptions are CHF and JPY). A soaring dollar means that those issuers have rising liabilities relative to their assets. U.S. dollar denominated debt must be serviced with U.S. dollars. Going forward, foreigners will not make that mistake again.

Despite the US having record amounts of ever-growing debt and deficits as far as the eye can see, the USD has remained the world’s currency simply because there is no other alternative. But the faith in the USD will slowly decline over time as a result of policies today and over the last decade. International trade will find a means of exchange away from a USD base. The US will slowly struggle to underwrite its colossal debt obligations. Deflation will likely be an issue in 2020, but 1970’s stagflation will likely be the result and the challenge in 2021 and beyond.

Bretton Woods No More

The US has lost interest in being the world’s policeman. Attitudes and action have been turbo-charged under a Trump presidency. The Bretton Woods agreement that established the modern world order and the USD as the world’s currency is fracturing. In return for the privilege of issuing the world’s reserve currency (in which 60%+ OF international trade is transacted) the US has provided security and military might.  For instance Germany and Japan have been protected without maintaining much a military. Providing safe shipping lanes for global trade has helped power globalization and peace for almost all nations.

As mentioned earlier, nationalism is on the rise. Trump’s motto is MAGA (Make America Great Again). A few years ago, the shale revolution made the United States energy self-sufficient and a net exporter of energy.  We are one of the few countries in the world capable now of being totally self-sufficient in regards to food security, energy and other essential products.  This means that we don’t need to offer as much protection across the world.

Former energy needs made the US dependent on oil exporters like Canada, Mexico, Venezuela, and Saudi Arabia. That Saudi Arabia is a strong counter balance to Iran is important, but our former dependence on oil is what has maintained our relationship with Saudi Arabia. There must have been a good reason, after all. Saudi Arabia is a brutal dictatorial regime brimming with human rights violations. Is the US shale industry the reason why the Saudi’s imploded the price of oil?  Most likely. Although this time they may have turned their sights on Russia, the other large oil exporter in the threesome.

Bottom line: The US is pulling back from its role in the world. Countries will be more vulnerable internally and externally. Ethnic group uprisings will occur. Border disputes will arise. Key shipping lanes will be under attack by adversaries and pirates. Regional trading blocs will develop that shut others out. The world is set to become an inherently more unstable place.

Please visit the “Library” tab at FETIgroup.com for other papers, including the ones mentioned in this note.

Moments ago, we reported that as part of what is the largest production cut deal in history, both Saudi Arabia and Russia will cut their output by 20%, capping their output to 8.5MM b/d in May and June under the new OPEC+ deal removing about 5 million barrels. The remaining countries in OPEC+ will contribute another 5 million or so with Bloomberg reporting that all members of OPEC+ have agreed to cut their output.

The market is unimpressed, though; after rallying as much as 10%, crude has swung to a 7% drop.

The reason: as we noted earlier, in a world where there is as much as 35MM b/d in less demand, the 10MMb/d production cut is, as Bloomberg puts it, “nowhere near enough.”

Worse, it appears that even the so-called deal is not really a deal, with Mexico reportedly objecting in the last minute, and Kazahkhstan and Brunei also unhappy:

Kazakhstsan, Brunei and Mexico consulting with their governments on their base line… they are not happy #OOTT

— Amena Bakr (@Amena__Bakr) April 9, 2020

And just when everyone thought there is a deal, an energy reporter notes that “the drama continues…. the smaller producers are holding up the deal now!”

The drama continues…. the smaller producers are holding up the deal now! #OOTT

— Amena Bakr (@Amena__Bakr) April 9, 2020

Assuming there is a deal, what happens to oil next?

Well, according to Goldman which predicted precisely this outcome – namely a 10mmb/d production cut today – WTI is headed back to $20. For those who missed it yesterday, here again is the summary:

Our updated 2020 global oil balance suggests that a 10 mb/d headline cut (for an effective 6.5 mb/d cut in production) would not be sufficient, still requiring an additional 4 mb/d of necessary price induced shut-ins. While this argues for a larger headline cut of close to 15 mb/d, we believe this would be much harder to achieve, since the incremental burden would likely need to fall on Saudi Arabia to be effective. Further, our price modeling suggests that Brent prices near $35/bbl already reflect such an outcome, with last week’s rally having brought crude prices to levels that likely slow the large-scale US production drop that are necessary to a deal in the first place.

