Clarmond: The Virus Exposed That Treasury Collateral Is Anything But Stable
Authored by Mustafa Zaidi, head of Research and Development at Clarmond Wealth
My father’s dark brown attache case, with its light, soft suede interior, lay invitingly open on his bed. The case was filled with intriguing goodies for a 10yr old to examine. There were files and photos of building sites (he was an engineer), a cluster of pens and a case of well sharpened Staedtler pencils, his passport, current and old stapled together and a multitude of colourful bank notes that I took out and spread out on the bed, making a pile of each kind. There were super large French Francs, small Deutsche Marks, crisp Japanese Yen, grimy UAE dirhams, grand looking British Pounds, AMEX travellers’ cheques, but the largest stack was of inky green US Dollars.
As I finished my piles, my father, who was watching, motioned me to bring the globe from his desk. “Can you match the notes to the countries on the globe.” I nodded and started from Japan, making my way to the United States. Putting his hand on the world he said – “you can pay for things with these notes – pointing to the francs, marks, yens, pounds – only in their own country, but these” – pointing to the dollars – “you can pay for anything….everywhere” “Wow”, as I held up the Dollar, “this is magic money;” he flashed a brief smile. “Yes, now put it all back in the briefcase.” Magic money……I was hooked.
Over the last four weeks this ‘hook’ has felt more like black magic and all my previous crises (1987, 1998, 2001, 2008) have felt as if rolled into this last month. Perhaps we all need a step back from the daily market fury and see what this pandemic has exposed. In January and February we all saw the events in Wuhan and the cruise ship in Yokohama; the market shrugged. But abruptly in March the virus mattered. Why?
The Asian supply chain was shut down; this is a 90 day credit chain and by March it had run out of credit and needed more. Suddenly there was a demand for US Treasury collateral with which to create credit and this collateral became unstable, with the Treasury yield falling 70% in a few weeks. This collateral was assumed to be stable given it is the keystone of the future global financial architecture.
The lesson from the 2008 crisis is that we needed secured lending rather than unsecured lending to create credit. This therefore meant a move from the old LIBOR system to the new SOFR (Secured Overnight Financing Rate); this transition is due in January 2021. What Covid-19 has done is give this future SOFR system an early test by fire.
The virus exposed the fact that the collateral is anything but stable. As the treasury collateral became unstable all assets around it became unhinged, from investment grade bonds, to high yield, to munis, to commercial paper, to US$s for settling trade and finally to equity markets.
Given the Covid-19 test the upcoming SOFR system has shown vulnerability on two counts: first, collateral can be unstable and second, there are not enough trade dollars for settlements. The Fed will have to address the first by actively controlling the yield curve and the second by opening up substantial US$ swap lines to other central banks. The Fed’s balance sheet cannot be challenged so it will either the castrate levered / hedge fund money so they cannot destabilise the treasury market again or they will temporarily lift the leverage regulations on the banks, as the banks assist the Fed in its policy rather than take it on like a hedge fund.
Our payment system is a credit system, and we need to have enough credit to settle our payments, even if we have no money. And this credit system needs a stable collateral and lots of US$s to work efficiently.
Four and a half decades may have passed but the world still needs its magic money found neatly stacked in my father’s briefcase. Hoping to see you post isolation.
Trump Weighs Legal Action Against China Over PPE Hoarding As International ‘Mask Wars’ Heat Up
The Trump administration is considering legal action against China after leading US manufacturers of medical safety gear say Beijing has prohibited them from exporting goods in what the New York Post says was a bid to “corner the world market” in personal protective equipment (PPE).
“In criminal law, compare this to the levels that we have for murder,” said Trump re-election campaign senior legal adviser, Jenna Ellis, who says that legal options include filing a complaint with the European Court of Human Rights or working ‘through the United Nations.”
“People are dying. When you have intentional, cold-blooded, premeditated action like you have with China, this would be considered first-degree murder,” she added.
Executives from 3M and Honeywell told US officials that the Chinese government in January began blocking exports of N95 respirators, booties, gloves and other supplies produced by their factories in China, according to a senior White House official.
China paid the manufacturers their standard wholesale rates, but prohibited the vital items from being sold to anyone else, the official said.
Around the same time that China cracked down on PPE exports, official data posted online shows that it imported 2.46 billion pieces of “epidemic prevention and control materials” between Jan. 24 and Feb. 29, the White House official said. –New York Post
In total, nearly $1.2 billion in gear – which included over 2 billion masks and 25 million “protective clothing” items which came from EU countries, along with Australia, Brazil and Cambodia according to the White House official.
“Data from China’s own customs agency points to an attempt to corner the world market in PPE like gloves, goggles, and masks through massive increased purchases — even as China, the world’s largest PPE manufacturer, was restricting exports,” they added.
‘Mask wars’
The shortage of vital protective equipment has pitted neighboring countries – and even US states – against each other, resulting in accusations of theft and modern piracy, according to the CBC. The United States, in particular, has been accused of stymying efforts by allies to procure said equipment – by allegedly attempting to scuttle European deals for purchases from China, as well as attempting to halt exports of US-made N95 masks to Canada and Latin America last week.
