Charlie McElligott: US Markets Are On The Cusp Of A “Tightening Tantrum”

It’s still too early to say for certain, but after stocks dumped on Monday as investors finally appeared willing to discount trade war fears (after President Trump promised that he’d be making a major trade-related announcement after the close), Charlie McElligott’s projection that September will be a month of “two halves” has aged gracefully – as has his analysis showing that US equity funds are heading for disaster now that longstanding market fundamentals are finally beginning to shift.

With the Fed’s discussion about possibly pausing rate hikes at “neutral” still ringing in the ears of many investors, Macrovoices’ Erik Townsend seemingly couldn’t have chosen a better time to interview McElligott as this week’s featured speaker on the Macrovoices podcast. During the interview (which was accompanied by a slide deck fleshing out McElligott’s observations surrounding constricting global financial conditions in greater detail), McElligott explains why investors should be worried about a reversal in the yield curve, as it portends the long-awaited unraveling of one of the longest equity bull markets in history.

To sum up, McElligott is trying to show that we are much further along in the Fed rate hike cycle than many investors believe.

While the Fed’s projections (which perennially lag the market) are still calling for another 75 basis points of hikes by the end of 2019, short-term interest rate futures are only pricing in 44 bps over the next year. A look back at the yield curve relative to Fed rate-hike expectations and US equity performance in the years leading up to the financial crash suggests how this dynamic might play out.

McElligot

Once conditions tighten and yields begin to rise, the transition from historical melt up to a period of tightening financial conditions will finally have started in earnest, ushering the long-awaited correction in bonds, US stocks are destined to follow.

My major message here is that I think there is an increasing likelihood that 2019 – even though the Fed is currently telling us they are projecting three hikes, the market is only pricing in 44 bits of hikes versus the Fed’s 75 bits – that there is an increasing likelihood that the Fed might have to pause if not ever to get to those three hikes.

But what’s so important about the short-term interest rates and these spreads, or these curves, is that it’s giving us a much more real-time prognostication tool with regards to where the market thinks the Fed is nearing the end of this normalization cycle. And the end of this normalization cycle is critical for the culmination of this phase 1 transition from the Cyclical Melt-Up phase into the phase 2 “Financial Conditions Tightening Tantrum” phase that is going to have major implications for the cross-asset universe and fund performance.

But the potential inflection points aren’t limited to the US. Indeed, when the shift begins in earnest, it will be a global phenomenon. And evidence is already appearing in China, where the slowdown of that country’s credit impulse as the PBOC tries to manage a painful but necessary deleveraging is a logical starting point for any conversation about tightening global credit conditions. McElligott addresses this in his slide deck with a chart illustrating the change in China’s yoy credit creation, which has fallen sharply into negative territory. Over the past two years, China has tried to rein in their “social financing” to contain contagion risks associated with their planned transition to a services based economy.

Ultimately, this has tightened credit conditions in a way that has an outsize impact on the emerging world, though it impacts G-10 economies as well. 

McElligot

To be sure, Chinese data has a strong seasonal skew, particularly around the beginning of the year, but, as the data show, the impulse tapers down from there. The end result is plainly obvious: The Chinese credit impulse is slowing.

As that credit impulse – these new loans that are being forced out to banks per quota – those asks from the PBOC and from the central planners have eased. What ends up happening is that (in that second panel) all system liquidity then slows as well. There is a seasonality.

There is a very powerful seasonality with Chinese credit impulse, with Chinese credit financing. Certainly, into their New Year, at the start of the year, there is a huge impulse to feed that multi-week shutdown. Then you kind of taper off from there. What ends up happening, though, is that you are seeing – under this deleveraging regime – a diminishing magnitude of these impulses.

All of those middle panels and lower, show what the diminishing magnitude of that impulse has on Chinese financial conditions. Meaning (in that fourth panel), Chinese financial conditions are moving lower. That means tighter financial conditions.

This slowdown is contributing to an disinflationary wave emanating from China which has been amplified by the weakening yuan (given China’s massive trade surplus, cheaper goods in China translate to cheaper goods everywhere else).