Net, while the prospect of a deal can support prices in coming days, we believe this support will soon give way to lower prices with downside risk to our near-term WTI $20/bbl forecast. Ultimately, the size of the demand shock is simply too large for a coordinated supply cut, setting the stage for a severe rebalancing.

And some more details:

The ability for the US to participate in coordinated cut is limited by regulation (as we discuss in this footnote) although such hurdles are unlikely to prevent a deal. First, the US administration has expressed its willingness to use political/defense leverage or tariffs on Saudi and Russia oil imports to obtain a cut. Second, and perhaps most importantly, the US can point to its contribution with upstream activity already dropping and the US Department of Energy forecasting on April 6 that production would be falling by 2 mb/d by year-end relative to its previous March forecast.

Assuming that a deal is reached – our base case now – the key question will be whether its size and timing will improve global oil balances sufficiently to support prices above current levels. This is key, as a cut that would prove too little too late would lead to storage saturation and additional necessary production shut-in, with distressed producers driving physical crude prices and spot oil prices sharply lower. Our updated 2020 global oil balance suggests that a 10 mb/d headline cut would not be sufficient, still requiring necessary price induced shut-ins on top of such voluntary curtailments.

To come to this conclusion, we update and refine our 2020 global oil balance (we provide a full breakdown of this analysis in Section 2 of this report). First, we once again slightly lower our demand expectations as isolation policies get deployed in a still growing number of countries and with their lift date increasingly pushed back. We now expect a hit to April/May/June global oil demand of 22/16/9 mb/d (19/12/6 mb/d previously). Second, we introduce an estimate of peak monthly storage fill capacity, which starting from current stock levels is of 17 mb/d in April (with 20 mb/d likely achieve last week[3]), 13 mb/d in May and only 5 mb/d in June. From a base-case production perspective, we broadly maintain our last published production forecast from March 17 (which reflected steady declines in output but did not allocate the necessary shut-in), allowing us to estimate both the sizes of the voluntary and necessary shut-ins.

While this would simply argue for a larger 15 mb/d “headline” cut (with “effective” supply reduction of 10 mb/d), we believe it would be much more difficult to pro-actively allocate an incremental 5 mb/d of voluntary cuts across countries that do not have Saudi’s geological oilfield flexibility, with the Kingdom’s own ability to cut to 8 mb/d likely challenged. In fact, recent price levels would likely keep US crude prices at levels that disincentivize the large scale US production drop that backdrop the rationale for the cuts in the first place. As a result, an 10 mb/d “headline cut” that would still require additional large but short-lived price-induced cuts is likely the preferred outcome for core-OPEC, as it ensures the contribution of many producers (and higher OSPs even should Brent prices return to their lows).

While the prospect of a deal can support prices near current levels in coming days, we believe this support will soon give way to lower prices, due to both positioning and fundamentals. First and foremost, we don’t believe that a 10 mb/d “headline” production cut can shore up oil balances with lower prices still needed. Second, the sharp short-covering rally of the past week has already brought prices to the levels that we forecast in 3Q20 when the surplus would be ending, a still uncertain outcome. Third, downward price pressure in coming days will be exacerbated by the roll of the long WTI future positions underlying the recent increase in speculative buying[4], as visible on April 6 and in early 2009. Fourth, the potential inability to broker a cut sufficiently large to support seaborne crude prices suggests that Saudi producing at high levels instead to maximize cash flow would actually not be irrational, an outcome that appears mis-priced, with the WTI options market currently only assigning an 18% probably that prices reach $15/bbl by mid-May.