That said, a Berlin senator who accused the US of “piracy” by diverting a shipment of protective masks slated for delivery in the German capital has reversed his position – saying that no US firms were involved in the case of the still-missing masks.
The CBC suggests that ‘the apparent desperation of some of the wealthiest countries on earth’ comes as a surprise which has ‘justifiably raised eyebrows in less fortunate parts of the world’ which are now preparing for coronavirus to hit, yet with a fraction of the resources.
Striking selfishness
“It’s normal for countries to take care of their own citizens first,” said University of Ottawa professor of international affairs and former Trudeau adviser, Roland Paris – who added that the selfishness and lack of coordination among leading countries “is striking.”
“We’re unfortunately seeing a mad scramble to grab whatever’s available, to hell with the other guy,” added Paris, who’s apparently unfamiliar with game theory.
Even more stark, the mask wars have seen American and other buyers scuttling European and Brazilian deals, some even snatching shipments already promised to other jurisdictions by outbidding them—even “on the tarmac” as planes prepared to take off. Some shipments reportedly just disappear. –CBC
Not just masks…
While global PPE supplies have run critically short, nearly half the supply of hydroxychloroquine – the Trump-touted treatment for COVID-19, comes from India – which has banned exports of all form of the ‘game-changing’ drug.
Consequently – while China is without a doubt the biggest antagonist to the US, India is beginning to grate on Trump’s nerves despite his nominally cordial relationship with Modi. According to data compiled by Bloomberg Intelligence, 47% of the U.S. supply of the drug last year came from India makers. Only a handful of suppliers in the top 10 are non-Indian, such as Actavis, now a subsidiary of Israeli generics giant Teva Pharmaceutical Industries Ltd. Still, it’s likely that some of their production facilities are nevertheless located in India.
India’s export ban on the drug is aimed at ensuring it has enough supply for domestic use after the American president’s endorsement sparked global stockpiling of the medication. Now, Trump’s decision to tout the drug will cause major shortages in the US.
Imagine if the United States hadn’t exported the manufacture of just about everything?
In this week’s pick of energy and commodity charts to watch, super tankers are in high demand to store oil while prices remain at historic lows. Plus, regional gas prices converge around all-time lows, European steel and aluminum demand plummets, and Asian gasoline markets expect little relief from oversupply.
1. Global crude oil glut creates demand for long-term floating storage
What’s happening? Some super tankers are being booked to store crude for up to three years—potentially the longest ever duration for floating storage—as traders seek to profit from hoarding oil to cope with the current oil demand and supply shocks. The race to secure floating storage has picked up significantly in recent weeks, with up to 40 VLCCs and 20 Suezmaxes already placed on long-term chartering, according to S&P Global Platts estimates.
What’s next? Freight rates and storage costs have ballooned as the market faces the prospect of more oil just as demand destruction due to the spread of coronavirus escalates. This has raised the stakes over how the world’s biggest producers, the US, Russia and Saudi Arabia will confront the challenges of competition over market share, lower prices and potentially a lack of buyers for their crude.
2. Weather, oversupply pressure gas prices across regions
What’s happening? Global gas prices have again converged, this time around record lows, pressured by the mild northern hemisphere winter, high gas stocks and a still oversupplied global market. The JKM benchmark LNG price has fallen to an all-time low of just $2.26/MMBtu for the front month, bringing it down closer toward the prompt TTF and Henry Hub prices.
What’s next? With winter now behind us and the start of the LNG shoulder season, there is little optimism in the market for a recovery in prices, especially with European stocks significantly higher than in previous years and concerns over the demand impact of the coronavirus. Producers are feeling the pinch and industry is watching closely for signs of any supply curtailments in the coming weeks.
3. European aluminum and steel demand decimated by automaker shutdowns
What’s happening? European automakers have been shutting down production since March 13 in response to the outbreak of coronavirus. With the automotive industry a major consumer of both steel and aluminum in Europe, the shutdowns have had a marked impact on demand, reducing daily consumption by an estimated 55,000 mt of steel and 11,000 mt of aluminum.
What’s next? Blast furnaces across Europe have idled in response, and players up and down the aluminum value chain have done likewise. Looking ahead, there is little light at the end of the tunnel as car manufacturers continue to revise dates for restarts.
4. Coronavirus effect could erase expected gasoline demand peaks in Asia
What’s happening? The Asian gasoline market has been hit hard by the coronavirus pandemic. Traditionally, Indonesia’s peak gasoline demand occurs during the Muslim fasting month of Ramadan, which begins toward the end of April and lasts till the end of May this year, followed by the Islamic holiday of Eid al-Fitr. More stringent containment measures could derail this trend. State-owned Pertamina has already tapered its pre-Ramadan intake of gasoline to around 10 million-11 million barrels of gasoline in April, down from the 12.236 million barrels the country imported in April 2019, according to market sources. In India, the country’s transition to Bharat Stage VI fuels from April 1, which was expected to result in a demand surge for motor fuels with low sulfur content, has so far had a muted impact on demand as its “Janta Curfew” and nationwide lockdown have dampened both market sentiment and consumption.
