Month: June 2017

From Bloomberg macro commentator Chris Anstey

Currency moves can be “brutal,” as the European Central Bank well knows, since then-ECB President Jean-Claude Trichet used that memorable adjective more than a decade ago. The problem for the ECB is it may be heading down a dark alley where two well-armed peers await.

Investors have reasonable clarity about the medium-term policy outlook for the U.S. Federal Reserve and Bank of Japan, with both central banks effectively anchoring long-term rates.

The Fed’s dot plot, along with senior policy makers’ comments, have cemented the idea that the benchmark rate will top out at 3 percent, a level that won’t be reached for years.

The BOJ has explicitly frozen long-term bond yields through its yield-curve control, and Governor Haruhiko Kuroda made crystal clear two weeks ago that he’s not about to embrace stimulus tapering.

While incoming data could still sway traders’ views on the Fed and BOJ, the scope for significant shifts is minor compared with the lack of visibility on the part of the ECB, where there’s long been a dissident minority in favor of tightening.

After President Mario Draghi roiled the euro this week, parallels were drawn to the Fed-induced 2013 taper tantrum. While the reaction has hardly been comparable, there’s a deeper parallel to consider: the euro zone financial and economic cycle is years behind the U.S. one, with households and banks still shaking off the legacy of the debt crisis.

Given the Fed is effectively the dependent variable and the ECB the independent actor, the ECB “can’t control the correction” in the euro if it maps out a path to normalization, as Kit Juckes at Societe Generale SA puts it. Throw the BOJ in there as another dependent variable, and it puts both euro-dollar and euro-yen in play.

As happened with the Fed’s stop-and-go pattern in the years after 2013, the ECB could be heading toward a patchy period where it periodically suspends stimulus withdrawal as it considers “brutal” moves in the euro that hurt the outlook for growth.

It’s not only the ECB that’s in a tough spot, but policy makers in the U.K. and even Australia, where one former Reserve Bank board member this week floated the possibility of a steep set of rate hikes in the coming two years.

There are still wild cards for the Fed and BOJ, not least that both their chiefs are facing looming expirations of their terms in early 2018. The Fed heads into uncharted territory when it starts shrinking its balance sheet, though the signal from markets for now is that investors are comfortable the process will be painless.

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After this week’s hawkish central banker whirlwind, traders and analysts were keenly looking forward to today’s Eurozone June inflation print to see if it would validate Draghi’s unexpected hawkish pivot; the data was released on Friday morning by Eurostat, and while dropping from May’s 1.4% headline print to 1.3%, it beat the 1.2% consensus expectations, rising 1.3%. The core print of 1.1% excl. energy, food, alcohol and tobacco likewise beat estimates of 1.0%, and was above May’s 0.9%.

Chart courtesy of Schuldensuehner

Looking at the main headline components, energy posted a sharp decline, rising at 1.9%, compared with 4.5% in May, followed by services (1.6%, compared with 1.3% in May), food, alcohol & tobacco, 1.4%, compared with 1.5% in May, while non-energy industrial goods rose 0.4%, compared with 0.3% in May.

And yet despite the upside surprise relative to expectations,the Euro – at least according to Citi – appears disappointed.

As Citi’s Rui Dint notes, the EURUSD is ticking slightly lower on the release of the overall Eurozone inflation print – despite a small upside beat, and asks – why isn’t EUR higher?

His answer: 

After German CPI on Thursday beat by 0.2% points at 1.5% YoY, market positioning seems to have adjusted slightly into today’s data print for a similar upside surprise. Such a print would also increase expectations that the ECB will remove accommodative monetary policy sooner than later, especially in the light of Draghi’s willingness to look through weak inflation on Tuesday. However this did not transpire and put together with the fact that the headline print is a YTD low, EUR isn’t trading higher on the data print.

Looking into the details, this was exactly in line with Citi Economics expectations. It previewed: “Base effects, coupled with renewed weakness in oil prices, are likely to shave another ~0.3pp off the headline YoY rate in June solely via the energy component. Fresh food prices have also probably remained quite weak, in line with the past three readings. Core HICP inflation on the other hand likely bounced back to 1.1% YoY, still affected by a different timing of spring holidays relative to 2016.”

EURUSD currently trades around 1.1400 between decent levels on either side – 1.1375-50 is the immediate area to watch on the downside. The kneejerk reaction, however, was clearly lower, suggesting the CPI whisper number was higher.

In summary: the inflation print was neither too hot nor too cold to demolish any potential, if only near-term, hawkish relent by Draghi.

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As the global equity research market continues to wrestle with how they will comply with the European Union’s MiFID II regulations, we noted a new study from McKinsey & Co. last week which effectively predicted that investment banks will have no choice but to fire a ton of equity research analysts who write a bunch of stuff that no one ever reads…which seems like a reasonable guess.

