Month: May 2016

Does any of it make sense?

 

 

Source: Townhall.com

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Via TheFIRE.org,

In a stunning attack on freedom of association, Harvard University announced today that members of independent, single-sex, off-campus organizations will be blacklisted from Rhodes and Marshall scholarships and banned from leadership of on-campus organizations or athletic teams.

Harvard President Drew Gilpin Faust stated that next year, members of fraternities, sororities, and “final clubs” will begin to be denied these opportunities in an effort to foster “inclusion” and “address deeply rooted gender attitudes.”

 According to Dean Rakesh Khurana, who recommended the changes, such organizations have been independent from Harvard since 1984. They operate as off-campus entities and do not receive any recognition or benefit from the university.

“Outrageously, Harvard has decided that 2016 is the right time to revive the blacklist,” said Robert Shibley, executive director of the Foundation for Individual Rights in Education (FIRE), which defends freedom of association on campus.

 

“This year’s undesirables are members of off-campus clubs that don’t match Harvard’s political preferences. In the 1950s, perhaps Communists would have been excluded. I had hoped that universities were past the point of asking people, ‘Are you now, or have you ever been, a member of a group we don’t like?’ Sadly, they are not.”

“Harvard’s decision simply demonstrates that it is willing to sacrifice students’ basic freedom of association to the whims of whoever occupies the administrative suites today,” said FIRE co-founder, civil liberties attorney, and Harvard Law alumnus Harvey Silverglate.

“Who’s to say that Harvard’s leaders five years from now won’t decide that Catholics or Republicans should be blacklisted because they might not line up with Harvard’s preferred values?”

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In a recent interview with CNBC’s Rick Santelli, Richard Fisher, former President of the Dallas Fed, explained “The Fed has the market on Ritalin—trying to keep the mood very smooth, keep volatility down as much as possible. As soon as they hint that they might remove that, then they create the problems they’re afraid of. So, they’ve boxed themselves into a corner, and the real art will be to see how they manoeuvre to get out of that”….“When [the Fed] move—and I hope they move sometime in June—there’ll be a settling in of the marketplace. There will be a correction. Suck it up. Deal with it. That’s reality.”

 

And, as Albert Edwards correctly notes, “the sad thing is that, as Fisher says, the Fed has boxed itself into a corner, for surely it is clear to all in the markets by now that it’s not “global risks” that worry the Fed but the impact on the S&P.”

And just in case it still isn’t clear, here is some Edwardsian sarcasm who points out that it is “definitely Global Risks that the Fed is concerned about… not the S&P” as the chart below “clearly shows.“

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Submitted by Danielle DiMartino Booth via DiMartinoBooth.com,

Following the Great War, indoor plumbing became without a doubt a Godsend for much of the world. However, few innovative leaps, including even the wonders of indoor plumbing, have ever been entirely free of at least a few drawbacks. Think of electricity and its dependence on any number of variables from lightbulbs to Mother Nature. Or the inevitability of those scratches that marred our favorite vinyl, or later CDs, rendering them unfit for the human ear. And, oh, the sparks that flew the first time we married metal with that fantastic new convenience, the microwave. The greatest innovative leap of our lifetimes started out easily enough with the personal computer. But even that technological disruptor has proven it too can be disastrously disruptive with nasty viruses, bugs and glitches working 24/7 to wreak havoc on our universal connectivity.

As for the wonders of indoor plumbing, its vulnerability rendered it anything but wondrous as it invited that inevitable bane to be borne, known worldwide as the dreaded backup. While no doubt it was a huge relief to no longer have to tiptoe into the night on an outhouse run or tow water to and fro for this and that, plumbing didn’t turn out to be exactly turn-key and stress-free. Anxieties soon arose from the prospect of that first call to the pricey plumber. Even in the 1920s, their service charge and hourly rate were bound to have given pause to the humble housewife. The beauty of the profitable plumber pariah was the subsequent innovation that followed, that of Drano, which was thankfully introduced in 1923.

Over that same 100 years, give or take a few, the financial system has also suffered its own bouts of clogged pipes though the culprits have tended to be a wee bit trickier to dislodge than gelatinous grease and hardened hairballs. Recall that in October 1979, Fed Chairman Paul Volcker formally announced that the monetary base would be the new and improved target to better control the price of credit. When overnight credit is priced perfectly, the funding spigots stay open just enough to keep credit flowing, but not flooding the financial system.

