Month: July 2016

As China continues to weaken the Yuan, it's important to note the impact that it has on the inflation expectations of other economies, namely the US, Japan, and Europe. As central planners aggressively try to boost inflation, and in the meantime have created a stunning $11.7 trillion in negative yielding debt, China could be hindering that effort quite a bit.

As Morgan Stanley points out, CNY has weakened over the last year or so versus the Euro, Yen, and Dollar and is helping to explain the continued undershoot of inflation in Japan and Europe – and we would add in the US.

From MS

The RMB decline has materialized mainly against the EUR and even more so against the JPY. This may explain the continued undershoot of inflation in Europe and Japan.

MS goes on to note that the overcapacity in Asia (something we have discussed often) and a weaker currency will continue to lead to lower export prices, and thus dampen future inflation expectations, which can be seen in the US 5y5y inflation expectations. MS also observes that developed market inflation behavior is led by movements in Chinese prices, and the rally in global bonds will continue to push the USD higher, putting further downward pressure on prices.

Moderate US growth together with overcapacity in Asia and a weaker RMB will likely result in lower export prices from Asia. Market-based US inflation expectations are now lower than April, supported by Michigan survey data, all despite commodity prices being generally higher. Post Brexit our rates strategy team remains long duration, which is further supported by this lacklustre inflation environment. Inflation expectations might be held back by falling import prices from economies that run spare capacity. Exhibit 23 shows that the recent DM inflation behaviour was actually led by the movements in Chinese prices. The rally in global bonds, particularly in the US, may actually push USD higher as foreign investors look for places with a relatively high yield.

MS concludes by saying that deflationary pressures are likely to remain in place as overcapacity persists.

Important for the outcome is the evaluation of global deflationary pressures, which may be primarily fed from Asia. Yes, China’s PPI has improved from -5.9%Y to -2.9%Y, but RMB has declined over the past couple of quarters at an annualized rate of 11%, suggesting that import price deliveries from China are currently falling by 5%. Importantly, deflationary pressures are likely to remain in place as overcapacity persists. Take for instance the steel sector, where production capacity has increased by 35 million tons as China progressed through its recent mini-cycle.

Within the G10, Australia, New Zealand and Japan are most likely to see the most import pressure to the downside.

* * *

In summary, while Kyle Bass has the ultimate long-term endgame pegged, in the short-term, China will continue to systematically export deflation around the world, and continue to be a significant thorn in the side of central planners everywhere who are trying desperately to generate any type of meaningful inflation and salvage whatever is left  of their credibility.

Source: Morgan Stanley

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Submitted by Jacob Hornberger via The Future of Freedom Foundation,

In its reporting on Brexit, the New York Times asks an interesting question: “Is the post-1945 order imposed on the world by the United States and its allies unraveling, too?”

Hopefully, it will mean the unraveling of two of the most powerful and destructive governmental apparatuses that came out of the postwar era: NATO and the U.S. national-security state. In fact, although the mainstream media and the political establishment elites will never acknowledge it, the irony is that it is these two apparatuses that ultimately led to the Brexit vote:

The Times points out:

Refugees have poured out of Syria and Iraq. Turkey, Jordan and Lebanon have absorbed several million refugees. But it is the flow of people into the European Union that has had the greatest geopolitical impact, and helped to precipitate the British vote.

But what was it that gave rise to that massive refugee crisis?

The answer: It was the U.S. national-security state’s regime change operations in the Middle East, including NATO’s bombing campaign as part of its regime-change operation in Syria.

What did U.S. and NATO officials think — that people would simply remain where they were so that they could get blown to bits with the bombs that were being dropped on them, by the U.S. assassination program, or by the massive civil-war violence that came as a result of the U.S. and NATO regime-change operations?

People don’t ordinarily behave in that fashion. Most people prefer to live rather than die and will do anything they can to survive. That’s why those refugees fled to Europe—  to escape the horrific consequences of interventionism by NATO and the U.S. national security state in the Middle East.

I wonder if deep down, those who are lamenting and groaning about the Brexit vote realize that: If there had been no U.S. invasion and occupation of Iraq, no regime change in Libya, no U.S. and NATO bombing and interventionism in Syria, there wouldn’t have been a massive refugee crisis in Europe and, almost certainly, a rejection of Brexit by a majority of British voters.

How’s that for dark irony?

Like the U.S. national-security state, NATO is a Cold-War era governmental apparatus, one whose mission was ostensibly to protect western Europe from an attack by the Soviet Union, which was America’s and Britain’s World War II partner and ally.

But as everyone knows, the Cold War ended more than 25 years ago. A question naturally arises: Why then didn’t NATO go out of existence once the Cold War was over?

The following statement by the Times perfectly reflects how the mainstream media and the political establishment elites just don’t get it:

NATO has rediscovered its purpose in the aftermath of Russia’s intervention in Ukraine. Yet the Baltic countries still worry whether the military alliance would truly defend them against Russian aggression, and the alliance has had trouble defining its role in fighting terrorism or dealing with the migrant flow.

What the Times is insinuating is that NATO is just as necessary today to protect western Europe (and now eastern Europe) from Russian aggressiveness as it was during the Cold War era.

But there is something wrong with that picture, something that the Times and the political establishment elites don’t want to focus on — that it was NATO and the U.S. national-security establishment that precipitated the crisis with Russia over Ukraine.

After the Cold War ended, not only did NATO decide to remain in existence, it began absorbing Eastern European countries that had formerly been in the Warsaw Pact. When the expansionary efforts finally reached Ukraine, NATO strived to absorb that country as well, which it came very close to doing thanks to a pro-U.S. coup that had all the earmarks of a successful CIA regime-change operation. Absorbing Ukraine into NATO would have meant U.S. bases, troops, tanks, and missiles on Russia’s border and the U.S. takeover of Russia’s longtime military base in the Crimean port of Sevastopol.

There was never any chance that Russia was going to permit that to happen, which led to Russia’s annexation of Crimea and the onset of the Ukraine crisis.

After all, imagine that the Warsaw Pact had remained in existence and had begun absorbing Cuba, Venezuela, Chile, Nicarargua, Guatemala, and Mexico, with aims of installing Russian military bases on Mexico’s border with the United States. What do you think the reaction among U.S. officials would have been to those provocative acts?

But what do we get from the mainstream media and the political establishment elites? That NATO is just an innocent party, one that is a force for good in the world, rather than a corrupt Cold War dinosaur-like apparatus whose mission is to provoke crises in order to justify its continued existence.

As I detail in my new ebook The CIA, Terrorism, and the Cold War: The Evil of the National Security State, it’s no different with the U.S. national-security apparatus that was also brought into existence to wage the Cold War against the Soviet Union and which fundamentally changed America’s government structure for the worse. After all, don’t forget: China and North Korea are national-security states as well. Totalitarian regimes are almost always national security states.