The next panel speaks to the Chinese inflation surprise index trailing lower. You see these peaks and then these fades. The yellow line is the global inflation surprises. Meaning: Is inflation data (CPI or CPI core data) around the world beating or missing? On average, those are missing now. China is the engine that drives global inflation is what I’m communicating here.

Circling back to the US, McElligott elaborates on his original point. Namely, that while dissipating term premiums in US debt have received more attention than they deserve so far this year – particularly since the widely held expectation that the yield curve would steepen haven’t panned out (much to Bill Gross’s chagrin). But while anxieties about a possible yield-curve inversion are understandable given the historical precedent, bulls should be much more concerned about tightening in the short-term credit complex, McElligott argued.

Interest rates on three-month Treasury bills, the essential cash equivalent, and the three-month LIBOR (the cost of money), have quietly (aside from some noise earlier this year about the blowout in the OIS-LIBOR spread) crept back to pre-crisis level, as the chart below illustrates…

McElligot

Instead of paying attention to proprietary indexes of financial conditions, McElligot argues that traders should instead focus on these short term rates for the simple

“Commercial paper – this is the stuff that lubricates the financial system. General collateral repo on the bottom. That’s the stuff that makes the system work, that funds businesses. It’s critical to keep moving.”

Listen to the full interview below:

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Thoughts on the Leaked Google Video and Why Populism Is Just Getting Started

The deal those bankers cooked up was to save the banks from capitalism.

– From Matt Taibbi’s recent piece: Ten Years After the Crash, We’ve Learned Nothing

While Google executives still attempt to portray themselves as scrappy, enlightened, countercultural tech luminaries, their reaction to Donald Trump’s victory in a recently leaked internal video leaves you wondering whether they understand anything at all about what’s happening around them.

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Why WTI Could Crash In The Coming Weeks

Authored by Irina Slav via Oilprice.com,

West Texas Intermediate could drop to US$65 a barrel later this year on the back of extra maintenance work at U.S. refineries, Tom Kloza from the Oil Price Information Service has warned. 

Speaking on CNBC, Kloza said this maintenance season was the last chance for many refineries to hop on the new bunker fuel train by boosting their capacity for low-sulfur diesel and fuel oil.

“The next six to seven weeks we’re going to see demand for crude drop by about 1 to 1.5 million barrels a day. It’s refinery maintenance season,” Kloza said.

The new bunker fuel emission rules, effective from 2020, stipulate that only vessels using fuels with sulfur content of 0.5 percent or less will be allowed to roam the oceans. The change is part of the International Maritime Organization’s strategy to cut carbon emissions from maritime transport by half by 2050.

The change has been touted as beneficial for refiners that are equipped to produce low-sulfur fuel oil and diesel, as well as LNG producers. Yet the adjustment will take time, and during this time demand for crude will be lower. How serious the effect on WTI prices will be remains to be seen, however.

For starters, many of those following WTI must have already factored in maintenance season and winter as weakening demand press down on prices. True, Kloza’s comment that this maintenance season will have a more severe impact on prices makes sense, but this additional maintenance should not come as a surprise to market watchers: there has been a lot of coverage about the IMO fuel rules and there’s likely to be even more in the run-up to its entry into effect.

Another thing that could curb the downside effect on maintenance season is hurricane season: Florence has hit demand for oil products but, one analyst told Market Watch, there will be demand destruction in the short term, but a surge in demand in a few weeks when [the region] starts to rebuild.” In other words, amid refinery season, rebuilding what Florence has damaged will apply counter pressure on prices, possibly curbing the decline.

Then there are the Iran sanctions, of course, the ace among bullish oil price factors that analysts and commentators have been waving in the market’s face since May. The United States is still trying to get its international allies to cut their imports of Iranian oil to zero even in the face of evidence that this will not be possible. The latest update in this respect suggests that there will be no waivers for countries that want to continue importing Iranian crude, even though earlier this year, senior Washington officials had said that waivers would be considered on a case-by-case basis.

So, in this context, the effect of additional refinery maintenance work on WTI prices could be limited, especially if the Iran-related signals from Washington continue in the same vein. Price trends have repeatedly demonstrated that benchmarks are equally strongly affected by fundamentals and geopolitical events that may or may not affect these fundamentals. As for Iran, there have been numerous assurances from OPEC and Russia that they will step up production to make up for lost Iranian crude. This should quell worry about supply, but it has not, so the upside potential for WTI remains as the U.S. benchmark tends to follow Brent, which will benefit from the sanctions even more: Kloza expects it at US$80 a barrel in the last quarter of the year.