Volcker’s pivot away from the fed funds rate, however, proved more Pandora than panacea. And so three years later, in October 1982, policymakers re-adopted the targeting of the federal funds rate where policy technically remains to this day. An Econ 101 refresher: the fed funds (FF) rate is the interest rate at which depository institutions lend reserve balances to one another on an uncollateralized basis in the overnight market.

Fast forward to the here and now and all is well for the rate setting masters of the universe save one niggling detail: for all intents and purposes, the fed funds market no longer exists. Relatively new regulations have simply made redundant the FF market as it once was and no longer is.

As intrepid readers of these weeklies, you should certainly be aware of one Zoltan Pozsar and his 20 years of groundbreaking work. Today, the thorough brilliance of his work has catapulted him to the rank of world’s preeminent professional plumber, at least as far as the global financial system is concerned.

Pozsar’s ascendance began as many things do, innocuously enough when one day early in his career he was tasked with a particular objective — to contextualize the importance of collateralized mortgage obligations and special investment vehicles within an obviously inflating housing bubble.

Conjure up an image of Russell Crowe in A Beautiful Mind, without the schizophrenia. Now you have a good idea of the ‘aha’ moment Pozsar experienced as he began to connect the dots between the various working pieces that had for years held together the housing market. His peers at the New York Fed knew it was no secret that subprime securitization had opened up housing availability to millions of Americans. But the extent to which toxic mortgages could infect the entire global financial system had not been readily apparent until Pozsar fully diagrammed the plumbing on a three-by-four-foot map. Google it for your edification. You’ll be the wiser for it.

Since leaving the Fed, Pozsar has been conspicuously prolific in his productivity. While at the IMF, he managed to remap the post-crisis financial system (it now resembles a one-foot-thick atlas). He then moved on to Credit Suisse where he is today, educating financial market participants on the vastly changed regulatory regime that has, by the way, eradicated the fed funds market.

Pozsar opens his latest Global Money Notes piece by redefining understatement given the impetus to invent a new monetary mouse trap, so to speak: “2016 is shaping up to be an important year for the Federal Reserve.” Before the year comes to a close, the Fed will not only specify the intended size of its balance sheet but also the securities to be stored on it over the long haul. Spoiler alert: there’s no shrinkage in the offing.

At the nexus of the Fed’s perennially large balance sheet are two seemingly complex terms: the Liquidity Coverage Ratio (LCR) and High-Quality Liquid Assets (HQLA). Hopefully your eyes didn’t roll into the back of your head after being hit with not one, but two, acronyms because these particulars are, well, important for understanding what’s to become the new normal of U.S. central banking.

The Third Basel Accord, or Basel III as it’s become less than affectionately known among banks, was handed down by the Bank for International Settlements (the global central bank to central banks) in 2009. The intent was to reduce the risks in the banking system in the aftermath of a crisis that revealed banks were anything but safe and sound. It should come as no surprise that the subject of reserve requirements was smack in regulators’ crosshairs. By the end of 2019, if all goes according to plan, when Basel III is scheduled to be fully implemented, the capital reserves that banks worldwide must hold against losses will have trebled.

Enter the LCR, which is effectively a global reserve requirement mandated by Basel III. For U.S.-based banks, the focus is on the ‘L’ in the LCR, as in liquid. Regulators prefer reserves over bonds to meet minimum capital requirements. From stage right then enters HQLA, which is the Fed’s baby and emphasizes that the quality of liquid assets held be high, as in pristine. The combination of these two regulations translates into banks having to hold loads more in reserves than they once did and that those reserves be of the highest quality.

“In the post Basel III world order, base liquidity (reserves) will inevitably have to replace market-based liquidity,” Pozsar explains. “This in turn means there are no excess reserves – every penny is needed by banks for LCR compliance. And this also means that the Fed has only limited ability to shrink its portfolio.”

Where does the fed funds rate fit into the picture? As mentioned above – it doesn’t.

Banks would never choose to hold their liquidity buffers in unsecured interbank markets as they would be penalized (the fed funds market is unsecured). Rather, they will be compelled to use the secured repo markets, backed by Treasury collateral, or by accumulating reserves directly at the Fed.

“Excess reserves are not sloshing but rather sitting at the Fed,” Pozsar continues. “They sit passive and inert because banks must hold these reserves as HQLA to meet LCR requirements. You have to fund what you hold and since HQLA cannot be encumbered, you can only fund them unsecured. And banks always attempt to fund assets with positive carry.”