Ultimately, the size of the demand shock is simply too large for a coordinated supply cut, setting the stage for a violent rebalancing (see Top of Mind – Oil’s Seismic Shock page 9). Looking forward, our base-case remains unchanged, with a shift to a deficit by July and a gradual recovery in Brent prices (from lower levels than currently) to $40/bbl by October as inventories start to wind down. The path of the demand recovery will be of course essential to how this price recovery plays out. But after such a violent rebalancing, supply cuts will matter increasingly and could create upside price risks later this year.

It will take time to restart the 10.5 mb/d of shut-in wells (6.5 mb/d voluntarily and 4 mb/d out of necessity) which could also lead to permanently lost productive capacity. For example, if we assume (1) a recovery in OPEC/Russia production through 3Q-4Q20 back to 1Q20 levels, (2) that production declines expected outside of shut-ins (due to lower capex and decline rates) don’t reverse and (3) that 1 mb/d of the remaining production cuts take at least a year to return online, our oil balance would feature fully normalized inventory levels by early 2021 and point to Brent prices at $55/bbl. While such a rally could be delayed by a faster unwind of the cuts, it does illustrate that the violent rebalancing we expect in coming weeks can set the stage for a potential large price recovery later this year.

After all that, it appears that oil trading algos have finally had time to google supply and demand.

If the “bait and switch” is becoming a Musk family tradition, Kimbal Musk could be learning from the best. But the brother of billionaire Elon Musk may have hit a new low in bilking money out of the staff at his own restaurants while calling them “family”.

Rank and file employees, many waiters and waitresses making about $2 per hour before tips at Musk’s Next Door restaurant chain, paid $2.50 per paycheck into an emergency fund that the chain was collecting. And when the coronavirus happened, the money wasn’t there for them, according to the Huffington Post.

When Musk’s chain of restaurants shut down for the pandemic, hourly workers were told they “would get no pay at all, though they were told they could access paid sick time”. They reportedly “never got” their paid sick time, prompting many of them to apply for grants from the emergency fund they had been paying into. 

Reggie Moore, the former head chef at the Indianapolis Next Door, said what happened next was “pretty shady”.

The company said they were altering the fund five days after the shutdown. “In an effort to better help our employees, we are in the process of revising our Family Fund program,” the restaurant wrote in an e-mail to employees.

They told employees they would need to re-apply for the Fund under the new parameters, but were never given a link to do so. 

“It’s a betrayal. It seems really sneaky,” one former Next Door manager said. “The Kitchen Restaurant Group did this 100% the wrong way. They took people who were loyal to them and they slammed the door in their face. I understand that sometimes business decisions must be made but doing it this way, I felt like it was really wrong.”

In Memphis, employees were confused. Employee Mason Whitman said: “It was a really uniquely encouraging atmosphere to work in. I never dreaded a single day of work.”

Speaking about the fund, Whitman said: “It was designed to aid individual employees during times of hardship or injury. The only figures I’ve heard have been between 50 cents and $2 per week. You could select an amount from your check to be donated into that fund every week.”

“There’s no reason for that fund to not be empty now. You’ve just lost employees — some are struggling financially.”

So, Kimbal, where’s the money?

Maybe it’s under his cowboy hat https://t.co/1wkYbbTGOa

— Quoth the Raven (@QTRResearch) April 9, 2020

Submitted by Jim Bianco of Bianco Research

As I’ve argued, the Fed and the Treasury merged. Powell said this was the case today (from his Q&A):

These programs we are using, under the laws, we do these, as I mentioned in my remarks, with the consent of the Treasury Secretary and the fiscal backing from the congress through the Treasury. And we are doing it to provide credit to households, businesses, state and local governments. As we are directed by the Congress. We are using that fiscal backstop to absorb any losses we have.

Our ability is limited by the law. We have to find unusual, and exigent circumstances and the Treasury Secretary has to agree, and we are using this fiscal backstop. There is really no limit on how much of that we can do other than meet the tests under the law as amended by Dodd-Frank.

The Fed needs the Treasury Secretary’s permission to do this.

That means Trump must approve this (as the Treasury Secretary serves at the pleasure of the President). No doubt Kudlow was asked to weigh in (which would be appropriate for the National Economic Chairman to do).

So, Larry was able to know this was coming when we said two days ago.