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Meet Rachel Goldsmith, the Woman Running the Free State Project: Podcast

Earlier this year, Rachel Goldsmith became executive director of the Free State Project, which describes itself as “a mass migration of more than 20,000 people who have pledged to move to New Hampshire.” By concentrating themselves in one state, the Free Staters plan to become a bloc pushing New Hampshire toward more libertarian policies.

In the latest Reason Podcast, Goldsmith, an MBA originally from Albany, New York, tells me that the number of year-over-year “movers” to New Hampshire has doubled, and that many of the people associated with the movement who have run in the state’s primaries have won. While the Free State Project doesn’t endorse specific candidates or pieces of legislation, more than a dozen current legislators are allied with the group. “It’s been pretty inspiring,” she says. “We’re definitely in the ‘family wave’ of things. We have a lot of folks with kids and young professionals who are considering having kids coming to our events.”

In a wide-ranging conversation, Goldsmith also previewed the group’s annual winter event, Liberty Forum. To be held February 7–9 of next year in Manchester, the gathering will be keynoted by Cody Wilson, head of Defense Distributed, a nonprofit that develops and publishes open-source gun designs suitable for 3D printing and digital manufacture.

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Audio production by Ian Keyser.

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This time is different because there’s free tequila…

We poke a lot of fun at the MANY absurdities we see in this current bubble.

As we’ve discussed countless times over the past few years, there are consequences from the fact that central bankers have conjured trillions of dollars out of thin air and pushed down interest rates to zero.

Stock, bonds and real estate are at or near record highs. Bankrupt countries are issuing trillions of dollars of debt with negative yields (not to mention, serial defaulter Argentina was able to issue 100-year bonds…).

Netflix is one of the most expensive and popular companies in the world even though it burns through billions and billions of dollars with no end in sight.

And, of course there’s Tesla, which we won’t get into here.

But perhaps nothing better captures the absurdity of the times more than WeWork.

I’ve talked a bit about WeWork in Notes, but not nearly as much as some of the other offending companies.

The company is the poster boy for the hot co-working trend. And it’s worth around $40 billion today. Of course, it’s also losing billions of dollars.

Of course, WeWork’s value is far more than any other company of its size because WeWork is a “cool, tech” company. But, at its core, it’s just another real estate play…

WeWork signs long-term leases for office space around the world, then turns around and provides very short-term leases to companies.

The companies pay more for the space, but they have more flexibility because they’re not locked into a traditional, long-term lease.

And this business model exposes WeWork to a HUGE amount of risk.

It’s great for the customers though. WeWork loses tons of money providing this service, which means investors are ultimately footing the bill.

If there’s an economic downturn (and there is a 100% chance of that happening), WeWork is stock with huge obligations and no way to generate revenue on its office space.

When the downturn comes, not only will WeWork’s tenants leave… the company will also be cut off from funding as investors tighten their purse strings.

And to give you an idea of the size of the obligations we’re talking about…

According to the Wall Street Journal, WeWork just surpassed JPMorgan Chase to become the largest leaser of office space in New York City with 5.3 million square feet.

But you don’t have to take my word on how risky this business model is.

The WSJ article also mentions a company called Regus, a European company that did the exact same thing as WeWork during the dot-com boom. It was growing as fast as it could in the late 90s, snatching up office leases all over the place.

And guess what happened…

When the bust hit, occupancy levels plummeted. And the company went bankrupt.

No, Regus wasn’t as cool as WeWork. They didn’t have fair-trade, organic coffee and kombucha on tap. And they didn’t give away free tequila.

But Regus was in the EXACT same business.

And the company still operates today, after it was purchased out of bankruptcy. But it’s been growing at a much slower pace after the lessons it learned in the 2000s.

To give you an idea of the value the market places on conservative growth today…

IWG, Regus’ parent company, manages five-times the square footage of WeWork. But it has about one-eighth the market value.

History has shown this business model is not only excessively risky, but it ultimately failed.