For those who have managed to avoid this particular distraction, the global equity research industry is in the midst of a major disruption which has been brought on by the European Union’s MiFID II regulations, enforced from Jan. 3, which aim to tackle conflicts of interest by requiring asset managers to separate the trading commissions they pay from investment-research fees.

Of course, while consumers of equity research are quite familiar with its ‘value’ and thus its inevitable fate (i.e. mass layoffs and consolidation of the highly fragmented market), it has hardly stopped overly-confident bankers from putting their best foot forward and demanding exorbitant fees in a futile effort to maintain the status quo.

Take, for example, the most recent pricing sheet just released by Credit Agricole which proposes that clients pay 400,000 Euros per year to gain access to all the same research they get today for free as the result of simply being a trading client of the bank…but, at least the “Macro Research” is free with every 400,000 Euro purchase.

 

Or, you could choose the 170,000 Euro ‘Basic’ package, but you would never be entitled to the honor of speaking with Credit Agrocole’s analysts.

 

Meanwhile, Nomura’s $134,000 package announced last week is suddenly looking like a bargain.

Unfortunately, none of these pricing proposals will change the fact that analysts, like the one below, will have to massively cut back on their budgets over the next couple of years…they might even have to restrict themselves to just 4 monitors…the horror.

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Authored by Raul Ilargi Meijer via The Automatic Earth blog,

The best comment on the June 13 Jeff Sessions Senate testimony, and I’m sorry I forgot who made it, was that it looked like an episode of Seinfeld. A show about nothing. Still, an awful lot of voices tried to make it look like it was something life- and game-changing. It was not. Not anymore than Comey’s testimony was, at least not in the sense that those eager to have these testimonies take place would have liked it to be.

Comey shone more of an awkward light on himself rather than on Donald Trump, by admitting that he had leaked info on a private conversation with the president he served at the time. Not quite nothing, but very little to satisfy the anti-Trump crowd. It’s just that there’s so many in that crowd, and most in denial, that you wouldn’t know it unless you paid attention.

To cut to the chase of the issue, it’s no longer possible -or at least increasingly difficult- to find coverage in the US -and European- press of anything related to either Trump or Russia that doesn’t come solidly baked in a partisan opinionated sauce.

For instance, I have a Google News page, somewhat personalized, and I haven’t been able to open it for quite some time without the top news articles focusing on Trump and/or Russia, and all the ones at the very top are invariably from the New York Times, Washington Post, CNN, The Hill, Politico et al.

But I am not interested in those articles. These ‘news’ outlets -and you really must ask whether using the word ‘news’ is appropriate here- dislike anything Trump and Putin so much, for some reason, that all they do is write ‘stuff’ in a 24/7 staccato beat based on innuendo and allegations, quoted from anonymous sources that may or may not actually exist.

In the case of Russia, this attitude is many years old; in the case of Trump, it dates back to him announcing his candidacy. And that’s funny, because when you think back to who else was a GOP candidate, how can you not wonder if Ted Cruz or Jeb Bush would really have been better presidents than Trump? The Trump presidency is not an indictment of the man himself, but of the entire US political system.

You only need to think back of the Republican hopefuls who got beaten in the primaries, or the Democratic candidates on the other side of the isle. There are 320 million Americans, and that was the cream of the crop? What does that say about the state of the union? That’s very much true about Trump as well: is that the best you can do?

It’s the story behind the multiple veils, the -political- policy choices of the likes of the New York Times and Washington Post, that is perhaps the most interesting part of this. Their anti-Trump stories are certainly not. They’re utterly boring repetitive propaganda material. Still, there are also reasons behind this that have little to do with politics.

With the advent of the interwebs, the MSM were always going to have a challenging time. As time passed, it became clear they were going to have to compete with 100 million other voices. And while the established media have clear advantages, it was never going to be an easy task. For one thing because unlike most of these 100 million voices, the traditional media have a lot of overhead, fixed costs etc.

They can establish their own web presence, but not much about that is obvious. Some have moved behind a paywall to manage costs, others focus on ads. But none of that really works well. Ad revenue is not enough to keep the vast machinery going, and a paywall limits readership.

Ergo, the MSM has to focus on both 1) what makes it strong, and on 2) what sets it apart from the ‘new competition’. That does seem evident, and it’s therefore surprising that they have elected to do the opposite. A choice that will inevitably hasten their demise.

I’ve long thought that the only way the MSM can survive in the age of the interwebs, for as long as they can indeed survive, is to be uncompromisingly objective, perhaps even to stay away from opinionating, period. Because all other areas, everything that is subjective, will be taken over, and often already is, by the millions who write and post their own opinions on social media.

And no-one will be able to make up their mind any longer about what’s real or not if they can’t figure out from reading between all these lines what is true or not. That is a battle the media establishment cannot win. So it’s more than a bit surprising that it is exactly that which they have elected to pin their futures on.