So, why did U.S. officials graft a totalitarian apparatus to America’s federal governmental structure, without even the semblance of a constitutional amendment? They said that a temporary totalitarian apparatus was necessary to wage a cold war against the Soviet Union’s and China’s totalitarian communist regimes.

In itself, that’s problematic, but one thing is certain: The Cold War is over. It ended more than a quarter-century ago. Rather than be dismantled, which is what should have happened back in 1989, the national-security state, having lost its official enemy with the end of the Cold War, decided to go into the Middle East and provoke trouble with invasions, occupations, sanctions, interventions, and regime-change operations. All that brought us anti-American terrorist attacks, the war on terrorism, a formal assassination program, a massive secret surveillance program, indefinite detention, torture, secret prison camps, and other dark things that characterize totalitarian and communist regimes.

And yet the mainstream media and the political establishment elite just don’t get it: They see the national-security state as a protector and as a force for good in the world, rather than as a major purveyor of death, destruction, crises, chaos, and loss of liberty, peace, and prosperity.

It’s time for Americans to do some real soul-searching. It’s time to do some fundamental post-World War II alterations here at home. A great place to begin would be a dismantling of both NATO and the national-security state. An American exit from these corrupt and expensive Cold War-era apparatuses would lead the way to freedom, peace, prosperity, and harmony with the world.

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As the middle class erodes in the US, we have pointed out the many things that have continued to financially squeeze what is left of The American Dream out of the average joe, from rent becoming increasingly unaffordable to healthcare premiums exploding higher. We now have another expense that is taking a toll financially on the average American family, and that is child care.

Child care expenses have climbed nearly twice as fast as overall prices since the recession ended in 2009 the WSJ reports, and coupled with lackluster wage gains, families with young children are finding themselves stretched financially.

As the WSJ points out, the cost of child care is so high that in 41 states, the cost of sending a 4 year old to full-time preschool exceeds 10% of a median family income, and full-time preschool is more expensive than the average tuition at public college in 23 states. Care for an infant even costs more than the average rent in 17 states.

Since the recession ended in 2009, the cost of child care and nursery school has increased at a 2.9% annual average, outpacing overall inflation of 1.6% during that seven year period.

According to the WSJ, it costs $245,340 to raise a child born in 2013 from birth to age 18, nearly five years worth of income for the median US household. By comparison, the cost of raising a child born in 2003 was $226,108 after adjusting for inflation.

Looking at the breakdown of costs for middle income families from 1960 to 2013, education and child care costs have exploded higher.

For Malki Karkowsky, child care costs account for almost a quarter of the family budget. Adding in rent for the family's Kensington, Md apartment, and more than half of her and her husband's month take-home pay is gone. Karkowsky has a 3 year old son and a daughter under the age of 1. "Thankfully, we can cover the cost of food and clothing, but not really the extras." Karkowsky said.

The family aspires to buy a home, but saving is difficult, even after moving to a cheaper location. The move saved $350 a month, but that doesn't even cover a week of day care.

According to the WSJ, an April Gallup poll found that 37% of Americans between 30 and 49, the age when many are raising children, said they didn't have enough money to live comfortably.

Increased costs are a struggle for many families, especially due to the fact that adjusting for inflation, incomes are barely above pre-recession levels.

Ironically, even the Federal Reserve admitted the inflation – which they can never seem to find anywhere – is higher for low income families.

From the WSJ

That presents a test for Federal Reserve officials who set economic policy based upon the average inflation rate experienced in the economy. A recent analysis by the Federal Reserve Bank of Minneapolis found that households with low incomes, more household members or older household heads experience higher inflation on average – but concluded that any given individual’s inflation rate can be several percentage points different from the average rate.

 

“It speaks to the challenge the Fed faces in communicating about inflation,” Minneapolis Fed Director of Research Sam Schulhofer-Wohl said. “Even if average inflation is around 2%, you have to be aware that many households face price changes that are much higher or lower than inflation.”

* * *

We're stunned that the Federal Reserve even acknowledged that inflation is out there in any form, since it continuously ignores rent, student loans, health insurance, and now child care costs. Then again, it's not likely that the Fed will stop its actions that create those situations to begin with of course.

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Submitted by David Stockman via Contra Corner blog,

The Eccles Building trotted out Vice-Chairman Stanley Fischer yesterday morning. Apparently his task was to explain to any headline reading algos still tracking bubblevision that things are looking up for the US economy again and that Brexit won’t hurt much on the domestic front. As he told his fawning CNBC hostess:

 “First of all, the U.S. economy since the very bad data we got in May on employment has done pretty well. Most of the incoming data looked good,” Fischer said. “Now, you can’t make a whole story out of a month and a half of data, but this is looking better than a tad before.”

You might expect something that risible from Janet Yellen – she’s just plain lost in her 50-year old Keynesian time warp. But Stanley Fischer presumably knows better, and that’s the real reason to get out of the casino.

What is happening is that after dithering for 90 months on the zero bound the Fed has run out the clock. The current business cycle expansion—as tepid as is was— is now clearly rolling over. So the Fed has no option except to sit with its eyes wide shut while desperately trying to talk-up the stock market.

And that means happy talk about the US economy, no matter how implausible or incompatible with the facts on the ground. No stock market correction or sell-off of even 5% can be tolerated at this fraught juncture.

That’s because the U.S. economy is so limp that a proper correction of the massive financial bubble the Fed and other central banks have re-inflated since March 2009 would send it careening into an outright recession. And that, in turn, would blow to smithereens all of the FOMC’s demented handiwork since September 2008, and indeed since Greenspan launched the era of Bubble Finance back in October 1987.

So when Fischer used the phrase “the incoming data looked good”, he was doing his very best impersonation of Lewis Carroll’s version of Humpty Dumpty. “Good” is exactly what our monetary politburo says it is:

“When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean—neither more nor less.”

The fact is, the “lesses” have it by a long shot, but the Fed cannot even whisper a word about the giant risks, challenges and threats which loom all across the horizon.

So for the third time this century, a business cycle contraction will come without warning from the Fed. Once again the Kool-Aid drinking perma-bulls, day traders and robo-machines will be bloodied as they stampede for the exit ramps. But it is the main street homegamers, who have been lured back into the casino for the third time this century, that will suffer devastating losses yet another time.

Indeed, if there were even a modicum of honesty left in the Eccles Building it would be warning about the weakening trends in the US economy, not cheerleading about fleeting and superficial signs of improvement.

Likewise, it would acknowledge the drastic over-valuation of the stock, bond, real estate and other derivative financial markets and remind investors that a healthy capitalism requires a periodic purge of such excesses in order to check mis-allocation of resources and malinvestment of capital.

Most importantly, it would flat out confess the inability of monetary policy—–even its  current extraordinary accommodation variant—–to ameliorate the structural and supply-side obstacles to a more robust rate of economic growth and wealth creation in the US.