This might be the biggest example of how unbelievably absurd the markets have gotten today.

WeWork is losing money leasing office space and hoping to make it up on volume. Basically, every lease WeWork signs adds more risk and more losses.

It’s the SAME thing that happened to Regus 20 years ago. But people are crazy enough to think this time is different because there’s free tequila…

Source

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Goldman Lists 329 Reasons Why Volatility Is About To Jump

One day after Goldman cautioned that “global risk appetite is becoming increasingly fragile”, the bank is out with another warning, this time predicting that volatility is about to spike, and listing over 300 stock specific catalysts why this will be.

In the latest report from derivatives strategist John Marshall, Goldman says that it expects volatility to increase over the next month both due to seasonal factors as well as midterm elections. As shown in the chart below, on average over the past 90 years, SPX volatility has increased 25% from August to October.

Goldman also reminds us that most major market corrections take place in October, and while some assume this is merely a coincidence, Goldman believes that “performance pressures for company managements (to meet full year expectations) and investors (final earnings season for the year) exacerbate shifts in investor sentiment at this time of year.”

Adding to the upward vol pressure, 2018 has the added feature of holding a mid-term election – one where the Democrats are expected to win at least the House, unleashing even more political chaos – which has the potential to add uncertainty this year.

In addition to index level vol, seasonality is also strong in single stock volatility according to Goldman’s analysis, which notes that since it is tough to make money buying volatility at the index level (due to the high volatility risk premium and the correlation risk premium), even with the wind at your back from seasonal factors, the bank prefers to focus at the sector and stock level to identify strong catalysts that could drive volatility over and above macro factors and with even more specific timing.

There is another reason why Goldman is urging clients to bet on single stock vol over index: According to Marshall – and as we first noted one month ago stock event moves are getting bigger, which the bank attributes to the global trend of increased surprises and uncertainty of earnings. As confirmation, the charts below show the average 1-day moves on earnings releases relative to their average daily move in the month before/after earnings: “this data suggests volatility is percolating under the surface across stocks globally.”

As a result of these observations, Goldman expects “the increase in volatility to be broad-based” and as a result the bank will be “focused on buying single stock volatility where events can provide a timing advantage.

So where will Goldman be buying vol?

To answer that question, Marhshall identified the top events across Goldman’s entire coverage universe through year-end. The result is a list of 329 major events over the next four months that could drive large moves in stocks across US, Europe and Asia. This list focuses on the largest events that investors will focus on, without a specific bet on absolute direction, merely buying vol ahead of the actual event, with the intention of selling once vol rises as other traders seek to hedge their exposure.

Our list is skewed toward events in names under our analysts’ coverage and those with liquid options markets. We look for option buying opportunities ahead of these events.

The following tables lays out all the 329 single-stock events the bank’s analysts believe have the potential to move stocks; together with local region date/time.

Consumer catalysts through year-end

Consumer Staples, Energy, Financials catalysts through year-end

Financials, Health Care catalysts through year-end

Health Care catalysts through year-end

Health Care, Industrial catalysts through year-end

Technology catalysts through year-end

Materials, Real Estate, Telecom, Utilities catalysts through year-end

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The Imminent Hard Stop

Authored by Chris Hamilton via Econimica blog,

There is an imminent hard stop to jobs growth in the US and therefore a concomitant problem to growth in consumption and economic activity.  The hard stop is simply the outcome of fast growth in employment versus fast decelerating population growth among the potential labor force… resulting in a labor participation rate that will peak as soon as 2019 or as late as early 2020.  And like night follows day, recession will ensue as soon as employment growth abates.

The US labor force participation rate amid 25 to 64 year olds, at midyear 2018, was 75.2%.  In the post 1980 period (since women have entered the workforce en masse), peak labor force participation rates have been somewhere between 76% to 78% (highlighted in the chart below).  At that point, essentially all those capable and/or willing to work are employed.  The remaining quarter of the 25 to 64 year old population are busy with parenting, caregiving, extended schooling, early retirement, incarcerated, on disability, face skills mismatches, or suffer physical or mental challenges that make work unlikely or impossible.  Simply said, if jobs continue growing anywhere near the current pace, by the end of 2019, the labor force will simply not be capable of providing further growth.