“the Fed is sitting with the ultimate bazooka”

The real question is not how far will they go, that is unlimited, but will Trump ever allow them to stop?

Does Trump think he can ram the stock market to DJIA 40,000 despite what fair value might say it is? And will he demand the Fed “print” the mother of all bubbles to get re-elected?

It is now legal, and Trump now has the authority to do exactly this. The Fed has given away its independence to the Administration. The only thing that would stop him is discipline and restraint … two words not often associated with Trump.

Though he remains hospitalized, UK Prime Minister Boris Johnson has left intensive care, Downing Street said Thursday afternoon.

The news will come as great relief to Britons who rallied around the PM this week as his condition deteriorated markedly, nearly leading to his intubation.

Fortunately, he was able to avoid that – though he did briefly receive oxygen assistance.

It remains unclear when Johnson will return to leading Britain. Dominic Raab said Thursday that he hadn’t spoken with Johnson directly in days, but assured the public that an update would arrive by the evening.

The PM has reportedly been moved back to the ward in the unnamed UK hospital where he is receiving treatment. His office said that he remains in “good spirits”.

All told, he spent 3 nights in the ICU.

Given his speedy improvement, we can’t help but wonder if he was given the ‘quine.

From an initial $75 billion per day, The Fed reduced its daily buying to $60 billion per day, then  last week announced another ‘taper’ in its bond-buying program to $50 billion per day for next week. Now it has slashed its buying to “just” $30 billion per day.

Having implicitly confirmed there is now a shortage of bonds as demonstrated by the recent repo ops that saw zero submissions as instead of using repo to park bonds with the Fed Dealers merely sell them back to the Fed, the NYFed has announced it will continue cutting back, or tapering, its “unlimited QE” bond-buying next week.

Here is the full schedule for the week ahead.

Additionally, The Fed will taper its MBS buying from $25 billion to around $15 billion in MBS per day next week: 

•  

• Mon: $14.55

• Tue: $15.675 

• Wed: $14.55

• Thur: $15.675

• Fri: $14.55

So, in aggregate, The Fed will buy a total of $225 billion of MBS/TSYs next week… still vastly more on a weekly basis than the largest “QE” programs monthly totals before this crisis.

Authored by Philip Marey via Rabobank,

Summary

• While the outlook for 2020 remains sketchy, heavily dependent on non-economic factors, we now expect GDP to fall by 6% in 2020.

• With a slowdown in February and a sharp contraction of the economy in March, we expect GDP growth in Q1 to be negative (-5% quarter on quarter at an annualized rate).

• However, the most extreme economic growth figure is likely to be Q2 GDP growth with the lockdown continuing through at least April and likely May. If we look at the industries affected, we estimate that GDP growth could fall by 31% quarter-on-quarter at an annualized rate.

• We estimate that the rebound would be 14% quarter-on-quarter at an annualized rate in Q3. This is still another unusually large number, but it is the echo of the supply effect in Q2. What’s more, it’s muted by demand constraints as consumers and firms will not come unscathed out of the lockdown.

• Therefore, we expect a modest decline in GDP growth of 1% in Q4. That would give us a Wshaped recovery or even a double dip recession.

• If we look at the year as a whole we expect -6% growth in 2020.

Introduction

A year ago, we wrote the special The Recession of 2020 in which we predicted a mild recession to occur in the second half of this year. Based on a range of indicators we noted that the US economy was in the late phase of the cycle and we foresaw that the Fed’s hiking cycle would lead to an inversion of the yield curve, a reliable harbinger of recession. The yield curve indeed inverted and GDP growth slowed down during the course of 2019. However, the business cycle was not allowed to run its course. The longest US economic expansion on record was cut short by the coronavirus. Instead of the economy running out of steam – in our forecast in the second half of 2020 – it came to a sudden standstill in March as the coronavirus found its way to the US. Instead of forecasting a modest 0.4% decline in GDP in 2020, we were forced to go back to the drawing board. While the outlook for 2020 remains sketchy, heavily dependent on non-economic factors, we now expect GDP to fall by 6% in 2020. The most likely scenario for this year now looks as follows.