That last part refers to the fact that banks get paid interest by the Fed for reserves they have parked there

Does all of this mean that the Fed will be forced to shirk its role as directive general of the price of credit? Of course not. But the fact is, it can’t just leave the fed funds rate swinging in the wind; the FF has yet to be replaced as the means by which to price a full array of contracts in the financial markets. Lest ye worry, a committee mandated with replacing said FF rate has been actively pursuing an ideal replacement thereof since January of last year. Of course it has an important name! It is none other than the Alternative Reference Rate Committee.

Presumably this esteemed group is working furiously to devise a new overnight bank funding rate (last acronym, promise – OBFR), which Pozsar says is a “necessity, not a choice” given the disappearance of the FF market. The new OBFR will not be interbank, as is the case with the FF rate, but rather a customer-to-bank target rate that’s a global dollar target rate rather than just an onshore dollar funding rate. It will be as if the Fed was targeting LIBOR today.

“What this means for the Fed’s reaction function isn’t clear,” Pozsar concludes. “But our instinct tells us that we will deal with a Fed inherently more sensitive to global financial conditions, inherently more sensitive to global growth and inherently more dovish than in the past…”

Far be it from yours truly to worry. Still, it’s hard to take comfort in the knowledge that the Drano we’ve all come to know, though maybe not love, is now off the market. Less comforting yet is the fact that the plumber among financial market plumbers managed to end his forecast for the future with an ellipsis. He may as well as have ended with, “Better the devil you know…”

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In his latest must read presentation, Citigroup’s Matt King continues to expose – and be very concerned by – the increasing helplessness (and cluelessness) of central bankers, something this website has done since 2009, fully aware how it all ends.

Take Matt King’s September 2015 piece in which he warned that one of the most serious problems facing the world is that we may have hit its debt ceiling beyond which any debt creation is merely pushing on a string leading to slower growth and further deflation.

Or his more recent report which explained why despite aggressive easing by the BOJ and ECB, asset prices continue to fall as a result of quantitative tightening by EM reserve managers and China, which are soaking up the same liquidity injected by DM central banks.

Or his February 2016 report, in which his bearishness was practically oozing from every page, and which started off with the stunned observation, that “none of this is “supposed” to be happening” – inflation and economic growth are supposed to be rising in a world as manipulated by central bankers as this one. Instead, the opposite is taking place.” He then went on to say that “maybe it will all fizzle by itself”… “but if it doesn’t, then we have a problem.”

It wasn’t just one problem: as we laid out it was at least 8 problems, of which the last one was the most dire one: “if there is a next phase, it’s likely a crisis of confidence in central banks.” Because if central bank confidence goes away, so do the asset price gains of the past 7 years, all of which have been on the back of an unprecedented push by central banks to preserve the system if only that much longer.

Sure enough, central banks appear to have heard his ominous warning, and starting with the January Shanghai Accord, and the concurrent Beijing debt firehose which unleashed $1 trillion in debt in the first quarter, managed to stabilize if not the world, then certainly stock markets for a few months, courtesy of another epic credit-impulse driven push.

* * *

Over the weekend, King released his latest must read presentation, dubbed aptly enough “When the wisdom of crowds becomes the blundering herd”, in which he no longer laments the failure of central planning – we assume it’s taken for granted – and instead proceeds to highlight some of the direct consequences of living in a world in which extreme events are becoming increasingly more common, in everything from elections and polls (for which Trump is especially grateful)…

 

… to historic polarization in politics…

 

… to polarization in geography…

 

… even to polarization in weather…

 

… and of course, record polarization in the economy…

… in wealth and income…

 

… and markets…

 

… King then goes on to show just how senseless is any attempt to centrally-plan complex systems… 

 

… in which the longer central planners push the world away from an equilibrium point…

 

… pushing the system into a state of increasing fragility, defined by homogeneity, extensive interconnection, critical linkages, and slow, violent feedback…

 

… the more violent the snapback will be, and the greater the probability of breaching the critical tipping point beyond which the world will devolve into full blown systemic chaos, from which there is no return even with full central bank intervention.

Matt King’s question is also the $64 quadrillion one: “at what point does behavior become nonlinear?”