In that regard, it would especially abjure the hoary notion that an excess of monetary stimulus is warranted because fiscal policy and regulators, for example, are allegedly not holding up their side of the bargain.

In fact, monetary stimulus is not the “only game in town”, as is often asserted; it’s the wrong game. Money printing is not a second best substitute for other pro-growth policies because it’s not pro-growth at all.

At best, it shifts the incidence of economy activity in time, such as when cheap mortgage rates cause housing construction to be higher today and then lower in the future when rates normalize.

But mainly monetary stimulus causes systemic mis-pricing of financial assets. It turns money and capital markets into gambling arenas where speculators capture huge unearned windfalls while the mainstream economy is deprived of growth and productivity inducing real capital investment.

Thus, instead of dispensing sunny-side agit prop Friday morning, Fischer might have noted the startling anomaly that was occurring at the very moment of his CNBC appearance.

To wit, the 10-year US Treasury note——the very benchmark of the entire global financial system—-had just kissed a record low yield of 1.38%. At the same moment, the futures market was signaling an open on the cash S&P 500 at 2110 or within 0.09% of its all-time high and at nosebleed PE ratio of 24X reported earnings.

Not in a million years would an honest, healthy, stable and sustainable free market have produced that combination. Starring at CNBC’s on set monitors, Fischer was looking at a screaming warning sign that financial markets have become radically unhinged. Starring into the cameras, he lied through his teeth in order to perpetuate the Fed’s sunny-side narrative.

Here’s the thing, however. The Fed’s primitive Keynesian models are all about quantity of economic factors and the short-run sequential change in the GDP and jobs data sets. There is not even acknowledgement of qualitative factors or how the “incoming data” aligns with historical trends.

Nor does a positive quarter purchased at the certain expense of a sharp reversal a few periods down the road get discounted. The Fed model is all about sequential GDP gains——even if there are blatant indications that they are not sustainable or compatible with the prerequisites for healthy capitalist prosperity and stability.

All of these considerations were evident in the incoming data releases on Friday and in recent days——the very items that Fischer insisted had gotten better from “a tad before”.

Booming auto sales have been a pillar of the weak overall recovery since 2009, but even they came in for June down by a sharp 4.6% from prior year at 16.7 million light vehicles. Moreover, this was a continuation of the weakening pattern since last fall, and a clear indicator that the peak sales rate for this cycle is already in:

But that’s not the half of it. Given population and household growth since the 2007 peak, 18 million units should be the floor of a healthy sustainable US economy, not a momentary peak, as is evident in the chart.

And this point is made all the more salient given the qualitative factors behind the peak levels that were achieved late last year. To wit, the entire rebound from the 2008-2009 crisis lows was funded with debt, and much of it was issued to anyone who could fog a rearview mirror.

That’s right. Since the auto cycle bottom in mid-2010, retail motor vehicle sales have rebounded at a $360 billion annual rate, whereas auto loans outstanding have risen by $355 billion.

Moreover, the apparent low default rate of recent years was self-evidently misleading in the context of Bubble Finance. Owing to the collapse of new car sales between 2007 and 2011, there has been a sharp reduction in the supply of used cars, causing the resale value of the existing fleet to steadily rise.

Rising used car prices, in turn, made it easy for even marginal consumers to refinance old loans into new vehicle purchases, thereby avoiding defaults. At the same time, artificially low interest rates enabled auto finance companies to finance loans and leases at exceedingly low but unsustainable monthly payment rates.

So the auto contribution to GDP growth during the last few years had an unsustainable “virtuous circle” character. There was no reason, therefore, to believe these gains could be replicated permanently. In fact,  there was every reason to believe that the artificial Fed induced auto finance cycle would be eventually reversed, thereby generating substantial, off-setting “payback” down the road.

That risk is now materializing. The entire “virtuous” but artificial auto finance cycle is reversing as a flood of used cars—–reflecting the booming sales of the last four years—–comes into the resale market.

Consequently, used car prices are heading south, thereby undermining trade-in values and eligibility for new loans.  The index of used car prices is now down 5% from its recent peak, and based on past cycles has a long way down yet to go.

Alas, downward trending used car prices will also means that default rates will be rising for the simple reason that underwater borrowers will not be able to refinance their “ride” into a new or more recent vintage used vehicle.

Likewise, new car loan and lease finance will be shrinking because the estimated “residuals” on leases and collateral value on loans will be lower. That means loan-to-car price ratios will come down—just as trade-in values on existing vehicles are also dropping. The resulting financing gap means lower sales and production rates in the auto sector.

In short, there has not been a healthy recovery of the auto industry owing to 90 months of ZIRP and the Fed’s massive money printing escapades. This misbegotten monetary stimulus has only generated a deformed auto financing cycle that is now reversing and which will soon be extracting its pound of payback.

Needless to say, Fischer eschewed the opportunity to talk soberly about the headwinds facing the strongest sector of the recent recovery. And this is only illustrative. The same can be said of housing—where cheap mortgages have raised prices far more than output of new housing—and countless others.

The recession will come, therefore, with the Fed flat-footed again and this time, out of dry powder, as well.

Indeed, so thoroughly will the Fed be discredited when the market crashes again by 40% or 50% or more, that modern Keynesian central banking will be faced with an existential crisis.

To use the metaphor, our monetary Humpty Dumpty is heading for a great fall, and all the Imperial City’s potentates and poobahs will not be able to put it together again.

And that would be a very good thing.

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While mom and pop investors and BTFDers (if not so much hedge and mutual funds and other “smart money“) have been delighted by the latest V-shaped surge in stocks, it has come as we have repeatedly shown…

 

… at the expense of collapsing long-term yields as another central bank liquidity tsunami is priced in. In fact, early Friday both 10Y and 30Y US Treasury yields plunged to new all time lows, a signal which at any other time would suggest a deflationary tsunami is about to be unleashed, but in this case simply meant that another bout of central bank generosity was coming to prop up risky assets in the aftermath of Brexit.

The problem is that while stocks can – for now – ignore this historic divergence, which has pushed the S&P back to just shy of all time highs while bond yields are at all time lows, one major market participant can no longer pretend to not notice what is going on. We are talking about pension funds, who according to Bank of America are about to “throw in the towel” and capitulate on the de-risking of their portfolios, unleashing the next major buying spree on the long end, in the process likely pushing the 10Y to 1% or even much lower.

As BofA’s Shyam Rajan writes, bull flattening of yield curves is rarely good news to anyone – but defined benefit pension plans are most leveraged to this pain. According to the most recent Milliman estimate, the average funded ratio of the top 100 US corporate defined benefit pension plans already had dropped to 77% by end of April. Since then, 30y rates dropped another 50bp and corporate spreads have tightened. While the asset side has provided some relief given that equities are hanging on to the highs, we think it is safe to assume that funding ratios over the last month have now reached the lows seen in 2012 – a rather sobering thought given that the equity rally of 70% since then has meant nothing and has been subsumed by the rate decline. The dominant factor of pension funding gaps has been the move in rates, as Chart 2 makes clear.