If the US population is still growing, why isn’t the potential labor force able to provide the labor for a growing economy?  The chart below shows the annual growth of the 15+ year old US population, from 1951 to 2028, through the next decade.  The black boxes with yellow numerals show the total 15+ year old population growth double peaking at +2.9 million persons annually in 1975 and 1998, decelerating to +2.7 million in 2008, and now down to +2.1 million in 2018.  But the bigger story is the demographic that makes up all the growth, shifting from the blue columns representing growth among the 15 to 64 year old population to the 65+ year old population.

As the head of household ages, their average annual income / expenditures and labor force participation rates rise, peak in mid-life, and fall away as they age (chart below).  So if the vast majority of population growth is among the elderly population with income / spending at just half of peak years…and collapsing labor force participation rates, then the growth in the potential labor force is severely impacted.

The chart below shows the annual growth in the potential labor force multiplied by participation rates among the different age segments.  The impact of the population growth shifting from the prime working age population to the elderly has impaired the potential labor force severely and this will only become more acute moving forward.  Peak annual potential labor force growth took place in 1998, adding 1.9 million persons…almost entirely among the prime working age population.  By 2008, total potential labor force growth was down about 15% (from peak) but the shift was well underway with the prime working age population growth down 25% to 1.4 million annually.  By 2018, the potential labor force growth is just 35% of peak.  By 2028, annual labor force growth will be just 15% of that seen at peak growth.

So how does this translate to jobs growth?  The chart below shows annual changes in non-farm payrolls versus the annual change in potential labor force.  Each period of jobs growth, well in excess of the labor force growth, is circled.  The years of peak 25 to 64 year old labor participation rates are highlighted in yellow as these were the years the labor market ran out of potential available laborers…and recession was imminent.

By year end 2018 or latest mid 2019, if employment continues trend growth, the labor force will essentially run out of employable persons.  Said otherwise, the economy will run out of new consumers and this situation of minimal labor force growth will only become more severe over the next decade (and yes, this is factoring in present rates of immigration…if those rates continue slowing, the situation only becomes more acute).

Of course, regardless the steep trouble facing the US…the US is still better demographically and population growth wise than many or even most of the developed and developing nations of the world (detailed HERE).  The US has ample resources to feed and fuel ourselves, care for one another, maintain and promote peace (for a change).  Unfortunately, the nation (and much of the world at large) have decided to believe in financial fairytales and false indicators that require no difficult choices or changes.  However, we still have options  about how we will approach what is likely to be the hardest epoch in this nations history…but the longer we wait, the more difficult and painful the remaining options become.

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New E-Cigarette Restrictions Could Be Lethal: New at Reason

Scott Gottlieb, the head of the Food and Drug Administration, says he still believes in the harm-reducing potential of e-cigarettes, which are far less hazardous than their combustible competitors. But by threatening to restrict e-cigarettes in the name of preventing underage vaping, he is knowingly setting a course that leads to more smoking-related deaths than would occur if the government let the market thrive.

“In closing the on-ramp to kids,” Gottlieb said in a speech last week, “we’re going to have to narrow the off-ramp for adults who want to migrate off combustible tobacco and onto e-cigs.” That “unfortunate tradeoff,” as he calls it, is not necessary, scientifically sensible, or morally justifiable, Jacob Sullum says.

View this article

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Congress Members Demand Trump Seek Approval Before Military Action In Syria

A group of over 40 Congress members have sent President Trump a bipartisan letter reminding him that the US Constitution requires that the president seek Congressional approval before taking military action in Syria or elsewhere. Congressman Justin Amash (R-Mich.) announced via Twitter on Monday that the letter had been sent to the White House.

Ironically Rep. Amash made the announcement just as Monday’s evening’s massive Israeli strike on Syria was underway, which resulted in a downed Russian surveillance plane carrying 14 troops amidst the confusion of missiles flying over the Mediterranean as it was hit by Syrian defense attempting to stave off the attack by Israel. 

While the Pentagon formally denied any US role in the strikes, it was an extremely dangerous situation with yet again the potential for serious escalation between Russia and the US and its allies. 