Neither we, nor King knows the answer – Janet Yellen most certainly does not – but looking at the gallery of unprecedented swings from one extreme to another, and of record divergences, we can’t help but think that we are very close, which is also why King is worried.

* * *

So until that one critical moment, in which central banks finally do push the world’s “complex system” beyond the tipping point of no recovery, here are Citi’s views on how to live, adapt and what to expect in world in which extreme events are now the norm, and in which complex systems have been hijacked by central planners.

First, the implications for politics: Direct democracy + disaffected populations = increased chance of extreme outcomes, as seen in election outcomes both in Europe and the US over the past year.

 

Then, the implication for profits, where it is increasingly a “winner takes all” outcome, especially if the winner has access to zero-cost debt with which to fund an expansive, monopolistic rollup.

The implication for jobs is well-known to regular ZH readers: “only the wealthy benefit from wage growth.” Now, even Citi admits it. To all other workers, better luck next time.

 

Then the one thing that nobody in power ever dares to mention: that near-record debt (the only time total US debt was higher as a % of GDP was just before World War II), merely amplifies the cycle and adds to the probability of tipping points.

 

Meanwhile, with defaults set to soar coupled with tumbling recovery rates, this means that whoever is on the hook will suffer massive losses now that the default outlook is even more binary than usual.

* * *

Finally, the two most important observations for market participants: market liquidity continues to deteriorate as a result of leverage constraints which imply lower diversity, and which together with central banks buying up increasingly more debt and equity securities, it means ever greater clustering of volatility, leading to periods of extremely low volatility punctuated by the occasional session of historic vol which forces exchanges to shut down the very measurement of the VIX as happened on August 24, 2015.

 

And then, finally, the implication for market levels is the most ominous: with the leverage cycle near – and in some cases beyond – its tipping point, equities are increasingly jittery as shown in the chart on the right.

 

Citi’s conclusion: the world is now much closer to a tipping point that what is implied by rates, which in turn merely represent what central banks want them to represent, which as we have said over many years, has nothing to do with the underlying reality.

In summary:

Extreme events are becoming more common, which is an intrinsic feature – not external shock – in a system that is fast approaching its “centrally-planned” tipping point. Citi’s suggestion: position for tipping points, and stay away from the conventional, fake optimistic forecasts that all shall be well as propagated by the financial media. This is why Citi is now very worried.

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Submitted by Richard Sisk via Military.com,

A small team of U.S. troops was on the ground in Yemen and Navy ships with Marines aboard were offshore to support friendly forces against an al-Qaeda offshoot as the U.S. deepened its involvement in yet another Mideast civil war, the Pentagon said Friday.

Capt. Jeff Davis, a Pentagon spokesman, declined to say how many U.S. troops were in Yemen near the port city of Mukalla, a former stronghold of the al-Qaeda in the Arabian Peninsula terror group, or whether they were Special Forces.

Davis said it was a "very small team" that had been sent into Yemen two weeks ago and was expected to be withdrawn soon. "We view this as short term," he said.

In addition, the U.S. has been conducting anti-terror airstrikes in Yemen against the terror organization apart from the effort to assist local forces on the ground, Davis said. Four airstrikes since April 23 had killed an estimated 10 fighters, he said.

The amphibious assault ship USS Boxer, lead ship for an amphibious ready group with Marines from the 13th Marine Expeditionary Unit aboard, and two Arleigh Burke-class guided missile destroyers, the USS Gravely and the USS Gonzalez, were also positioned off Mukalla, Davis said.

The troops on the ground and the ships offshore together were providing "airborne intelligence, surveillance and reconnaissance, advice and assistance with operational planning, maritime interdiction and security operations, medical support and aerial refueling," Davis said.

At a Pentagon briefing, the spokesman was vague on the mission of the troops but stressed that they were not advising and assisting friendly forces much like similar teams embedded in Iraq and Syria.

After some back and forth with reporters on the semantics of how to characterize the troops, Davis said it was appropriate to call them an "intelligence support team. We have a small number of people who have been providing intelligence support."

Davis said that the U.S. troops were supporting forces of the United Arab Emirates, but in a sign of the complexity of Yemen's civil war, forces of Yemen's embattled government and troops from Saudi Arabia were also involved in the drive to oust al-Qaeda in the Arabian Peninsula from Mukalla.