According to BofA there are five reasons why capitulation is more likely now.

Talking about pension capitulation seems counterintuitive when funded ratios are at record lows on the heels of a significant decline in rates. After all, why would a pension manager hoping for mean reversion at the beginning of the year feel forced to throw in the towel at these levels? 10y rates have been here before, funding ratios have been this low before, and this is not the first time for a flight to quality out of Europe and Japan into the US. What makes this time different? We identify five reasons (three macro, two pension-specific) that make capitulation this time around much more likely:

Here are the reasons:

1. Longer term growth

The key difference from a few years ago is the formalization of the “new normal” in the markets. Global estimates of neutral real rates are much lower, the Fed’s estimate of the long-run rate has dropped nearly 100bp, and the yield curve in itself sends a bleak message (Chart 2). While in 2013, 10y rates reached similar levels and the market pushed out the Fed nearly three years, it remained optimistic for the long run. Terminal rates were priced to be north of 3.5%, with forward inflation expectations above the Fed’s target. Today, every intermediate forward beyond 3y1y is 50-200bp lower than the lowest point in 2013. There is greater understanding that the yield moves are not temporary but a glaring reflection of the new normal across the globe

2. Inflation expectations

The inflation market signals the same pessimism. Chart 4 shows inflation expectations across global markets relative to central bank inflation targets. Zero on the chart indicates that the markets on average expect the central bank to hit its inflation target over 30 years, while negative indicates a miss to the target. Among the markets that priced-in positive inflation risk premia in late 2013, almost all now project  their central banks to miss their targets over 30 years.

 

3. The gravitational pull of negative yields

Any assumed lower bound for rates has been thrown out the window given the moves to negative rates. Nearly 33% of the BofAML Developed Market (DM) sovereign index now trades negative in yield, and the US makes up nearly half of the positive yielding assets available to investors. The long end of the US curve remains cheap to European and Japanese investors (on unhedged or partially hedged basis) who are getting pushed out of their domestic sovereign markets because of QE. Fundamentally, the macro rationale for the ECB and BoJ to stop QE is years away, and flow-wise, the safe haven scarcity problem motivating flows into the US is here to stay.

4. Variable PBGC premiums

The penalties for underfunding have increased markedly since 2012 and are scheduled to increase even more. Based on the latest budget act, for each $1,000 of underfunding, variable rate Pension benefit Guarantee Corporation (PBGC) premiums increase from $30 to $33 in 2017, $37 in 2018, and $41 in 2019. Nearly 33% of the BofAML Developed Market (DM) sovereign index now trades negative in yield Essentially, the top 100 corporate defined benefit pension plans will be paying at least ~$20bn/year in variable premiums by 2019 if current levels of underfunding remain.

5. Borrowing to solve the pension tension

The greatest impediment to pension risk transfers (used loosely as a term for offloading some or all of the pension risk to an insurance company who then fund them with annuities) is the need to raise cash to bring funding ratios to par before passing it on to the insurance company. In this regard, low corporate bond yields (and ECB corporate buying) actually could help. Consider the BofAML Corporate Master index – the effective yield of single A rated corporates is 2.52% and that of BBBs is 3.4%. The relative tradeoff now between issuing debt vs paying 3-4% of variable premiums is increasingly attractive – corporates could consider issuing debt to make pensions whole and probably come out with a net positive after tax savings on debt interest (Chart 6). While issuing debt to buyback stock has been a popular strategy, issuing debt to make pensions whole could be the next trend in fixing balance sheet risk. A broader discussion of this trade-off is beyond the scope of our piece, but it reinforces the point that despite wider funding gaps, there is likely a greater incentive or larger fear that is likely to motivate pension de-risking in the coming months.

 

To be sure, the current collapse in yields has precedented: in 2011, rates declined more than 100bp, curves flattened by more than 75bp, the large scale downgrade of European bonds left Treasuries as the only choice, and there was greater acceptance that 10y yields probably wouldn’t go back to 4% anytime soon. This move prompted significant pension de-risking in 2012 – evident in the two large risk transfer trades (GM and Verizon), widening long-end swap spreads, and significant increase in Treasury holdings of defined benefit pension plans (Chart 7).

As Bank of America summarizes, a capitulation at this point seems inevitable:

Today, all of the above is amplified. Treasuries make up nearly 50% of the positive-yielding DM sovereign bonds; curves are 100bp flatter; and there is a greater likelihood that 10y yields probably won’t go back to even 2.5%. We would expect a bigger capitulation by pension managers in the coming months/years.

How big of a market are we talking about here in case there indeed is a capitulation be? Well, in a word – massive. It’s a $3 trillion trade.

For the rates market, the significance of this acceptance phase by pensions cannot be understated, in our opinion. A $3 trillion industry running a $500 billion funding gap and a significant duration gap waking up to reality is likely to have major implications for the market. The nature of the de-risking is less important but could amplify the impact. In the simplest de-risking scenario, pension managers would stop underestimating the perceived lower bound for US rates and be more aggressive in using rate sell-offs to close duration gaps. In the extreme case, entire pensions could be offloaded from corporate balance sheets to insurance companies (increasingly like the UK, Exhibit 1)–generating significant demand for long-end duration during such transactions. One only needs to look at the long end of the UK rates market to see the significance of pension demand (Chart 9). Note that the UK regulation on inflation protection for pensions is more stringent, leaving the impact primarily on real yields. A similar move in the US is likely to be more evenly divided between reals and breakevens.

 

The final question: what will be the market impact of the capitulation:

Flatter curves, positive sign for swap spreads & long-end balance sheet trades. Ultimately, the de-risking of pensions whether via a full risk transfer or not would have significant implications for the rates market. Defined benefit pension holdings of USTs still stands at a rather low 6% of total assets (Chart 8)

• Rates: It would add to the long list of buyers (Japanese, European investors, index shorts) eager to add duration on any modest sell-off in US rates. This would limit any sell-off in rates to short-lived, positioning-led squeezes higher in yields, following which a flood of demand would take over. Active hedging by pensions also
  is likely to keep receiver skew in longer tails rich.
• Curve: Any sizable de-risking is likely to be a flattener. Even if corporations issue to shore up pensions, which then subsequently de-risk, the net impact would likely be a flattener, in our view. This is because issuance would be skewed toward the belly of the curve where demand dominates, while the de-risking flow happens in the long end of the curve. While this is a long-term theme, it should help our tactical flattening call on the curve.
• Spreads and strips: Long-end demand from pensions also would be the welcome sign of relief the long end of the spread and coupon-strip curve need. The lack of consistent real money demand combined with $150bn in 30y UST supply every year and lack of dealer appetite to police these relationships has in short been the primary driver of tightening of long-end spreads and cheapening of coupon strips. Some 46bp of extra yield in USTs over swaps and 25bp of extra yield in c-strips over p-strips should look extremely attractive to investors settling for below-2% yields.