What’s next? Market participants will be closely watching the US RBOB/Brent crack as well global economic growth indicators. Asian gasoline crack spreads closely track movements in the US RBOB/Brent crack, with the latter typically rising during summer, from April to October. However, given the weakness in the US RBOB/Brent crack and global GDP, the downward pressure on the gasoline market is likely to persist in Q2.
5. China’s PMI: A V-shaped recovery?
What’s happening? After falling to an all-time low of 35.7 in February, China’s manufacturing PMI, a keenly-watched indicator of economic health, rebounded to 52.0 in March, exceeding many analysts’ expectations. That doesn’t mean China’s economy is roaring back to life, just that over half of companies surveyed reported that their production, employment, new orders and the like were higher than last month – hardly an achievement given the economy was at a virtual standstill in February. Even the National Bureau of Statistics noted this reading did not mean that China’s economy had returned to normal.
What’s next? Government action to prevent a second wave of infections is likely to be a drag on economic activity. China has cut the number of international flights allowed into the country and closed cinemas again. Shanghai’s government has gone further, ordering tourist attractions to close in April. Sinopec, the country’s largest refiner, expects domestic oil product consumption to more or less recover in the second-half of the year. An S&P Global Platts survey found that Sinopec’s refinery operating rate was 72% in March, well up from the historical low of 64% in February, but still well under Sinopec’s average utilization rate last year which was more than 90%. More measures to close the economy will be a drag on demand meaning that, unlike the PMI, the shape of the recovery is likely to be far from V shaped.
6. EU power demand set to dive 10% in Q2 on shutdowns
What’s happening? European power demand is expected to fall 10% over the coming months due to coronavirus restrictions, with Italy and Spain the worst hit by extended lockdowns to non-essential activities. S&P Global Platts Analytics has cut its Q2 demand forecast for the four big Eurozone economies (Germany, France, Italy and Spain) by 16 GW, down 11% on year. Early indications for the second half of March show Italian demand down over 20%, while Germany was down 9%.
What’s next? April and May are generally low demand months for electricity, so additional cuts could be a challenge for system operators, as renewables’ share in the mix rises. A demand cut of 10% across the EU4 would be the energy equivalent of 70 standard LNG cargoes over the quarter. On the flipside, hydro resources are healthy and Europe’s wind and solar parks on a sustained run of output increases, reflecting on-going capacity additions. Daily load curves are changing as solar hours increase and morning peak demand flattens, reflecting the absence of industrial load. A low-demand, high-supply scenario tests system operation just as much as the reverse.
Tesla Posts Video Of Engineers Working On Ventilator Prototype Made From Tesla Car Parts
Just days after we reported that Elon Musk had sent several boxes of sleep apnea machines to New York under the guise of buying ventilators for help with the coronavirus, Tesla has now posted a video of their engineers working on a “prototype” ventilator.
The “prototype”, posted on Sunday night, relies heavily on using Tesla car parts, according to one of the engineers in the video.
And despite Musk saying more than two weeks ago that he was going to open his factory to produce ventilators – and while other companies are already setting up factory space for a ventilator production line – there was no timeline for production specified in Tesla’s video, according to Reuters.
“There’s still a lot of work to do, but we’re giving it our best effort,” an engineer in the video said.
Recall, in late March Ford said they aimed to produce 50,000 ventilators over the course of 100 days at a plant they have in Michigan, in cooperation with General Electric.
It was one day later that Musk said he was going to supply FDA approved ventilators free of cost to NY hospitals. Then, he donated several boxes of 5 year old sleep apnea machines instead.
As for Tesla’s ventilators? We honestly hope they can get them off the line and produced.
Since the passage of “tax cuts,” in late 2017, the surge in corporate share buybacks has become a point of much debate. I previously wrote that stock buybacks were setting records over the past couple of years. Jeffery Marcus of TP Analytics, recently confirmed the same:
“U.S. firms have been the biggest incremental buyer of stocks in each of the past four years, with their net purchases exceeding $2 trillion – Federal Reserve data on fund flows compiled by Goldman Sachs showed.”
“For much of the last decade, companies buying their own shares have accounted for all net purchases. The total amount of stock bought back by companies since the 2008 crisis even exceeds the Federal Reserve’s spending on buying bonds over the same period as part of quantitative easing. Both pushed up asset prices.”
In other words, between the Federal Reserve injecting a massive amount of liquidity into the financial markets, and corporations buying back their own shares, there have been effectively no other real buyers in the market.
Of course, as a corporation, you can’t spend all of your cash buying back shares, so with near-zero interest rates, debt became the most logical option. As shown below, much of the debt taken on by corporations was not used for mergers, acquisitions, or capital expenditures, but the funding of share repurchases and dividend issuance.
Unsurprisingly, when you are issuing that much debt for share repurchases, there is a correlation with asset prices.