The Saudi Embassy in Washington said in a statement "Saudi forces are also on the ground alongside the UAE forces in Mukalla and that it is a Saudi-led Arab Coalition that is fighting AQAP alongside the U.S. military contingent on the ground."

The U.S. National Counter-Terrorism Center has described the terror group as "a Sunni extremist group based in Yemen that has orchestrated numerous high-profile attacks" against the U.S. It was the organization that sent Nigerian-born Umar Farouk Abdulmutallab on a Northwest Airlines flight over Detroit on Christmas day 2009 to detonate explosives in his pants but other passengers foiled the attack.

The group's most prominent operative was the charismatic Anwar al-Awlaki, a dual U.S. and Yemeni citizen, who communicated with Army Maj. Nidal Hasan prior to Hasan's shooting rampage at Fort Hood, Texas, in 2009, killing 13 people. Al-Awlaki was killed by a U.S. drone strike in Yemen in September 2011.

Davis said that the organization remained fixated on attacking the U.S. "This is of great interest to us. It does not serve our interests to have a terrorist organization in charge of a port city, and so we are assisting in that," he said.

Davis said the U.S. involvement was specifically aimed at "at routing AQAP from Mukalla, and that has largely occurred," suggesting that the ships and troops would quickly be withdrawn.

*  *  *

Yemen's civil war has killed more than 6,200 people, displaced more than 2.5 million and caused a humanitarian catastrophe in one of the world's poorest countries, according to the United Nations and human rights groups.

The war began in March 2015 when Houthi rebels, members of the Shia Zaydi sect and backed by Iran, overran the capital of Sanaa, forcing the government of Abd Rabbo Mansour Hadi to flee. A month later, al-Qaeda in the Arabian Peninsula took over Mukalla.

Saudi Arabia then came to the aid of Hadi, forming a coalition of Arab states including Bahrain, Qatar, Kuwait, United Arab Emirates, Egypt, Jordan, Morocco, Senegal and Sudan.

 

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Massive capital outflows from China in an effort to preserve capital is something that we've covered extensively in the past (here and here for example). Last month, China's Ministry of Commerce (MOC) came out to do some damage control, and downplayed the extent of the activity. It also hinted that the government would "help" Chinese companies with overseas M&A in the future…

From Xinhua

The Ministry of Commerce (MOC) Tuesday denied that Chinese companies were on a global buying spree and said the speed of their overseas mergers and acquisitions (M&A) was "appropriate and normal."

 

"It is an overstatement to say Chinese companies are 'buying out the world' as such a claim confuses finalized deals with those that are pending approval," said MOC spokesperson Shen Danyang at a news conference.
 

Overseas M&A deals by Chinese companies in the first quarter of the year stood at 16.56 billion U.S. dollars, a far cry from the 113 billion dollars cited by some reports, Shen said.
 

Instead of the rumored 100 billion dollars, Shen said that the worth of overseas M&A deals by Chinese companies last year was 40.1 billion dollars, or a mere 6.2 percent of the world's total M&A market value.
 

Although Chinese companies have increased transnational acquisition in recent years, their M&A and China's overseas investment were both in the early stages, he said.
 

According to Shen, Chinese overseas investment only accounts for 3.4 percent of the world's total, while the figure for the United States is 24.4 percent. China trails behind other developed economies such as the United Kingdom, Germany, France and Japan.
 

Overseas M&A by Chinese companies create win-win results, he said, citing the acquisition of AMC Entertainment by Dalian Wanda Group in 2012. The deal helped AMC turn losses into profits the same year, and get listed in the New York Stock Exchange the subsequent year, while some 1,100 new jobs were created in the United States.
 

Shen proposed more government support for Chinese companies to help them with overseas M&A as they still lack experience of dealing with cultural differences and policy hurdles.

As far as the size of the current 2016 deal flow, the MOC is using carefully worded language which excludes announced takeovers, which if included in the total puts the number at $92 billion through the end of March (excluding the Anbang/Starwood debacle) according to the Wall Street Journal. 

Regarding outflows being "appropriate and normal", we will just leave this CLSA chart here, which shows ODI surpassing FDI on an annualized basis for the first time in 2016.

 

And finally, as we've said to many times in the past, it will only be a matter of time before Beijing clamps down on this method of circumventing capital controls in order to preserve capital ahead of the coming devaluation of the yuan. With the MOC public relations effort, and more specifically MOC spokesperson Shen's comments about "helping" companies in the future, we wonder if that time has now come.

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