What all of this means in simple, numeric terms for the two securities everyone is most familiar with, namely the 10Y and the 30%? It means look for the 10Y Treasury to drop under 1% while the 30Y plunges to 1.50% or lower, as the entire world slowly but surely turn Japanese, where incidentally, the world’s largest pension fund – the GPIF – just lost $43 billion in the past quarter as a result of the failure of Abenomics and its hail mary attempt to offset billions in underfunding using a monetary policy gimmick. Similar losses are coming to pension funds much closer to you next.

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While mom and pop investors and BTFDers (if not so much hedge and mutual funds and other “smart money“) have been delighted by the latest V-shaped surge in stocks, it has come as we have repeatedly shown…

 

… at the expense of collapsing long-term yields as another central bank liquidity tsunami is priced in. In fact, early Friday both 10Y and 30Y US Treasury yields plunged to new all time lows, a signal which at any other time would suggest a deflationary tsunami is about to be unleashed, but in this case simply meant that another bout of central bank generosity was coming to prop up risky assets in the aftermath of Brexit.

The problem is that while stocks can – for now – ignore this historic divergence, which has pushed the S&P back to just shy of all time highs while bond yields are at all time lows, one major market participant can no longer pretend to not notice what is going on. We are talking about pension funds, who according to Bank of America are about to “throw in the towel” and capitulate on the de-risking of their portfolios, unleashing the next major buying spree on the long end, in the process likely pushing the 10Y to 1% or even much lower.

As BofA’s Shyam Rajan writes, bull flattening of yield curves is rarely good news to anyone – but defined benefit pension plans are most leveraged to this pain. According to the most recent Milliman estimate, the average funded ratio of the top 100 US corporate defined benefit pension plans already had dropped to 77% by end of April. Since then, 30y rates dropped another 50bp and corporate spreads have tightened. While the asset side has provided some relief given that equities are hanging on to the highs, we think it is safe to assume that funding ratios over the last month have now reached the lows seen in 2012 – a rather sobering thought given that the equity rally of 70% since then has meant nothing and has been subsumed by the rate decline. The dominant factor of pension funding gaps has been the move in rates, as Chart 2 makes clear.

According to BofA there are five reasons why capitulation is more likely now.

Talking about pension capitulation seems counterintuitive when funded ratios are at record lows on the heels of a significant decline in rates. After all, why would a pension manager hoping for mean reversion at the beginning of the year feel forced to throw in the towel at these levels? 10y rates have been here before, funding ratios have been this low before, and this is not the first time for a flight to quality out of Europe and Japan into the US. What makes this time different? We identify five reasons (three macro, two pension-specific) that make capitulation this time around much more likely:

Here are the reasons:

1. Longer term growth

The key difference from a few years ago is the formalization of the “new normal” in the markets. Global estimates of neutral real rates are much lower, the Fed’s estimate of the long-run rate has dropped nearly 100bp, and the yield curve in itself sends a bleak message (Chart 2). While in 2013, 10y rates reached similar levels and the market pushed out the Fed nearly three years, it remained optimistic for the long run. Terminal rates were priced to be north of 3.5%, with forward inflation expectations above the Fed’s target. Today, every intermediate forward beyond 3y1y is 50-200bp lower than the lowest point in 2013. There is greater understanding that the yield moves are not temporary but a glaring reflection of the new normal across the globe

2. Inflation expectations

The inflation market signals the same pessimism. Chart 4 shows inflation expectations across global markets relative to central bank inflation targets. Zero on the chart indicates that the markets on average expect the central bank to hit its inflation target over 30 years, while negative indicates a miss to the target. Among the markets that priced-in positive inflation risk premia in late 2013, almost all now project  their central banks to miss their targets over 30 years.

 

3. The gravitational pull of negative yields

Any assumed lower bound for rates has been thrown out the window given the moves to negative rates. Nearly 33% of the BofAML Developed Market (DM) sovereign index now trades negative in yield, and the US makes up nearly half of the positive yielding assets available to investors. The long end of the US curve remains cheap to European and Japanese investors (on unhedged or partially hedged basis) who are getting pushed out of their domestic sovereign markets because of QE. Fundamentally, the macro rationale for the ECB and BoJ to stop QE is years away, and flow-wise, the safe haven scarcity problem motivating flows into the US is here to stay.

4. Variable PBGC premiums

The penalties for underfunding have increased markedly since 2012 and are scheduled to increase even more. Based on the latest budget act, for each $1,000 of underfunding, variable rate Pension benefit Guarantee Corporation (PBGC) premiums increase from $30 to $33 in 2017, $37 in 2018, and $41 in 2019. Nearly 33% of the BofAML Developed Market (DM) sovereign index now trades negative in yield Essentially, the top 100 corporate defined benefit pension plans will be paying at least ~$20bn/year in variable premiums by 2019 if current levels of underfunding remain.

5. Borrowing to solve the pension tension

The greatest impediment to pension risk transfers (used loosely as a term for offloading some or all of the pension risk to an insurance company who then fund them with annuities) is the need to raise cash to bring funding ratios to par before passing it on to the insurance company. In this regard, low corporate bond yields (and ECB corporate buying) actually could help. Consider the BofAML Corporate Master index – the effective yield of single A rated corporates is 2.52% and that of BBBs is 3.4%. The relative tradeoff now between issuing debt vs paying 3-4% of variable premiums is increasingly attractive – corporates could consider issuing debt to make pensions whole and probably come out with a net positive after tax savings on debt interest (Chart 6). While issuing debt to buyback stock has been a popular strategy, issuing debt to make pensions whole could be the next trend in fixing balance sheet risk. A broader discussion of this trade-off is beyond the scope of our piece, but it reinforces the point that despite wider funding gaps, there is likely a greater incentive or larger fear that is likely to motivate pension de-risking in the coming months.

 

To be sure, the current collapse in yields has precedented: in 2011, rates declined more than 100bp, curves flattened by more than 75bp, the large scale downgrade of European bonds left Treasuries as the only choice, and there was greater acceptance that 10y yields probably wouldn’t go back to 4% anytime soon. This move prompted significant pension de-risking in 2012 – evident in the two large risk transfer trades (GM and Verizon), widening long-end swap spreads, and significant increase in Treasury holdings of defined benefit pension plans (Chart 7).

As Bank of America summarizes, a capitulation at this point seems inevitable:

Today, all of the above is amplified. Treasuries make up nearly 50% of the positive-yielding DM sovereign bonds; curves are 100bp flatter; and there is a greater likelihood that 10y yields probably won’t go back to even 2.5%. We would expect a bigger capitulation by pension managers in the coming months/years.

How big of a market are we talking about here in case there indeed is a capitulation be? Well, in a word – massive. It’s a $3 trillion trade.