“The explosion of corporate debt in recent years will become problematic during the next bear market. As the deterioration in asset prices increases, many companies will be unable to refinance their debt, or worse, forced to liquidate. With the current debt-to-GDP ratio at historic highs, it is unlikely this will end mildly.”
While that warning fell mostly on “dear ears,” the debt is now being bailed out by the Fed through every possible monetary program imaginable.
No, Buybacks Are Not Shareholder Friendly
Let’s clear something up. Buybacks are NOT shareholder-friendly.
The reason that companies spent billions on buybacks is to increase bottom-line earnings per share, which provides the “illusion” of increasing profitability to support higher share prices. Since revenue growth has remained extremely weak since the financial crisis, companies have become dependent on inflating earnings on a “per share” basis byreducing the denominator.
“As the chart below shows, while earnings per share have risen by over 270% since the beginning of 2009; revenue growth has barely eclipsed 60%.”
Yes, share purchases can be good for current shareholders if the stock price rises. Still, the real beneficiaries of share purchases are insiders where changes in compensation structures have become heavily dependent on stock-based compensation. Insiders regularly liquidate shares that were “given” to them as part of their overall compensation structure to convert them into actual wealth. Via the Financial Times:
“Corporate executives give several reasons for stock buybacks but none of them has close to the explanatory power of this simple truth: Stock-based instruments make up the majority of their pay and in the short-term buybacks drive up stock prices.”
That statement was supported by a study from the Securities & Exchange Commission which found the same issues:
SEC research found that many corporate executives sell significant amounts of their own shares after their companies announce stock buybacks, Yahoo Finance reports.
Not surprisingly, as corporate share buybacks are hitting record highs, so was corporate insider selling.
The misuse, and abuse, of share buybacks to manipulate earnings and reward insiders clearly became problematic.
Furthermore, share repurchases are the “least best” use of company’s liquid cash. Instead of using cash to expand production, increase sales, acquire competitors, make capital expenditures, or buy into new products or services, which could provide a long-term benefit. Instead, the cash was used for a one-time boost to earnings on a per-share basis.
Now, all the companies that spent years issuing debt, and burning their cash, to buy back debt are now begging the Government for a bailout.
“Perhaps no other industry illustrates the awkward position that corporate America finds itself in more than airlines. Major airlines spent $19 billion repurchasing their own shares over the last three years. Now, with the coronavirus virtually paralyzing the global travel industry, these companies are in deep financial trouble and looking to the federal government to bail them out.” – The New York Times
And who gets the privilege to PAY for those bailouts – YOU. The U.S. Taxpayer.
Loss Of Support
As we warned previously, when CEO’s become concerned about their business, the first thing they will do is begin to cut back, or eliminate, stock buyback programs. To wit:
“CEO’s make decisions on how they use their cash. If concerns of a recession persist, it is likely to push companies to become more conservative on the use of their cash, rather than continuing to repurchase shares. If that source of market liquidity fades, the market will have a much tougher time maintaining current levels, or going higher.”
Yes, companies are indeed reacting to the “coronavirus” pandemic currently. However, they were already in the process of cutting back on repurchases in 2019. As noted recently by Jeffery Marcus:
“Birinyi Associates, the leading firm that does research on buybacks, shows below that announced buybacks have declined significantly in 2019… ‘ it’s the biggest drop to start a year since 2009.’”
This is also because cash balances fell sharply, as corporations loaded-up on debt.
As the impact of the “economic shutdown” deepens, corporations are scrambling to protect their coffers. As noted on Friday, 75% of announced buyback programs have been cancelled.
Corporate buybacks have been the largest source of demand the last few years. 75% of announced buyback programs have been cancelled. So who is the incremental buyer with Boomers retiring in droves who hold the majority of wealth? pic.twitter.com/1IlRrruxDX
Greg’s tweet has a complete table, but here is the relevant chart. There is a tremendous amount of support being extracted.
Do not dismiss the data lightly.
The chart below is the S&P 500 Buyback Index versus the Total Return index. Following the financial crisis, as companies began to lever up their balance sheets to increase stock buybacks. There was a marked outperformance by those companies leading up to the crisis.
However, while corporate buybacks have accounted for the majority of net purchases of equities in the market, the benefit of pushing asset prices higher, outside of the brief moment in 2018 when tax cuts were implemented, allowing for repatriation of cash, performance has waned. Now, those companies which engaged in leveraging up their balance sheet to engage in repurchases shares are significantly underperforming the total return index.
Without that $4 trillion in stock buybacks, not to mention the $4 trillion in liquidity from the Federal Reserve, the stock market would not have been able to rise as much as it did over the last decade.
Conclusion
As I stated, CEO’s make decisions on how they use their cash. With the economy shut down, layoffs in the millions, and no clear visibility about the economic recovery post-pandemic, companies are going to become vastly more conservative on the use of their cash.
Given that source of market liquidity is now gone, the market will have a much tougher time maintaining current levels, much less going higher. As noted by the Financial Times:
“The rebound in equities has sparked optimism that we may be past the worst. However, we still believe it is too early to the call the bottom. From a positioning perspective we still believe there hasn’t been a full capitulation.