Media organizations like the New York Times and the Washington Post have over a long time built the contacts, the revenue (for now) and the resources to do what newer media can not: that is for instance, to assign a team of good and smart researchers and/or writers to difficult topics that may take months to cover satisfactorily. It just so happens that is what their entire business model was always based on.

But they’ve thrown it away. They’ve chosen to compete with the entire world, who can all write and all have opinions, in the shadowy realm of fake news, anonymity and mud-slinging. But the opinion of a Washington Post writer, or even its editorial staff, is just another opinion. That’s not where they can stand out. That they can only do in truth-finding. And then they choose not to.

Mainstream media are not short on content, but they ARE short on news. What they do is opinion, propaganda, and that’s not what they’re there for. Both they themselves and their readers should be very worried about that. Because news gathering and dissemination is a vital function in any democratic nation. Taking it away leaves a big hole.

And they’re pouring out so much of the same stuff that even if inside the echo chamber the audience just can’t get enough of it, those on the outside get pushed ever further away. The distance between these groups of people keeps growing, and that’s not what media should be doing, let alone aim for.

There comes a point when people will say: we get it, you don’t like Trump, but we don’t need to see that repeated 100 times a day, and certainly not if you don’t provide facts to base your preferences on. Outside the echo chamber that has already happened. I haven’t read anything in the New York Times or Washington Post forever. If I can’t trust them to write facts on Trump, I can’t trust them, period.

They already have so much going against them. Sales of paper copies are under relentless pressure, because they’re a day old when they’re published, and nobody needs to wait for their news that long anymore. Another kind of pressure comes from the fact that a huge part of their subscribers are older, and the younger stay away from print.

A story over the weekend said CNN, one of its “brethren in crime”, is clamping down on stories about Russia. All stories have to go through the senior editors now. CNN the next day fired 3 people over one of the many stories. How about the rest? Did they all meet those ‘rigorous editorial standards?

As for CNN, have you watched those guys on TV lately? They’re like a firing-squad. Henchmen don’t ask questions either.

Before I forget: Does anyone think there would have been a Special Counsel appointed if the anti-Trump echo chamber press had not incessantly came up, and still does, with new narratives about President Trump, his campaign, his advisers, his staff, and all of the above’s links to Russia? For which to this day no proof has been revealed?!

I find it hard to fathom. I even think it is possible that the feeding frenzy will cost Trump his presidency, not because of evidence but because of neverending innuendo. The frenzy has shown no signs of letting up, and it can continue because it feeds on itself.

While it’s strange that the MSM should risk their own credibility and even survival to be competing, as I said, with a 100 million other ‘sources’, a fight that it can never win, in the short term they have established a loyal echo chamber following that has even ‘miraculously’ increased their subscription numbers.

The flipside of that is they have lost half of their potential readers, but they got so many more from inside the chamber in return that the bottom line looked good. But at some point you will have to prove something, if you want to live. And very little of the ‘material’ on both Trump and Russia has turned out to actually be wearing clothes.

Then again, once you’re inside the chamber, it’s hard to leave. Which is a disgrace for America in all its facets, but there’s not easy way back out. There’s only one, and it’s more out of reach than perhaps ever before: that of the truth, which only the MSM have the resources to provide on a consistent and wide-ranging basis. But they’ve rejected the truth.

They will find out soon enough that the echo chambers are all booked full, with nutjobs and snake oil salesmen. Why they would want to be thrown in with that crowd, who knows? Sure, a quick profit can work miracles. But then you die.

The entire drama has caused an enormous impoverishment of the American media landscape. And it never had much, if anything, to do with news.

The best way to illustrate what’s really going on is probably in these graphs. The negative ‘reporting’ about Trump is off the scale (don’t miss German TV network ARD’s 98% score):

But when it comes to bombing the Middle East, all the ducks get in line. As ducks do. As behooves ducks. Even when it comes to Trump, they can’t hide their true nature.

We’re done here.

 

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Validating the recent surge in iron ore, which has jumped more than 18% from 2017 lows hit just two weeks ago on speculation the PBOC may be willing to flirt with another round of inflation, overnight Beijing reported an unexpectedly strong bounce in its manufacturing and service sectors. 

China’s NBS June manufacturing PMI came in at 51.7 for June, above both the previous reading of 51.2 and expectations of a 51 print, remaining comfortably above the 50-point expansion line. This was the second highest level of 2017, on the back of improving market sentiment and industrial upgrading, according to an NBS statement posted on its website, despite an ongoing troubling contraction in the employment subindex. Unlike the Caixin PMI, the official index tracks mostly larger, state-owned enterprises.

Two key sub-indices both increased from the previous month, although ominously the employment index declined for one more month and remained in contraction territory:

• The production sub-index went up to 54.4 in June, higher than 53.4 in May.
• The new order sub-index also increased to 53.1 in June from 52.3 in May.
• The employment index slightly declined to 49.0 in June, from 49.4 in May.