For the rates market, the significance of this acceptance phase by pensions cannot be understated, in our opinion. A $3 trillion industry running a $500 billion funding gap and a significant duration gap waking up to reality is likely to have major implications for the market. The nature of the de-risking is less important but could amplify the impact. In the simplest de-risking scenario, pension managers would stop underestimating the perceived lower bound for US rates and be more aggressive in using rate sell-offs to close duration gaps. In the extreme case, entire pensions could be offloaded from corporate balance sheets to insurance companies (increasingly like the UK, Exhibit 1)–generating significant demand for long-end duration during such transactions. One only needs to look at the long end of the UK rates market to see the significance of pension demand (Chart 9). Note that the UK regulation on inflation protection for pensions is more stringent, leaving the impact primarily on real yields. A similar move in the US is likely to be more evenly divided between reals and breakevens.

 

The final question: what will be the market impact of the capitulation:

Flatter curves, positive sign for swap spreads & long-end balance sheet trades. Ultimately, the de-risking of pensions whether via a full risk transfer or not would have significant implications for the rates market. Defined benefit pension holdings of USTs still stands at a rather low 6% of total assets (Chart 8)

• Rates: It would add to the long list of buyers (Japanese, European investors, index shorts) eager to add duration on any modest sell-off in US rates. This would limit any sell-off in rates to short-lived, positioning-led squeezes higher in yields, following which a flood of demand would take over. Active hedging by pensions also
  is likely to keep receiver skew in longer tails rich.
• Curve: Any sizable de-risking is likely to be a flattener. Even if corporations issue to shore up pensions, which then subsequently de-risk, the net impact would likely be a flattener, in our view. This is because issuance would be skewed toward the belly of the curve where demand dominates, while the de-risking flow happens in the long end of the curve. While this is a long-term theme, it should help our tactical flattening call on the curve.
• Spreads and strips: Long-end demand from pensions also would be the welcome sign of relief the long end of the spread and coupon-strip curve need. The lack of consistent real money demand combined with $150bn in 30y UST supply every year and lack of dealer appetite to police these relationships has in short been the primary driver of tightening of long-end spreads and cheapening of coupon strips. Some 46bp of extra yield in USTs over swaps and 25bp of extra yield in c-strips over p-strips should look extremely attractive to investors settling for below-2% yields.

What all of this means in simple, numeric terms for the two securities everyone is most familiar with, namely the 10Y and the 30%? It means look for the 10Y Treasury to drop under 1% while the 30Y plunges to 1.50% or lower, as the entire world slowly but surely turn Japanese, where incidentally, the world’s largest pension fund – the GPIF – just lost $43 billion in the past quarter as a result of the failure of Abenomics and its hail mary attempt to offset billions in underfunding using a monetary policy gimmick. Similar losses are coming to pension funds much closer to you next.

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Authored by Bonner & Partners' Bill Bonner (annotated by Acting-Man's Pater Tenebrarum),

Sliding Into Absurdity

Stock markets continued their rebound to almost erase all Brexit losses. London’s FTSE 100 Index is above Brexit levels but Europe’s equivalent of the Dow, the Euro Stoxx 50, remains lower.

 

No wonder the Dragon and his partners in crime flooded the EU banking system with “money” this past week…

 

Investors have realized Brexit isn’t the end of the world. First, because they think it won’t really happen. After all, elites can fix elections, buy politicians, and control public policy… surely, they can fix this!

A letter in the Financial Times reminds us that Swedish voters cast their ballots against nuclear power in 1980. The government just ignored them, doubling nuclear power generation over the next 36 years.

Second, because investors see the panic over Brexit leading to more spirited intervention by central banks! The EZ money floodgates – already wide open – are to be opened wider.

The U.S. has its QE program on hold, but Europe’s scheme is gushing like Niagara. Mario Draghi at the European Central Bank buys $90 billion a month in bonds. And he’s not only buying government bonds; he’s buying corporates, too.

 

Less Than Zero

In Japan, always a trendsetter, the Bank of Japan has bought so many bonds it has pushed Japanese government bond yields below zero – out to more than 45 years on the yield curve!

In other words, you can now lend to the bankrupt Japanese government until 2051 with no hope of making a single yen, nominally, on your investment. Now, with bonds stacking up in their vaults, the Japanese feds are diversifying. They’re buying exchange-traded funds (ETFs), too.

 

JGB weekly over the past 5 years….still a widow-maker! – click to enlarge.

 

Via its ETF purchases, the BoJ buys about $30 billion of Japanese stocks a year. This has made it a top 10 shareholder in about 90% of the companies listed on the country’s Nikkei 225 Index.

Apparently, the BoJ announced it would buy a particular kind of politically correct ETF, even before such an investment existed. This led to a rush to meet the demand (no matter how looney) to create exactly the ETF the Japanese feds were looking for.

So now, the phony money created by the BoJ buys phony ETFs created by the sushi equivalent of Wall Street – solely for the purpose of letting the Samurai feds put more phony money into the financial sector. The ETF then must buy politically fashionable companies, many of which probably wouldn’t exist were the fix not in so deeply.

Result?  The Bank of Japan – not private investors – is the proud owner of stocks and bonds that private investors didn’t want, bought at prices they wouldn’t pay. The whole show is too goofy for words. But words are all we’ve got!

 

Meet Goofy.

 

Capitalism Without Capital

“It is just a matter of time,” says a friend writing from Switzerland, “before the feds own all our assets. They’re determined to keep prices high and they have unlimited resources.”

Yes, stocks, bonds, old copies of Mad Magazine… everything will be owned by the government. Then our liberty will be complete. We will have nothing… and nothing to lose.

We will have become what leading German post-war economist Wilhelm Röpke had anticipated: the “stable fed” animals that depend on their masters to keep them going.

 

Moooo!

 

At last, we will have the kind of capitalism another economist – Karl Marx – dreamed of: capitalism without private capital. The Deep State will control all our wealth.

We will go to college on federal loans… we will drive cars, leased of course, at federally subsidized low rates… we will live in houses mortgaged by federal mortgage lender Fannie Mae… with the mortgage rates pushed down by its fellow manipulator, Freddie Mac… we will work for companies that depend on the Fed’s EZ money financing…and, of course, our medical care will be in the hands of the feds… and our retirement finances too.

Cradle to grave – Chapter 1 to Chapter 11 –  all on central bank credit.

Each dollar in the private sector is either earned or borrowed. The feds and their crony friends get their money for free. Gradually, they own more and more assets, while the rest of the people owe more and more debt.

 

Sacred Tether

But wait –  let us look again at the maze of dots. How did this happen? Yesterday, we saw that price is not the same as value. If you want to increase prices, all you have to do is spread around some cash. Drop money from helicopters, especially in bad neighborhoods, and prices will soar. But value?

Here is where it gets interesting.  Because when you drop money from helicopters, values tend to drop, too. What shoemaker will still take pride in a making a good pair of walking boots, when his money floats down from Heaven with no effort at all?