Hedge funds and risk-parity funds have reduced their equity exposure considerably. But institutional active funds and passive products have room for further outflows. The fiscal bill passed by the US government also allows individuals to withdraw up to $100k from their 401k, without penalty. We believe this could result in over $50bn of further outflows from the retail community.As well, over 50 companies in the S&P 500 have already suspended their share repurchase programs, which accounted for over 25% of buybacks in 2019. We believe the slowdown in buybacks could result in $300bn of lost inflows in the next two quarters.” – HSBC
Be careful.
The bear market isn’t over yet… not by a long shot.
Oil Spikes After Russia Says Ready For “Substantial Output Cut”, But Warns 10MMb/d Cut Not Enough
Over the weekend, following the biggest ever oil short-squeeze in history following rampant hopes that Saudi Arabia and Russia were considering putting their differences aside and cutting up to 10mmb/d in oil output, we said that in a world where oil demand has plunged by as much as a quarter due to the coronavirus pandemic, or as much as 26mmb/d, such a cut would “not be nearly enough to balance the oil market but at least it was a start.”
Then, moments ago, oil which had been drifting in Monday’s session after the report that a new burst of animosity between Saudi Arabia and Russia has pushed back today’s virtual R-OPEC meeting to later in the week, oil spiked after a Reuters rehash of headlines over the past 3 days, namely that Russia is ready to discuss very substantial oil output cuts “due to global demand collapse“, but – just as we warned over the weekend – Russia dded that “global oil output cuts of 10mmbpd might not be enough to balance the market.”
Well, yeah: with demand down 26mmb/d, supply would have to drop by a similar amount to balance the market.
As a result, Dow Jones reported separately that Saudi Arabia has also invited non-OPEC member Norway, UK and Brazil to the summit in hopes of getting everyone nation to agree to cut output, not just R-OPEC and potentially US shale producers. And as DJ also added citing sources, according to OPEC Plus – which now hopes to hold its summit on Friday – the output cuts would be contingent on G-20 cooperation. In short, while Saudi Arabia destroyed OPEC when it flooded the world with oil last month, it now hopes to not only recreate the oil producing cartel to include every single oil producing nation in the world but to convince said cartel to ease production.
Good luck with that.
In any case, since Brent shorts are now just shy of all time highs…
… any even remotely favorable news is being used by algos to spark a short covering squeeze, and this latest report was no different, sending WTI to session highs…
… even as the real news hit quietly after the flashing red healines, namely that OPEC+ countries still cannot agree on quotas to reduce oil production, and that Saudi Arabia is becoming dangerously petulant…
“IF THERE IS NO DEAL, WE WILL HAVE SOME NICE NUMBER OF FLOATING TANKERS GOING NOWHERE,” AN OFFICIAL IN SAUDI ARABIA SAID: WSJ
… repeating something else we said, namely that oil storage is running out.
Yellen Blames “Enormous Debt And Buybacks” For Coming Default Wave; Morgan Stanley Says It’s All The Fed’s Fault
In June 2017, Janet Yellen decided to wave a red flag before the bulls of fate, and responding to a question on financial system stability, the then-Fed chair said post-crisis regulations had made financial institutions much “safer and sounder”, and as a result she went on to predict that there would never again be a financial crisis “in our lifetimes” to wit:
“Will I say there will never, ever be another financial crisis? No, probably that would be going too far. But I do think we’re much safer and I hope that it will not be in our lifetimes and I don’t believe it will.”
While the bulls cheered this idiotic prediction, some were quick to compare this statement by Yellen to Neville Chamberlain’s infamous – and very, very wrong – “peace in our time” speech. In retrospect the some were right because less than three years later, the world is going through the biggest financial crisis in every living person’s lifetime, which has resulted in the most aggressive central bank market stabilization and intervention in history.
Also in retrospect, it is clear that Yellen didn’t have any bloody idea what she was talking about (then, or any other time when she was boring traders and analysts to death with her droning, narcoleptic monotone) even as we – among others- were warning that it was her monetary policy decisions that guaranteed the next crisis would put 2008 to shame. And sure enough, while the current crisis was sparked by the coronavirus pandemic, it is what comes next that the financial crisis will truly strike home as thousands of companies that loaded up on cheap, cheap debt during the Bernanke, Yellen and Powell Feds, default.
Amazingly, it was again this same intellectual and otherwise midget, that last week had the audacity to deflect blame for the current crisis (which she said would never happen in her lifetime) when last Monday, Yellen said that choices by broad swaths of the financial industry and companies were going to make it harder for the economy to recover from the coronavirus crisis. Choices, which apparently, took place in a vacuum in which the Fed did not keep interest rates at the lowest level in history while blowing the biggest asset bubble ever. Or at least that’s how the recent past looks like through Yellen’s revisionist perspective.
Commenting on Yellen’s video broadcast hosted by the Brookings Institution, the WSJ wrote that while the banking and financial sector was in “generally in good shape” ahead of the crisis, problems were already taking shape according to Yellen, who three years failed to predict the future with her patently idiotic “no crisis in our lifetimes”, and now also appears unable to accurately discuss the past, where she just happened to be a key catalyst for the epic crash that is coming.