Both inflation indicators were higher, as the input prices index rose to 50.4 from 49.5 in May, and the output price index rebounded to 49.1 from 47.6 in May after three consecutive months of decline. Trade indicators were stronger: Both the new export order index and the import index increased by more than 1.0 pt, reaching 52.0 and 51.2 respectively. Raw material inventory inched up (to 48.6 vs. 48.5 in May) but finished goods inventory declined (to 46.3 vs. 46.6 in May). The suppliers’ delivery times suggested longer delivery times (which imply better demand conditions) – it fell for a third consecutive month in June, from 50.2 in May to 49.9.

“Stronger foreign demand is helping to support manufacturing activity,” Capital Economics’ Julian Evans-Pritchard wrote. “The price components both increased for the first time since December, suggesting that downward pressure on producer prices may now be easing.”

Separately, the official non-manufacturing PMI (comprised of the service and construction sectors at roughly 80%/20% weights) also surprised to the upside, rising to 54.9 in June from 54.5 in May. Services PMI rose to 53.8 from 53.5 in May, while construction PMI climbed to 61.4 from 60.4 in May.

The stronger than expected numbers “mean that momentum in the economy continues to be robust and we’ll have only a gradual slowdown at worst in the coming quarters,” Dariusz Kowalczyk of Credit Agricole in Hong Kong, said in a Bloomberg Television interview. “China is doing very well.”

As Bloomberg notes, economic activity this year has so far proven more resilient than expected – likely on the heels of the loan explosion at the start of the year which has since been tapered alongside China’s shadow banking crunch – giving policy makers time to focus on reining in financial risks and cooling a frothy property sector. Firmer global trade is boosting corporate profits and hiring, easing fears – for now – that efforts to cut excessive financial borrowing could derail the government’s target of 6.5% expansion in output.

Companies are assuming that curbs on excess leverage and the property sector will be transient this year, as the Communist Party won’t allow much economic pain before the leadership transition in the fall, according to a report published by research firm CBB International this week.

Goldman adds that judging from the NBS PMIs, June activity growth appeared to be healthy, however it adds that one caveat is that China’s mfg PMI trends seem to be at least slightly distorted by prices – thus the increase in output prices in June might have flattered somewhat the pickup in the headline PMI reading.

The Caixin manufacturing PMI release next Monday will give another early gauge of activity momentum in June.

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Now that the Supreme Court has approved a “narrower” version of President Donald Trump’s travel ban, the measure is set to go into effect for the first time since late January, when it sparked chaos and protests at airports across the country.

The revised ban, which the court ruled must allow the admittance of individuals who have a "credible claim of bona fide relationship" in the country, will take affect at 8 p.m. Eastern on Thursday, according to the Hill. Under the court’s new standard, an individual must have a close US family relationship or formal ties to a US entity like an employer or academic institution to be admitted to the United States under guidance distributed by the US State Department on Wednesday, according to the Hill.

Otherwise, they are temporarily banned for 90 days or 120 days if they're a refugee coming from any country in the world. In preparation for the ban to take effect, the State Department issued a cable adding a few clarifications to the Supreme Court ruling, advising that close family "does not include grandparents, grandchildren, aunts, uncles, nieces, nephews, cousins, brothers-laws and sisters-in-law, fiancés, and any other 'extended' family members,” according to Reuters.

The cable also specified that any relationship with a US entity "must be formal, documented, and formed in the ordinary course, rather than for the purpose of evading the E.O.," a reference to U President Donald Trump's March 6 executive order barring most US travel by citizens of the six nations for 90 days.

It also provided a narrower definition of what constitutes a “bona fide” relations, explaining that visiting lecturers and student-visa applications would be welcome, but individuals who had simply made a hotel room reservation would not. However, many important issues – like whether the State Department's own dealings with refugees constitutes a "bona fide" relationship – remain unresolved. And there's also the question of whether courts could issue their own guidance that would supersede the State Department's.

Here’s Reuters:

The cable provides advice to US consular officers on how to interpret Monday's Supreme Court ruling that allowed parts of the executive order, which had been blocked by the courts, to be implemented while the highest U.S. court considers the matter.

 

The countries covered by order include Iran, Libya, Somalia, Sudan, Syria, and Yemen, after the administration removed Iraq from the list in its updated ban.

 

The cable's language closely mirrored the Supreme Court's order on the travel ban, though it appeared to interpret it in a narrow manner, notably in its definition of close family.

 

It was unclear on Wednesday evening whether the State Department's interpretation of the court's order would spark further legal action by opponents of the ban.

 

The guidance gave several examples of what might constitute a bona fide relationship with a U.S. entity, and said broad categories would be exempt from the travel ban, such as those eligible for student visas, "as their bona fide relationship to a person or entity is inherent in the visa classification."

 

Similarly, those eligible for family or employment based immigrant visa applications are exempt from the travel ban, the cable said.