Q1: Plunging into Recession

The US lockdown started mid-March and this was highly visible in the initial jobless claims skyrocketing in the third week of March, followed by an acceleration in the fourth week. However, the coronacrisis was already having a negative impact on the US economy prior to that. For example, the second week of March already saw a substantial increase in initial jobless claims, although this was dwarfed by what happened in subsequent weeks. Even earlier, in February, Markit’s services PMI – reaching its lowest level since the Great Recession – showed that the leisure and travel sectors were getting big hits, pushing the services sector into contraction. What’s more, the PMI for the manufacturing sector had fallen to its lowest level since the government shutdown in October 2013 and the PMI for the services sector had. What’s more, the services PMI had fallen into contractionary territory.

With a slowdown in February and a sharp contraction of the economy in March, we expect GDP growth in Q1 to be negative (-5% quarter on quarter at an annualized rate). This means that by the technical definition of two subsequent quarters of negative GDP growth the US recession started in Q1. However, in the US the NBER Business Cycle Dating Committee decides on the basis of a wide range of data in which month the recession started and in which it ended. Looking at these data, we expect that the NBER will choose March as the start of the recession (i.e. February as the peak of the last expansion).

Q2: Into the Deep

However, the most extreme economic growth figure is likely to be Q2 GDP growth with the lockdown continuing through at least April and likely May. If we look at the industries affected, we estimate that GDP growth could fall by 31% quarter-on-quarter at an annualized rate. Apart from US GDP growth data being represented at annualized rates (factor 4), this extreme number is possible because the economy is supply-constrained, not demand-constrained as in normal circumstances. The latter case has much less variation than a sudden stop on the supply side of the economy.

Q3: On the Rebound

If we assume that the US economy will be open again by Q3, the mere fact of reopening supply will cause another extreme swing in GDP growth, but then upward. However, once the economy is open again the economy will be demand-constrained. Then the question is how much impact the lockdown will have on demand. Consumers and firms will not come unscathed out of the lockdown. Many consumers will have lost income or even their job. This will restrain consumer spending. They will also remain risk-averse as long as there is no vaccine. In particular, spending on leisure and travel sectors may be slow to recover. Many businesses will have lost income as well, often incurring additional debt. This will limit business investment. Keep in mind that the Fed’s lending facilities for corporates are only available to those with an investment grade rating. The negative impact on aggregate demand will take the edge off the supply-induced rebound in Q3. Therefore the rebound will not be as large as one would expect based purely on supply considerations. We estimate that the rebound would be 14% quarter-on-quarter at an annualized rate in Q3. This is still another unusually large number, but it is the echo of the supply effect in Q2, muted by demand constraints.

Q4: The Moment of Truth

This leaves Q4 as the first quarter where GDP growth will reflect fluctuations in demand, like in normal circumstances. While the stimulus measures taken by the federal government and the Fed may keep a substantial fraction of the business sector alive, the question is whether these businesses will be able to survive on their own. What’s more, many businesses – below investment grade – may perish without getting any help. The outlook for business investment does not look good. Therefore, Q4 may be the moment of truth for many businesses: can they survive the damage incurred by the lockdown? Perhaps the drag on demand will still allow a modestly positive GDP growth rate in Q4, but more likely we are going to see GDP growth turn negative again, although not as extreme as in Q2. For now, we expect a modest decline in GDP growth of 1% in Q4. That would give us a W-shaped recovery or even a double dip recession. If we look at the year as a whole we expect -6% growth in 2020. Not the mild recession we had anticipated a year ago (-0.4%).

Unemployment Peak at Depression Level

This is already showing up in the labor market data, with initial jobless claims skyrocketing in the last two weeks of March. If we look at the industries and occupations affected, we expect the unemployment rate to peak between 20% and 30% in April or May, comparable to levels we saw during the Great Depression. However, for now this is largely supply-induced, so we should see a decline in unemployment once the lockdown is over. However, since the damage to the demand side of the economy will be substantial we are not likely to see unemployment falling back to the 3.5% figure of February anytime soon. We expect 8.5% unemployment by the end of the year.