Blaming everyone but herself, Yellen said that “non-financial corporations entered this crisis with enormous debt loads, and that is a vulnerability. They had borrowed excessively” and they did it not so much for productive purposes like investment, but for buying back stocks and paying dividends to shareholders. And while these firms borrowed, investors also let their guards down in their hunt for high yields, the former central bank official said, shocking oblivious of the Fed’s role in permitting all of this behavior to continue for years and years, building up massive imbalances which are now finally being unleashed and forcing the Fed to do absolutely everything in its power to prevent true price discovery which would take place… about 60% below current S&P levels.
This blameless narrative continued, with Yellen having the gall to go so far as saying that the corporate borrowing binge – which she helped unleash – “creates risk to the economy. And I’m afraid we’ll see that in spades in the coming months, because it may trigger a wave of corporate defaults. Even where a company avoids default, highly indebted firms usually cut back a lot on investment and hiring, and that will make the recovery more difficult,” the former central banker said, once again hoping to never be named in the list of antagonists whose actions led to the biggest US depression in a century.
We are confident that history will have a different take that Yellen’s endlessly self-serving bullshit, and it was none other than Morgan Stanley’s Michael Wilson who best explained last week why the corporate bond bubble, which will over the coming weeks and months mutate into the biggest default wave in decades, is a direct consequence of the Fed’s actions in general, and Yellen’s stupidity in particular to wit:
We have never seen corporate leverage as high as it is now. Much of this credit was added because credit markets have rarely been so inviting to issuers. This is the direct result of the financial repression era orchestrated by central banks during and after the Great Recession.
In short, the abnormally low cost of borrowing has encouraged companies to lever up and use this financial leverage to drive better earnings growth in what has been a sluggish economic recovery.
Companies are capitalist entities and so they are simply acting in their fiduciary duty to shareholders when they behave in such a manner. Much of this financial arbitrage has been executed via share buybacks, which is now being criticized by members of Congress as they pass the largest fiscal stimulus in history.
It’s important to note that low growth is very different from negative growth. Now that we have entered a recession, the corporate bond market knows the risk of default is much greater – hence the dramatic moves we have seen in credit spreads in the past month. As an aside, the correction in stocks really took a turn for the worse when tensions between Russia and OPEC caused a collapse in oil prices.
This is what triggered the stress in corporate credit markets, in our view, which contributed significantly to the crash in stocks and the economy.
Many acknowledge that credit markets are more important to the functioning of the economy than equity. As bad as the moves were in stocks this month, they were much worse in credit than they were in equities on a risk-adjusted basis.
And while Yellen’s entire career, and her ability to “predict” the future are now the butt of all financial jokes, here is one forecast that we are absolutely certain will come true: when historians look at the cast of villains responsible for the coming second great depression, Yellen’s name will figure in the top three, and for her sake, one hopes that the US public – traditionally clueless when it comes to all maters Fed-related – remains clueless, or else when it comes to “lifetimes” hers may be materially tapered once the tribunals start rolling.
It took less than 5 minutes for Her Majesty to put us right last night:
“..we may have more still to endure, better days will return, we will be with our friends again; we will be with our families again, we will meet again.”
As is becoming normal, the coming week holds out the prospect of good and bad news.
Despite the crisis point of virus being upon us over the Easter Break, authorities sound increasingly confident. Lockdowns look to have worked. It’s likely the numbers have peaked in Spain and Italy, and may even be topping out in London and New York. Over the next few days the narrative is going to start to shift from the immediate crisis to recovery. We will start to hear talk about relaxing lockdowns, selective reopening, and easing social distancing to start economies working again.
That’s the hope.
There is the likelihood of exuberant markets on the improving outlook – there is already a feeding frenzy going on in corporate debt on the back of the billions of Central Bank monetary QE infinity. There is a story in Bberg about accounts switching wholly into investment grade debt: Top Fund Manager is “Hoovering Up” Hugh Amounts of Cheap Credit.
The fiscal support packages announced by Governments are creating the illusion anything can be done to maintain the status quo. On top of them – markets are likely to read any positive news on containing the virus as a screaming buy signal.
Authorities acted fast to preserve jobs, keep the structure of economies together, avoid bankruptcies deepening the shock and addressed the many of the consequences of the shock including economic slowdown and individual misery and misfortune. There will be problems and delays in policy deliverables, but it was a fine effort by government.
However, the reality of the virus tragedy seems to have become completely detached from the euphoric world of financial assets. And that can’t be a good thing.
Despite the negative newsflow from overcrowded hospitals, and still rising death tolls, the market is likely to accentuate any immediately positive news while ignoring the long-term economic consequences of 10 million unemployed Americans? Massive job losses and slowdowns across Europe? Companies ending the stock buybacks that drove the last 8 years of rally? Dividends stopped around the globe? Rising risks around EM economies? Oil prices? Whole sectors of the global economy stopped?