 

The State Department guidance was unclear on what U.S. refugee agencies regard as a key question: whether their own dealings with refugees applying to come to the United States constituted a bona fide relationship.

 

The cable said that consulates should continue to interview applicants for so-called diversity visas, which are granted to individuals from countries that typically do not send many immigrants to the United States. In 2015, around 10,500 citizens from the six banned countries were selected for the diversity visa lottery, according to State Department figures.

 

The cable said "a worker who accepted an offer of employment from a company in the United States or a lecturer invited to address an audience in the United States would be exempt" from the travel ban, but someone who simply made a hotel reservation would not count as someone with a bona fide relationship.

The travel ban will likely bar such visas for citizens of the six countries, the cable acknowledged, stating that "we anticipate that very few DV applicants are likely to be exempt from the E.O.’s suspension of entry or to qualify for a waiver."

The Supreme Court has said it would issue a final judgment on the ban in October. Until then, there’s little recourse left: The ban is going to effect – end of story.

* * *

Meanwhile, CBS reports that a dozen lawyers have volunteered to set up shop near JFK's Terminal 4 to monitor the implementation of the ban. A representative from the New York Immigration Coalition says more than 1,000 lawyers are ready to back them up if the ban's implementation leads to the same type of chaos seen in January.

“We have an army of over 1,000 lawyers who have their back and are ready to go back out to JFK if that becomes necessary,” said Camille Mackler, Director of Legal Initiatives at the New York Immigration Coalition.

Though Mackler noted that such an outcome is unlikely because most of the travelers arriving in the states already have visas approved.

“In terms individuals arriving at the United States… they should already have visas approved, and are not subject to the ban, the injunction, the stay on the injunction  or anything like that,” Mackler said.

“For now it seems, just from the way that the second order was written and also from the Supreme Court’s pretty limited stay on the injunction, that most of those who will be impacted are actually abroad,” Mackler said.

No word yet as to whether we'll see the same wave of protests at airports like those that occurred in January when the original travel ban went into effect.

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Ukraine, Syria, Iraq, the Islamic State, Yemen, Libya, Boko Haram – the world seems to be steeped in violence these days. Pretty much everywhere, you can hear and read the phrase, "This is as bad as it gets" – broadcast on TV, written in the newspapers and repeated by friends. However, that isn't quite true. As a matter of fact, it has almost always been worse than it is today.

As Bill Clinton once remarked, "Don't follow the headlines, follow the trend lines!", because, as Statista's Dyfed Loesche notes, a look at recent death tolls shows that this world has never been a more peaceful place than during the first decade of the new millennium.

You will find more statistics at Statista

Starting in 1945, the huge mountain of war battle deaths has been levelling out ever since. The infographic pictured below shows the number of deaths per 100,000 people per year. The post-war period rightfully carries its name, as a bigger share of mankind is living through a sustained period of peace, before dying of old age.

Why then are so many people still under the impression that the world is a more violent place than ever?

One reason is increasing media coverage: while today's wars are broadcast live, constantly remaining in the public eye, reports on conflicts of earlier decades – such as the various Congo Wars with hundreds of thousands of casualties – did not reach equally big audiences.

What is true and terrible, however, is the fact that the number of war deaths has recently been on the rise again, mainly due to the ongoing conflict in Syria. Nevertheless, the present is not nearly as bloody as the nineties, eighties, seventies or sixties were before.

This chart and text was first published by German journalist and author Guido Mingels. It is available as a book here. This post is brought to you in collaboration with German news magazine DER SPIEGEL.

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One of the recurring laments about the Fed’s hiking cycle, most recently from Goldman, is that despite 2 rate hikes so far this year, financial conditions remain the loosest they have been in over two years.Whether that is due to the market being so drunk on the Fed’s “punch bowl” it is unable to grasp the liquidity is being dragged away, or for some other unknown reason despite repeated warnings by FOMC members that stocks here are overvalued, markets simply refuse to concede that financial conditions should be tighter, in fact, as Goldman observed yesterday “so far, the Fed’s efforts to tighten financial conditions have achieved too little, not too much.”

That, in the view of Bank of America’s rates strategist Shyam Rajan is a big mistake because as he explains in his latest note titled “When paint dries, does the wall crumble?” despite the market’s repeated unwillingness to acknowledge what the Fed is doing, “recent market moves mark the beginning of a prolonged tightening of financial conditions.”

And, more notably, he underscore that despite the benign financial condition regime, the market is missing one key thing: in light of what the market perceives as a “benign flow effect” the risk currently is in the the Fed’s balance sheet “stock” and adds that “we think the market is complacent on the stock effect of the Fed’s balance sheet decline. Specifically, higher deposit betas, UST supply and/or real rates could all trigger significantly tighter financial conditions.”