 

Manna from heaven… we’ll all be rich! As Keynesian economists will confirm, capital is a self-replicating blob, that only waits for us to “spend”!

 

What company will still sweat and strain to produce the best possible products, when its revenues no longer come from demanding customers? What analyst sharpens his pencil to find the best companies to invest in, when there is no longer any connection between money and quality performance.

In rich neighborhoods or in poor ones, giving away money causes trouble. Quality declines, as fewer and fewer people are willing to put in the time and trouble to produce it. And why should they? The ancient and sacred tether, connecting quality to wealth, effort to reward, has been severed.

Want to know why the average American man earns less today than he did 40 years ago? Want to know how the rich got so filthy rich? Want to know why, as the Financial Times put it yesterday, Hillary is afraid of a “populist contagion”?

 

Something went wrong along the way… but what?

 

The feds got out the knife in 1971. They changed the money system itself. They severed the link between gold and the dollar – and between value and price. It was so subtle almost no one objected… and so clever almost no one saw what it really meant.

It took us more than 40 years to figure it out. And even now, the dots reveal a pattern, but it is indistinct… hard to see… and easy to misinterpret. Most people see only the symptoms, the boils. the fever, the night sweats – and the daytime delusions:

The masses voting for Brexit or Donald. Interest rates falling to 5,000-year lows. The gap between rich and poor opening wider and wider. What is the cause?

Stay tuned…

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Despite the rapid central-bank-inspired decline in short-term risk momentum, there is no doubt in BofA's mind that the world is a riskier place following the UK’s decision to leave the EU. Hence, they warn, the chances for additional critical stress events as Brexit unfolds remain high, and given the critical role of central banks in supporting markets in recent years, a loss of credibility remains the biggest visible tail risk.

Global Financial Stress (GFSI) remains high… but, as BofA's Abhinandan Deb exclaims, the decline in some stress measures within GFSI (particularly short-term risks) has been remarkably fast following the UK’s vote to leave the EU.

In fact, short-term volatility in both European and US equities fell at speeds only expected if the UK had voted to "Remain."

 

However, several factors help explain this unusual decline, in our view:

1) The political nature of Brexit risk has led to high uncertainty over its timeline. The potential for volatility to be kicked down the road with pending negotiations has helped short-term risk measures understandably decline.

 

2) The fact this risk was self-inflicted has led to speculation that it may be just as easily reversed, though we see this as unlikely,

 

3) Bearish investor positioning ahead of the referendum, has likely helped squeeze risk-assets higher, and

 

4) the anticipation of central bank support – the key to reversing every major stress event since 2013 – has been strong in recent days.

However, long-term risks are clearly higher post the vote

Despite the rapid decline in short-term risk momentum, there is no doubt the world is a riskier place following the UK’s decision to leave the EU. Hence, the chances for additional critical stress events as Brexit unfolds remain high, in our view. Brexit risk is also not the only concern expressed by GFSI today.

Japan remains the most at-risk region globally, as stress has risen materially following the BoJ’s decision to move to negative rates in February.

Given the critical role of central banks in supporting markets in recent years, a loss of credibility remains the biggest visible tail risk, in our view, and is why Japanese stress should be carefully monitored.

Positioning for Brexit; own longer-dated EU volatility

The recent strong rally in risk assets despite longer-term risks rising demonstrates the challenges in timing markets in the short-term around Brexit threats. The fact that we expect to see more volatility, but with unknown timing, argues for efficient systematic hedging overlays. For those able to trade volatility directly, we believe one of the best ways to profit from this unique risk is owning longer-dated European realized volatility,
particularly vs. US volatility as

1) we expect Europe to lead volatility higher and

 

2) US markets have shown a strong tendency to downplay European risks until they become concrete and acute.

And it appears professionals remain of the same concerned opinion…

 

Despite the world's fastest collapse in hedges ever…

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Submitted by Claire Bernish via TheAntiMedia.org,

As a species, humans tend to behave as a herd, following one another in opinion and action — whether or not the consequences for doing so are dire. Of course, politicians and others holding seats of power, fully cognizant of the opportunities provided by this herd mentality, deftly manipulate the masses — particularly through public polls during the lead-up to presidential elections.

Most everyone comprehends how bias-infused political polling can be; however, the extent such polls play in the outcome of elections — and, conversely, how their artfully constructed questions and population samples often miss the mark — makes polling an essentially needless, if not dangerous, facet of the American electoral season.

Polls, to put it plainly, are propaganda — and have been for decades — but one particular election handily evidences this, and offers chilling insight into this year’s presidential race: the 1980 election between incumbent President Jimmy Carter and challenger Ronald Reagan.

Polls, for months, predicted either Carter’s win or declared the race anyone’s guess; but when Reagan managed a landslide victory — veritably crushing his opponent — politicians and the public, alike, revisited polls to parse out how pollsters managed such skewed and inaccurate forecasts.

“For weeks before the presidential election, the gurus of public opinion polling were nearly unanimous in their findings,” wrote John F. Stacks for TIME in April 1980. “In survey after survey, they agreed that the coming choice between President Jimmy Carter and challenger Ronald Reagan was ‘too close to call.’ A few points at most, they said, separated the two major contenders.

 

“But when the votes were counted, the former California Governor had defeated Carter by a margin of 51% to 41% in the popular vote — a rout for a U.S. presidential race. In the electoral college, the Reagan victory was a 10-to-1 avalanche that left the President holding only six states and the District of Columbia.”

In countless analyses of Carter’s staggering defeat in the face of opinion polling, several issues emerged just as relevant now as they were at the beginning of the 80s.

Noting that in the 30 years prior to the 1980 discrepancy, election results had largely concurred with pre-election polling, Stacks explained, the “spreading use of polls by the press and television has an important, if unmeasurable, effect on how voters perceive the candidates and the campaign, creating a kind of synergistic effect: the more a candidate rises in the polls, the more voters seem to take him seriously.”

Déjà vu, much?

Add the Internet’s undeniably critical role to the press and TV Stacks describes, when examining Donald Trump’s astronomically successful, albeit darkly negative, campaign — which had, at first, been taken less seriously than if Donald Duck had announced joining the race — and the demonstrative importance of polling in elections becomes markedly clear.

But even further, a parallel drawn by Victor Davis Hanson for Real Clear Politics between the 1980 and 2012 elections more closely – if not uncannily – relates to this year’s dogfight for the White House. Using the examples of Carter’s highly contentious economic policies and the Iran hostage crisis as a backdrop, Hanson noted, with emphasis added:

“Without a record to defend, Carter instead pounded Reagan as too ill-informed and too dangerous to be president.”

If you’ve even set foot in the United States over the past few months, that statement sounds like strategy ripped straight from the Hillary Clinton campaign playbook in its no holds barred assault on the character of the erratic demagogue, Trump.

Notably, in Carter’s case, that strategy cum character assassination — all comments on validity aside — didn’t exactly work out so well.