Any rally at this point will simply be markets arbitraging the policy interventions and gorging on ever greater amounts of government support.
Cynical, but that’s pretty much what markets do now. Fundamentals don’t count when policy speaks louder and offers opportunities.
If all that monetary policy interventions have done is keep markets artificially high, and kept investors from suffering losses, while maintaining massive income inequality – then you have wonder if they are the right policies…
Someone in government might just realise…
Fire up the helicopters. Time for a new approach….
Going back to the virus and the real world: How quickly can we reopen?
The reality of how quickly economies reopen depends on what (often inadequate) testing shows, the experience of second wave infections, and how politicians respond to the changing public mood.
I suspect there will still be loads of assumptions made, but these will switch from a slowing the virus bias, to getting economies functional again. For instance, don’t be surprised if the UK decides to assume far higher infection levels occurred in the general population despite our lack of random testing, and makes assumptions such as UK rates being in line with observed rates in countries, like Germany, that did test.
Also expect more reliance on anecdotal data. A few weeks ago my Economic modeller chum, Robert Hillman of Neuron Capital asked why can’t the government mobilise a mobile phone app to get a better idea of the infection spread? If the nation can vote for X-Factor and Strictly on our phones, then why act on reported symptoms widely across the networks. (I understand apps are there to do so, but they are not being pushed at the population through mainstream media like the BBC.) Apps to improve contact tracing are also likely to come to the fore, despite civil liberty concerns.
There will still be virus trouble ahead. The threat of second waves remains, it has re-emerged in guest-worker dorms in Singapore, and the rising doubts about how honest China is being sharing data – whatever really happened in China, it does look like they got the transmission rate down close to zero.
Whatever the CIA accuse China of doing, the real picture in The Middle Kingdom is probably one of balancing a cautious reopening against an urgent imperative to get the economy open again, but leaving all the mechanisms in place to quickly test, isolate, contact track and quarantine any new blooms quickly (and quietly, to demonstrate the party’s wisdom).
Whatever the Chinese are, they ain’t daft.
Let’s be brutally honest:
we’re getting away with strict social distancing in the West because the public has been persuaded its virtuous. If the mood changes, in the light of further testing delays, how the news flow develops, then perhaps the mood changes. The very last thing the Authorities need will be a warm hot summer while the lockdown continues.
European Sovereign Credit
Back in 2010 the World Bank produced a report on sovereign debt to GDP. It theorised that a “tipping point” existed around 77% debt to GDP, where additional point of debt would cause a fall in growth. Low debt equals higher growth. At some point rising state debt starts to strangle real growth.
If you believe in Modern Monetary Theory, then that’s not going to be a problem. Countries should just print more and more money – with the important caveat they have to be able to print money.
All around the globe, we are going to see Debt to GDP levels rise in coming months. Most countries will deal with the crisis by printing money – playing off the threat of rising inflation against the massive deflationary shock the virus has caused. They will then hope to demonstrate growth and credibility to avoid money printing degenerating into a debt crisis or hyperinflation.
It’s not so simple in Europe
Members of the Euro don’t have that fundamental right to print money. They don’t hold the keys to the Euro printing presses. The ECB can collectively decide to allow members to borrow (but is effectively a political body), and has reluctantly agreed some effective transfers, but for all the talk of “ever closer union” there is no prospect of debt mutualisation or joint and severality for ECB borrowers. Even the much heralded Coronabonds now look unlikely to find agreement.
The ECB is buying members’ debt at incredible rates, but largely pretending it’s just market, and not de-facto money printing.
Despite the ECB dither, European Debt To GDP levels are going to rise dramatically in coming months.
Italy – 2019 Debt/GDP 135.6%. Estimate for 2020: 157%
Spain – 2019 Debt/GDP 96%. Estimate for 2020: 113.5%
France – 2019 Debt/GDP 99.2%. Estimate for 2020: 114.4%
Germany – 2019 Debt/GDP 59.2%. Estimate for 2020: 68.3%
Germany can afford to borrow (not print) more, which could help rest of Yoorp. The rest are clearly in trouble. How will Spain recover when 12% of its economy depends on tourism? Italy looks headed for a social bustup.
Let’s spice it up with European banking weakness. There is a great article by Elisa Martinuzzi of Bloomberg: Bankers are Sitting on a Vast Mountain of Risky Trades. It examines the billions/trillions of dollars European banks are holding in highly risky, unclear and illiquid lending. Is that a story you have heard before? Read the story, and figure out just how wobbly European banks are…
Put the following factors together and decide if you are a buyer of European debt: Rising Debt. Rising Unemployment. Banking System in Crisis. Reliance on Someone Else’s Currency. Prospects for Growth. Political Stalemate.
Kudlow Says He “Likes” Cramer’s “War Bonds” Plan, Promises He’ll “Mention It” To Trump
Appearing on CNBC once again Monday morning, Larry Kudlow tried to throw more fuel on Monday’s market rally by insisting that the outbreak in the US was finally slowing, while defending the administration by insisting that “no one could have expected” the virus’s exponential spread (though about a dozen Zero Hedge articles published during the months of January and February would suggest otherwise).