To underscore his point, Rajan shows the following chart which shows just how vast the upcoming normalization will be, in light of the moves for both inflation expectations and real rates that took place during QE2 and QE3, and how small the unwind has been so far under the Fed’s tightening regime. As Rajan explains further (more below), “ever since the conversation for the Fed shifted from hikes to balance sheet after the March meeting, we have seen a significant increase in real rates and a decline in inflation expectations: the anti-QE trade. Recall that the primary objective of an expanded balance sheet was to push real yields lower (when the nominal funds rate was constrained at 0) and inflation expectations higher. As shown in our Chart of the day, when looked at through that lens, the reversal over the last few months is just the beginning of a long process.”

Rajan’s main point, as noted above, is that while the market has remained focused on the central bank flow which it – erroneously – assumes will not be a major risk factor, what the market should be looking at instead is the stocks. He explains:

With rate hikes in the background, market and policymakers’ attention has squarely moved to the Fed’s balance sheet. In this regard, over-communication from Fed officials to prevent a repeat of the taper tantrum has  no doubt helped. Repeated emphasis on the balance sheet being a “passive tool” and the tapering reinvestments being equivalent to “watching paint dry” seem to have convinced markets that the initial steps ($6bn UST, $4bn MBS runoffs) are unlikely to cause disruptions. Yet, while the market appears very comfortable with the flow effect, we think the longer-term stock effect is underappreciated.

Specifically, we identify three areas where the market seems most complacent going into the unwind experiment.

1. Does the balance sheet unwind lead to an increase in deposit betas sooner than expected?
2. Can the resulting increase in Treasury supply have a significant impact on yields?
3. Will the increase in real yields have knock-on implications for other asset classes? All three signal a significant, albeit slow moving, tightening of financial conditions up ahead.

Going back to a point we have pounded the table on since 2011, Rajan notes that the excess reserves created by the Fed have created a liquidity illusion on bank balance sheets, in the form of excess deposits (the same excess deposits which not only are not inert as many erroneously assume, but are in fact what JPM’s London Whale used – as collateral – to corner the IG market with notable consequences).

It is these deposits that wil now contract as the Fed proceeds to normalize.  Here is Rajan:

Ultimately, as the Fed’s balance sheet shrinks, so does the banking systems’. On the asset side, banks lose cash (excess reserves) while on the liability side deposits leave (to absorb the new Treasury supply) triggering a mirror image decrease of the Fed’s sheet. However, critical to this process is the kind of deposits that leave the banking system. Although consensus remains that given the $2.1tn in excess reserves, competition for deposits will be non-existent, this assumption is heavily reliant on the less stable deposits leaving the system first (corporate, non-operational, etc.) before the more stable ones (FDIC insured retail deposits). Were the first run-offs in October to trigger the more LCR friendly retail deposit outflow, significant knock-on implications could result:

• Deposit betas will be projected to rise faster than expected resulting in a repricing of the asset side of bank’s balance sheets (loans, mortgages etc.;
• If deposit rates were to increase (and deposit-IOER spreads decline), demand for short-dated fixed income, especially at current levels (close to IOER) is likely to dramatically reduce.
• Third, cash will increasingly become an attractive asset to rich valuations across asset classes. This would reduce the safe haven premium of USTs to hedge against a risk-off.

Then there is the issue of issue of Treasury supply-demand imbalance, something we first touched upon at the start of the month in “BofA: “If Bonds Are Right, Stocks Will Drop Up To 20%.” This point can be summarized simply as follows: there is $1 trillion in excess TSY supply coming down the line, and either yields will have to jump for the net issuance to be absorbed, or equities will have to plunge 30% for the incremental demand to appear. 

Rajan summarizes these concerns below:

An unwind of the Fed’s balance sheet also increases UST supply to the public. Ultimately, the Treasury needs to borrow from the public to pay back principal to the Fed resulting in an increase in marketable issuance. We estimate the Treasury’s borrowing needs increase roughly by $1tn over the next five years due to the Fed rolloffs. However, not all increases in UST supply are made equal. This will be the first time UST supply is projected to increase when EM reserve growth likely remains benign. Note both the 2003-06 and 2009-13 increase in UST supply were met with the largest increase in Chinese buying of USTs. With this unlikely to repeat, we believe price sensitive buyers need to step up. Our analysis suggests this would necessitate a significant rise in yields or a notable correction in equity markets to trigger the two largest remaining sources (pensions or mutual funds) to step up to meet the demand shortfall. Again, this is a slower moving trigger that tightens financial conditions either by necessitating higher yields or lower equities.

Readers can read the full analysis of the Treasury’s dilemma at the following link.

Treasury market dynamics aside, BofA says that the third, and perhaps most important, aspect of renormalization is that the forward path of the balance sheet decline is already having an impact on one market in the form of rising real yields:

Ever since the conversation for the Fed shifted from hikes to balance sheet after the March meeting, we have seen a significant increase in real rates and a decline in inflation expectations: the anti-QE trade (Chart 3). Recall that the primary objective of an expanded balance sheet was to push real yields lower (when the nominal funds rate was constrained at 0) and inflation expectations higher. As shown in our Chart of the day, when looked at through that lens, the reversal over the last few months is just the beginning of a long process.