Conclusion

It will take until Q4 before we can assess how much damage has been done to the US economy. At this point in time, we expect the economy to continue to struggle well after the lockdown has been lifted. If a vaccine against the coronavirus arrives in early 2021, economic growth could pick up and we might end up with 4% GDP growth in 2021. However, a range of more negative scenarios is also possible. Delays in getting the coronavirus under control could be one reason. But the indirect economic impact of the lockdown and subsequent social distancing measures should also not be underestimated. Many businesses won’t survive or accumulate huge debt burdens and many households will face loss of income and employment. While the supply effects are prevailing at the moment, the demand effects may last for years.

BNP Paribas SA, the largest French bank, lost hundreds of millions of dollars on complex stock trades as markets crashed in March, Bloomberg reports. Traders at the Paris-based bank, which together with SocGen has long carved out a niche in sophisticated derivative trades which worked great as long as the market was levitating unperturbed – lost an estimated €200 ($219 million) on equity derivatives once the market tumbled. According to Bloomberg, the trades that went awry included dividend futures and structured products.

BNP lost about 100 million euros on structured products, ostensibly by taking the other side of trades they sold to retail investors across Japan and South Korea; the trades were linked to baskets of stocks and other assets. The bank also lost about 100 million euros on dividend futures, with losses surging at one point to about 300 million euros before improving.

Dividend futures are derivatives that investors use to speculate on the payouts that companies make to shareholders. They have tumbled to historic lows in recent weeks as some of the world’s biggest corporations shred their awards in response to the coronavirus and, in some industries, pressure from regulators.

According to a JPM note, BNP and its crosstown rival SocGen are some of the biggest arrangers of dividend futures. Banks in this business are often “structurally long dividends,” JPM analyst Kian Abouhossein wrote, which means they were betting on an increase in payouts and “exposed to a decline in dividend expectations.” Alas, that’s precisely what happened.

That said, it’s unclear how much the losses will weigh on BNP Paribas’s overall first-quarter results. Banks taking a hit on dividend futures could likely offset them with gains elsewhere, Abouhossein wrote. He estimated that overall equities revenue at BNP Paribas could climb 13% year-on-year to 550 million euros.

While the French bank lost in the chaos, US banks were winners:JPMorgan and Citigroup made hundreds of millions in revenue from equity derivatives, as previously reported.

Preliminary orders for Class 8 trucks in March plunged to their lowest levels since February 2010.

And to make matters worse, one could argue that March wasn’t even fully affected by the coronavirus and that April’s numbers could wind up being significantly worse. 

ACT Research said that orders for March were just 7,800, which falls 51% lower than what was considered an “easy” year over year comp. FTR Transportation Intelligence estimated March orders at 7,400. All four major heavy duty truck manufacturers suspended production for March as a result of the virus, according to FreightWaves.

ACT is now estimating that 2020 production is going to be 53% lower than the 345,000 build in 2019. Meanwhile, the industry was already looking mired in a slowdown before the virus even hit. 

Kenny Vieth, ACT president and senior analyst said: “On a seasonally adjusted basis, March was the weakest Class 8 order month since February 2010, and with COVID-19 becoming an even hotter topic over the course of March, one wonders about the impact on order activity on a go-forward basis.” 

FTR stated the obvious: the uncertainty around the virus is limiting orders to only what people definitely need for the short term. They predict orders will stay under 10,000 per month until the economy eventually recovers. 

Contributing to the issue is the fact that many carriers already have newer trucks in their fleets. The industry has been plagued by a backlog since a production spree caused an inventory glut back in 2018. 

Don Ake, FTR vice president of commercial vehicles said: “The only good news here is that the number was still positive despite the high number of expected cancellations. The gross order number is probably higher than 10,000 trucks, which means at least some fleets need more vehicles.”

But carriers with contracts for items like consumer goods and paper goods aren’t seeing a slowdown. Jeff Shefchik, president of Paper Transport Inc. in De Pere, Wisconsin, said: “We always knew [toilet paper] was important and saw it as not a very glamorous product. But all of the sudden, it became very glamorous.”