The letter was signed by a handful of Republicans including Thomas Massie, Mark Sanford, and Walter Jones, as well as 42 Democrats. It begins as follows: 

We write to strongly urge you to consult with and obtain authorization from Congress before ordering any additional U.S. military action in Syria. We are deeply concerned by recent reports indicating that your administration is preparing again to strike Syria in the event of another chemical weapons attack

And the letter continues by outlining Constitutional limits on the President’s power to wage war without seeking Congressional approval first:

The Constitution gives the power to declare war to the U.S. Congress and only permits the President to act in delf-defense, not simply to further perceived U.S. interests. The War Powers Resolution of 1973 also requires the President to consult with and obtain authorization from Congress prior to the use of offensive military force. 

The letter follows a similar one that was signed by 88 total Congressional members last April, thus it appears pushback in the House against a potential future US attack on Syria has waned in the wake of unfounded prior accusations that Assad is “planning” to use chemical weapons. 

In recent years in Syria, as the Pentagon’s “boots on the ground” presence grows (now at over 2,000 publicly acknowledged troops in eastern Syria), and as calls for direct military intervention against Damascus are also heightened, the White House has routinely invoked the 9/11 era Authorization For Use of Military Force (AUMF) mainly framing its mission as “anti-ISIL” and increasingly in terms of preventing Iranian expansion, in a policy that goes back through the Obama administration. 

Meanwhile other Congressional leaders have called for a full US attack on the Syrian government, with Republican Congressman Adam Kinzinger (Illinois) appearing on CNN this week to argue that American forces should impose a no-fly-zone over Syria. 

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Newly Released Eric Holder Memo: Feds Can Use FISA to Spy on Journalists

The federal government can use the Foreign Intelligence Surveillance Act (FISA) to spy on journalists. So said a pair of 2015 Justice Department memos, including one from then–Attorney General Eric Holder.

FISA is controversial in itself. The act is supposed to be used to justify surveillance on foreign targets. But as Reason‘s Scott Shackford has explained, intelligence agencies often use it to secretly spy on American citizens, sometimes without a warrant.

According to the newly released documents, obtaining permission to surveil members of the media is not easy, but it is possible. In one memo, dated March 19, Holder says FISA applications against journalists must be approved by the attorney general and deputy attorney general prior to being brought before a FISA court.

In the other memo, dated January 8, the deputy attorney general writes that “the Attorney General and the Deputy Attorney General shall retain discretion to refer such FISA applications to the Assistant Attorney General for the National Security Division for Disposition.”

Both memos were obtained in a Freedom of Information Act (FOIA) lawsuit brought against multiple federal agencies by a pair of press freedom groups: the Freedom of the Press Foundation and the Knight First Amendment Institute at Columbia University. The lawsuit originally sought answers regarding the Trump administration’s war on leaks.

Berkeley law professor Jim Dempsey, a former member of the Privacy and Civil Liberties Oversight Board (an independent agency within the executive branch), claims that the information contained in the memos is “a recognition that monitoring journalists poses special concerns and requires higher approval.” Dempsey tells The Intercept he sees the rules “as a positive, and something that the media should welcome.”

Patrick Eddington, a policy analyst in homeland security and civil liberties at the Cato Institute, disagrees. “If the government wants to conduct surveillance of any American for alleged criminal conduct, they should have to obtain a probable cause-based warrant from a federal judge, exactly as the Fourth Amendment requires,” Eddington tells Reason. “These guidelines,” he adds, “degrade that Fourth Amendment standard to the point of making it meaningless.”

On top of that, we don’t know whether the guidelines are being violated. Past audits of the Department of Justice “have routinely shown violations of the law,” Eddington says, so “we have no reason to believe these guidelines have not been similarly ignored or abused.”

While the memos date to the Obama era, the Trump administration seems willing to snoop on journalists as well. Earlier this year, the Justice Department demanded the phone and email records of New York Times reporter Ali Watkins in an attempt to find out whether her source, a former Senate aide, had leaked classified information.

Eddington suspects the guidelines for spying on journalists under President Donald Trump may be “looser” than they were under Obama, especially given Trump’s “almost daily stated antipathy towards the press as a whole.”

Regardless of who’s in the White House, one constant remains: The federal government doesn’t seem to have any problems with going after journalists.

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