 

The message from this combination (higher real rates, lower breakevens) is that even though there is a decline in nominal interest rates, the composition is a “bad” decline.

Besides rates, the “bad” decline shown above is negative for risk assets because ultimately “lower inflation expectations (if right) should lower forward earnings growth estimates (as earnings grow with nominal GDP) while higher real rates should raise discount rates for these earnings: an unfriendly outcome for risky assets.”

Which brings us to Ra’jan’s gloomy conclusion: “Ultimately, all three of the above – a repricing of the asset side on bank balance sheets higher, higher term premium because of UST issuance, and higher real yields – signal tighter financial conditions up ahead.”

 While slow moving, the knock-on impact on asset classes either through a shift in the underlying supply or demand dynamics is significant. We remain a structural bear on real rates to position for this scenario.

And, if right, the conclusion by the BofA strategist is precisely what Yellen, Fischer, Dudley and others have been desperate to communicate to the market over the past 5 months – unsuccessfully – when pointing out as recently as Tuesday, that “Asset valuations are somewhat rich if you use some traditional metrics like price earnings ratios, but I wouldn’t try to comment on appropriate valuations, and those ratios ought to depend on long-term interest rates.”

Judging by stocks’ reaction to the latest yield spike, the market may be finally getting it.

via http://ift.tt/2slnDdy Tyler Durden

Authored by Aaron David Miler and Richard Sokolsky via The Strategic Culture Foundation,

Pursuing an ambitious mission against all three adversaries in Syria is dangerous, imprudent and unnecessary

The idea du jour circulating inside the Trump administration and among terrorism experts and Syria watchers alike is that ISIS cannot be destroyed in Syria unless Bashar al-Assad is removed from power and Iran’s presence and influence are drastically curtailed. And in a perfect world, this indeed would be the best possible outcome to prevent ISIS and other jihadi groups, including Al Qaeda, from ensconcing themselves there. But needless to say, the Middle East isn’t a perfect world. U.S. retaliation against another chemical-weapons attacks, as the White House threatened late Monday, would be both necessary and justified. (Assad and his military would “pay a heavy price,” the statementread.) But pursuing an ambitious mission against Iran, Assad and the Russians in Syria is dangerous, imprudent and unnecessary to protect vital American security interests.

Here are five compelling reasons why.

The United States Can’t Eradicate ISIS in Syria

In his inaugural address, President Trump spoke about eradicating radical Islamic terrorism from the face of the earth. It cannot be done. Syria alone will remain an incubator for jihadists and Salafists of all stripes due to a toxic brew of poor governance, bleak economic opportunities, sectarian hatreds and beleaguered Sunni communities. And its ideology and propaganda will still be able to feed on the resentments and sense of victimhood and grievance among the Sunni population. Those who argue for a more assertive policy in Syria are right that, unless these problems are addressed, ISIS and other jihadi groups will continue to thrive even without the caliphal proto-state. But even the most risk inclined in the Trump administration cannot envision that kind of U.S. commitment in Syria, which would entail the United States and its allies committing thousands of troops and billions of dollars to militarily defeat all of their adversaries in Syria and to occupy, stabilize and reconstruct the country. Indeed, the president himself has strongly argued against nation building. Containing jihadists is realistic; ridding them from Syria is a pipe dream.

There’s No Foreseeable Stable End State for Syria

The idea that confronting Iran or trying to weaken the Assad regime in an effort to remove him from power or force him into a negotiated political transition is chimerical. That’s been evident for several years. Even if the United States made a commitment to take Assad out, it would lead to more chaos, no organized force aligned with the West to replace him and a mad scramble among all kinds of groups—Sunni jihadists like ISIS and Al Qaeda, pro-Iranian Shia militias, Alawites and Kurds—to consolidate control over real estate, making the situation worse. Assad was unprepared for a negotiated political transition before Russia’s intervention in 2015 helped turn the tide in his favor. He certainly would never agree to such an outcome now that he controls most of the critical cities and regions in Syria. Moreover, the Russians, who may ultimately want a political solution as an exit strategy, don’t seem to be in a hurry for one—and Moscow won’t be pressured and intimidated into accepting one, given what it has invested in Syria. Thus, even if getting rid of ISIS, in theory, means ridding Syria of Assad and Alawite domination, reducing Sunni grievances and stemming Iran’s influence, it simply isn’t feasible at a cost the American Congress and public are willing to pay. And if there is no attainable stable end state, the Trump administration’s moves to deepen military and civilian involvement in Syria need to be carefully weighed and evaluated against the precise objectives that an escalating commitment is designed to achieve. Those who are pushing for a more aggressive role in Syria have never identified the relationship between more U.S. engagement and any conceivable end state.