Hanson also aptly surmised Reagan’s bevy of gaffes — ordinarily the cause of a candidate’s downfall — were a moot point in conjunction with tepid support for Carter in the national vote. In fact, describing the incumbent’s support base as “divided and indifferent” certainly echoes the country’s ambivalence to Hillary Clinton’s scandal-plagued campaign — not to mention widespread rumors of electoral fraud, proven media complicity, and multiple ongoing criminal and corruption investigations.

Even recent opinion polls seem to mimic the period prior to the 1980 election, both in inexplicable public support for Clinton — how many of you have met actual Hillary fans? — and in discrepancies surrounding what her actual lead might be.

Consider polling numbers from the last few weeks, alone. Voters’ preference for either Clinton or Trump diverged so sharply depending on which outlet performed the survey, it appeared the answers might as well have been pulled from thin air.

In a general election match-up between the two presumptive nominees, on June 14, Bloomberg found Clinton with a whopping 12 percentage point lead over Trump, while Fox News yesterday handily tailored her lead to just 6 points. Quinnipiac University, on the other hand, released survey results Wednesday showing the two in a virtual dead heat, with Hillary’s lead at just 2 points.

In other words, polling in 2016 remains as much an arbitrary slave of propaganda as it had been in 1980.

“At the heart of the controversy is the fact that no published survey detected the Reagan landslide before it actually happened,” Stacks wrote. “Three weeks before the election, for example, TIME’s polling firm, Yankelovich, Skelly and White, produced a survey of 1,632 registered voters showing the race almost dead even, as did a private survey by Caddell. Two weeks later, a survey by CBS News and the New York Times showed about the same situation.”

Returning to the herd analogy, the problem with propagandic and arbitrary polls is that people tend to blindly lend them a degree of credence — they listen, and they follow each other’s lead. The Associated Press’ wholly unfounded crowning of Clinton as the presumptive nominee the day prior to California’s critical primary had the desired effect — likely dampening the spirits of already-dejected Sanders voters and keeping them from ‘bothering’ to vote at all.

But Clinton’s inordinately aggressive campaign might be forgetting the lessons Carter’s learned over three decades ago: people generally don’t respond well to arrogant posturing and negativity. And no matter what the polls claim about popular opinion, the people will ultimately decide in November who they favor — or who disgusts them less.

And in 2016, that matter is truly up for debate.

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Following the terrorist attack on Istanbul's airport last week, a pro-ISIS Twitter account was used to make threats against airports such as Heathrow, JFK, and Las Angeles International over the Fourth of July weekend.

As the LA Times reports, as of Thursday the FBI nationally said the bureau knew of no known specific or credible threat to the US during the Fourth of July weekend, however SITE Intelligence Group identified and publicized the threat on Friday.

Pro-IS Twitter Account Warns of Attacks in Heathrow, LAX, and JFK Airports on July 4 Weekend https://t.co/nResxCNiwL

— SITE Intel Group (@siteintelgroup) July 1, 2016

With that said, the New York Police Department has been working around the clock to get ahead of any potential attackers, looking far beyond the city limits to do so. "I think that it's inevitable that there'll be another attack in this country. We are well-prepared to respond to that." said Chief James Waters, the head of NYPD's Counterterrorism Bureau.

As ABC News reports, about 525 specially trained officers rotate shifts so that at any given time, 24/7, some 100 of the officers are ready to roll out with high-powered weapons, radiation detectors and bomb-sniffing Labrador Retrievers that can detect the chemicals known to be used by ISIS for its suicide explosives. The operation is run from a command center in an undisclosed location in lower Manhattan, where the feeds from more than 9,000 surveillance cameras, from the Brooklyn Bridge to Times Square to inside the city's subways are piped in and displayed.

Aside from the specifically New York City, the NYPD Counterterrorism Bureau is looking for global trends to be concerned with as well.

"We look at the global threat environment. What's happening in the world? Are there any new trends that we need to be concerned with? Any new tactics that terrorist groups may be using that have any implication for us here in New York City?" said Meghann Teubner, Director of Counterterrorism Intelligence Analysis in the NYPD's Counterterrorism Bureau.

The security operation has been referred to as a "ring of steel," an expansion of the concept first used in London. "It's our way of protecting New York" Waters said, adding "It gives us an optic into what goes in New York City on any given day, and it tells us an awful lot with 9,000 cameras and the license plate readers. It gives us a sense to keep our finger on the pulse of what's happening here in the city"

Though officials have said there is no specific threat to New York or any American city over the holiday weekend, Waters thinks New York is a prime target.

The NYPD has studied the recent major terrorist attacks in order to better prepare – "We are constantly looking at tactics, techniques and procedures that are used at those events and how we can better prepare ourselves here in New York City" Captain Gene McCarthy said.

Should someone slip through the cracks and attempt an attack, the NYPD's "last line of defense" is a unit of Labrador Retrievers that are specially trained to detect explosive suicide vests. 

"Instead of them just going after a static package where the handler directs them to search a package or an item, these dogs will air-scent, and will track any odor that is coming off a person or what the person is carrying. The dogs play a major role. They are pretty much the last line of defense for stopping that potential suicide bomber." NYPD Lt. Brian Corrigan said.

Waters says the dogs are so good they can stand and watch an entire subway train pull in and can clear a whole train as people pass, just by standing in one place.

If an attacker does manage to start shooting in a public place, Capt. McCarthy said the NYPD officers are trained not to hesitate, just go in and "stop the shooting."

"Whether they're police officers walking a foot post, CRC officers performing specific, directed missions or a tactical response team, the mission is to stop that shooting. Once the shooting stops, there is a reassessment. If it turns into a barricade or a hostage type situation, we would bring more experienced, trained officers in to deal with. But the initial object is to stop that shooting and remove victims, remove witnesses, remove people that are sheltering in place, get them out of harm's way."

Teubner said that recent ISIS attacks abroad prompted the NYPD to operate "in a heightened threat environment" but the city should feel safe. "I think the city should feel safe, the people, the civilians walking on the streets, they should feel safe and they should see the presence of law enforcement officers out there doing their job."

Circling back to the 9,000 cameras for a moment, and the sensitive topic of a reasonable expectation of privacy versus measures to keep cities safe, here is how Chief Waters explains it.

From ABC News

The 9,000 surveillance cameras are a mix of NYPD-owned cameras and those owned by “stakeholders,” private entities that provide their feeds to the police. License plate readers on roads can capture three million license plates a day, Chief Waters said, and the plate data is kept for five years.

 

As for fears of Big Brother-style privacy invasion from thousands of lenses, Waters said all the cameras are in public locations.

 

“So your expectation of privacy is just that – if you’re walking down the street, or if you’re driving your car and your license plate is read,” he said. “This is to protect us.”

* * *

We'll leave that topic of debate for another time. With that said, we wish everyone a safe and happy Fourth of July weekend.

Here is a rare look inside the NYPD command center:

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