Toward the end of the interview, Kudlow’s former TV co-host Jim Cramer asked if the administration would consider his plan to issue coronavirus “war bonds”, a scheme the CNBC host has been pushing every chance he gets for weeks.
But for the first time, on Monday, Kudlow seemed to indicate that Cramer’s idea was being taken semi-seriously by the White House. Kudlow responded that he “liked the idea” and promised Cramer that he would raise it with President Trump, offering a glimpse behind the curtain to an audience that got to see a little on-air lobbying.
“This is a time, it seems to me, to sell bonds in order to raise money for the war effort, in this the pandemic effort,” Kudlow said. “I’m all for it.”
Already, the US government, via the nation’s biggest banks, has issued about $38 billion worth of loans to small businesses as of Monday morning (far short of the tens, if not hundreds, of billions in loans that have already been requested, as we explained earlier).
But as Congress kicks around a potential fourth coronavirus relief bill, we suspect we’ll be hearing more about what might be in it over the coming week or so.
Following Kudlow, Former Fed Chairwoman Janet Yellen confirmed that she believes war bonds would be “an appropriate approach” as long as its done in a way so that the interest burden will be “manageable” for years to come.
Though while Yellen projected that the true unemployment rate in the US is already well into double-digit territory, and that the recovery might take longer than we’d ideally like, Kudlow insisted that the dynamic US economy would rebound within 4 to 8 weeks.
NYT Op-Ed Calls For People To Stop Using Toilet Paper
The New York Times has published an Op-Ed which shames people into the ‘correct’ way to clean up after dropping a steamer – arguing that amid an absurd toilet paper shortage due to coronavirus, people should simply ditch trees and begin using bidets to strip-mine their crevices.
Panic buying of toilet paper has spread around the globe as rapidly as the virus, even though there have been no disruptions in supply and the symptoms of Covid-19 are primarily respiratory, not gastrointestinal. In many stores, you can still readily find food, but nothing to wipe yourself once it’s fully digested.
This is all the more puzzling when you consider that toilet paper is an antiquated technology that infectious disease and colorectal specialists say is neither efficient nor hygienic. Indeed, it dates back at least as far as the sixth century, when a Chinese scholar wrote that he “dared not” use paper from certain classical texts for “toilet purposes.” –NYT
The author, Kate Murphy, educates us on the history of ass-wiping, writing that before TP was readily available for our bungholes, “people used leaves, seashells, fur pelts and corn cobs,” and that “The ancient Greeks and Romans used small ceramic disks and also sponges on the ends of sticks, which were then plunged into a bucket of vinegar or salt water for the next person to use.“
This is all according to forensic anthropologist and historical pooping expert Philippe Charlier, who wrote a 2012 book – “Toilet Hygine in the Classical Era.”
“It’s not sexy,” said Charlier. “but when you study poo from 2000 B.C. you can get a lot of information about alimentation, digestion, health, genetics and migration of populations.”
Modern, perforated toilet paper was invented by Seth Wheeler in 1891 according to a patent he took out on the concept.
Then we have the invention of the wet wipe – which any modern parent knows is far superior to toilet paper.
…they are now marketed aggressively to adults with gender specific brands like Dude-Wipes and Queen V. Sales reached $1.1 billion worldwide last year, up 35 percent from five years ago, according to Euromonitor International. The unfortunate result is that the wipes have begun to coalesce with grease in city sewer systems to form blockages the size of airliners. –NYT
The ultimate solution?A bidet.
According to Murphy, “experts agree that rinsing yourself with water is infinitely more sanitary and environmentally sound.”
According to Dr. H. Randolph Bailey, a colorectal surgeon (when he could have chosen literally any other specialty), said “A lot of people who come to see me have fairly significant irritation of their bottoms,” adding “Most of the time it has to do with overzealous cleaning.”
Bailey added that ‘you’re just never going to get as clean as rinsing with water.‘
Murphy, meanwhile, shames readers by comparing the rest of the world to Japan – which has “high-tech toilets capable of cleansing users with precisely directed temperature-controlled streams of water,” we’ve become bidet-averse.
Blame prudishness and puritanism, at least in part: Bidets, once ubiquitous in France, became associated with hedonism and licentiousness. Marie Antoinette had a red-trimmed bidet in her prison cell while awaiting the guillotine. And during World War II, American soldiers first saw bidets in French brothels, which made them think they were naughty. An often-told joke was that a wealthy American tourist in Paris assumed the bidet in her hotel room was for washing babies in, until the maid told her, “No, madame, this is to wash the babies out.”
But even in France, toilet paper has taken over. “Now, when constructing a new flat, nobody puts a bidet in it,” Dr. Charlier said. “There’s not room for it, particularly in Paris.” Although, when the bidet is incorporated in the toilet, as modern versions are, space is a nonissue. “Maybe there are also psychological reasons we do not embrace the newer technology,” he said. –NYT
So – with toilet paper flying off the shelves amid the coronavirus pandemic, is it time to start freshening up with a targeted blast of H20?