Iran is run by a repressive regime. It abuses human rights, has expansionist aims and sponsors terrorist acts throughout the Middle East. But trying to roll back Iran’s influence in Syria looks a lot easier in theory than in practice. Those pushing to eject Iran from southeastern Syria and stymie its efforts to control border crossings between Iraq and Syria—with the intention of creating a land bridge to the Mediterranean—have yet to demonstrate how any of this would contribute to the defeat of ISIS. Nor have they been forthright about the forces it would take to achieve these goals and sustain control over the region. One White House official recently referred to the creation of a Rat Patrol modelled after the 1960s TV show depicting a bunch of tough U.S. soldiers riding around in jeeps and harassing German soldiers in the North African desert. The administration is also planning to send a seven-member team to provide humanitarian assistance to areas in southeastern Syria that have been liberated from Islamic State control. All of this amounts to tactical gimmicks bound to fail, not a strategy. The administration’s Syria policies are untethered to any broader set of goals for combating ISIS and other jihadi groups—a goal that Iran shares more urgently, given the recent terror attack in Tehran. Moreover, ramping up a more aggressive and escalatory policy against Iran might jeopardize the nuclear accord. That agreement is far from perfect, but it will significantly slow down Iran’s march toward a nuclear-weapons capability for the next ten to fifteen years. Indeed, with the North Korean nuclear file very much open, the last thing the United States needs is another outlier state pushing to join the nuclear club.

The United States Can’t Sideline Russia

Fears that the United States and Russia will slide into a full-scale war over Syria are overblown because both fully appreciate the potentially catastrophic consequences. But continued escalation of military incidents involving U.S. and Russian forces in Syria will make it all but impossible for the two countries to work out any kind of modus vivendi for stabilizing the country after Raqqa falls to U.S. and coalition forces. Russia confronts Washington with several inconvenient truths: first, it’s in a much stronger military and diplomatic position than the United States. Second, because Putin has the upper hand it is hard to imagine that he (or the Assad regime) will be amenable to imposing any meaningful restrictions on Assad’s freedom of action. Nor is Putin likely to accept any kind of international presence in Syria for peacekeeping, stabilization and reconstruction that undermines their control. Third, Moscow will be critical to establishing the political and economic arrangements that will be required for stabilization and reconstruction. In short, any kind of post-conflict cooperation with Moscow in Syria will not be possible if the United States tries to put the squeeze on Russia. Those who argue that pressure on Moscow is the only way to change Putin’s calculations ignore the president’s seeming unwillingness to tangle with him, the unwillingness of the United States to apply serious pressure and Putin’s willingness to push back if necessary.

U.S. Interests in Syria Aren’t as Vital as Those of Its Adversaries

No matter how important Syria is to the United States (and an argument can be made that it’s not all that important), Washington needs to decide how much it’s prepared to sacrifice and whether it’s ready to stay the course when Iran and Russia push back. There’s an elemental divide between the way the United States sees this issue and those who live in or close to the region: whether it’s Iran, Turkey, Israel, Jordan and the Gulf Arabs, they seem prepared to sacrifice far more than the United States. They know their neighborhood better, geography and demography give them key advantages, and for many the stakes are existential in a way they’ll never be for America. Nowhere is this more apparent than in Syria: Assad is fighting for his survival; Syria may not be as vital to Iran as Iraq is, but Tehran has already sacrificed huge resources, men and material to the fight; and Putin didn’t project Russia’s military power into Syria only to fold in the face of U.S. pressure. The reality is that the Syria-Iran-Russia coalition is much more a coalition of the willing than the alliance the United States has managed to assemble, which seems more like a coalition of the semi-willing and self-interested. The argument that the only way to change Russian or Iranian calculations is to escalate the pressure is a dangerous game, given the disparity in will, interests and allies that exists between the two sides. Who’d blink first, given the absence of congressional and public support for another military adventure with no end state (see Afghanistan and Iraq)?

Like Afghanistan where the United States is now also stuck, Washington will likely need to settle for a good-enough outcome, certainly not a victory. What this means now is impossible to say. After all, the United States has been in Afghanistan for a decade and a half, and still doesn’t know if anything resembling sustainable success is in the cards.

Still, the primary goal in Syria must continue to be weakening and containing jihadi groups, keeping them on their heels to prevent attacks on the United States, Europe and regional allies. This is not an optimal outcome, but it’s far more preferable than pursuing unrealistic and unrealizable goals that could drag the United States into endless and distracting wars it cannot win against far more committed and determined adversaries. Managing rather than eliminating the jihadist threat in Syria is neither a pretty nor heroic strategy, and it certainly won’t fix Syria or deal Iran a strategic blow. But for America, it’s the right approach, particularly when considering the risks and downsides of taking on Syria and Iran in these contested areas. And there are hopeful signs that the Pentagon at least is well aware of these dangers.

via http://ift.tt/2uqapZk Tyler Durden