Month: October 2018

Authored by Lance Roberts via RealInvestmentAdvice.com,

Last Friday, I discussed that without much fanfare or public discussion, Congress decided to push the U.S. into deeper fiscal irresponsibility with the passage of another Continuing Resolution (CR). To wit:

“The House on Wednesday passed an $854 billion spending bill to avert an October shutdown, funding large swaths of the government while pushing the funding deadline for others until Dec. 7.

The bill passed by 361-61, a week after the Senate passed an identical measure by a vote of 93-7.”

Without the passage of the C.R. the government was facing a “shut-down” just prior to the mid-term elections. So, rather than doing what is fiscally responsible for the long-term solvency and financial health of the country, not to mention the generations to come, they decided it was far more important to get re-elected into office.

As I noted last week:

“For almost a decade, Congress has failed to pass, and operate, underneath a budget. Of course, without any repercussions from voters in demanding that Congress ‘does their job,’ the path to fiscal insolvency continues to grow.

The Committee For A Responsible Federal Budget made the following statement:

“We’re pleased policymakers have likely avoided a shutdown and actually appropriated most of this year’s discretionary budget on time. But let’s not forgot that Congress did so without a budget and had to grease the wheels with $153 billion to pass these bills. That isn’t function; it’s a fiscal free-for-all.”

Of course, with trillion-dollar deficits just around the corner, the negative impact from unbridled spending and debt increases will begin to reverse the positive effects from deregulation and tax reform.”

With the end of the Fiscal year for the government ending September 30th, the government now marches into 2019 after having added $2,423,000,000,000 to the debt over the next decade. Of course, that debt was the result of the fiscally irresponsible legislation passed last year which will also add a minimum of another $445 billion to the deficit in the coming year.

As the CRFB notes:

“Two pieces of deficit-financed legislation explain the vast majority of this increased borrowing – the Tax Cuts and Jobs Act of 2017 (TCJA) and the Bipartisan Budget Act of 2018 (BBA18). Looking at next year alone, TCJA is projected to add about $230 billion to the deficit, including its effects on interest costs and economic growth. BBA18 is projected to add another $190 billion. Other legislation, including to delay health-related taxes, provide for disaster relief, and fund the government, is projected to add about $30 billion.”

While the markets have been the beneficiary of the tax cut legislation, which gave a short-term boost to corporate profitability, the economy has enjoyed a boost from the massive increases to spending from what should have been more aptly termed the “Bipartisan Non-Budget Act of 2018.” Notice in the chart below the pickup in economic activity has coincided with a surge in the deficit. Spending on natural disasters and defense spending increases “pull forward” future economic growth which is an illusion of an economic turn.

Importantly, surges in budget deficits as a percentage of GDP, are normally associated with “recessionary” activity in the economy. As noted, the increases in Federal spending create a temporary boost to economic growth which supports higher asset prices. Currently, the government is running one of the largest deficits, in both dollar terms, and as a percentage of GDP, in history. This is occurring at a time when the economy is “booming” and deficits should be reduced for the next “rainy day.” 

Furthermore, with sequester-level budget caps returning next year, the budgetary issues in Washington will become even more complicated. The last time budget-caps came into play Ben Bernanke launched QE-3 to offset the economic drag from expected reductions in government spending. However, given the recent track record of the “conservative” Congress, it is highly likely spending will be increased further in the months ahead. Look for an even larger “C.R.” in December when the current resolution runs out.

The Congressional Budget Office recently estimated the outlook for the economy over the next decade. First, let me shown you their estimates.

Debt to GDP will rise to nearly 100% of GDP.

The deficit will remain large but won’t widen.

The growth of real GDP will remain around 2% over the next decade (in line with Fed Reserve estimates.)

The problem is that it is pure fantasy.

it is highly likely the CBO will be incorrect in their assumptions, as they almost always are, because there are many items the CBO is forced to exclude in its calculations.

First, the CBO’s governing statutes essentially require a distorted view of the finances by not allowing for an accounting of the tax breaks Congress routinely extends. As William Gale from the Tax Policy Institute explained:

“Here’s the bad part:  Under current law, CBO projects that the debt – currently 77 percent as large as annual GDP – will rise to 96 percent of GDP by 2028.  And that’s if Congress does nothing.  If instead, Congress votes to extend expiring tax provisions – such as the many temporary tax cuts in the 2017 tax overhaul – and maintain spending levels enacted in the budget deal (which is called the “current policy” baseline), debt is projected to rise to 105 percent of GDP by 2028, the highest level ever except for one year during World War II (when it was 106 percent).”

So, once you understand what the CBO isn’t allowed to calculate or show, it is not surprising their predictions have consistently overstated reality over time. However, it’s how Congress wants the projections reported so they can continue to ignore their fiscal responsibilities.

Secondly, a big problem David Stockman, former head of Government Accountability Office, pointed out:

“Whereas the CBO report already forecasts cumulative deficits of $12.5 trillion during the next decade, you’d get $20 trillion of cumulative deficits if you set aside Rosy Scenario and remove the crooked accounting from the CBO baseline.

In a word, what was a $20 trillion national debt when the Donald arrived in the White House is no longer. Now it’s barreling toward $40 trillion within the next decade.

We have no ideas how much economic carnage that will cause, but we are quite sure it will not make America Great Again.”

Besides those flaws, the CBO gives NO WEIGHT to either a potential for an economic “slowdown” or “recession.” Nor is consideration given to the structural changes which will continue to plague economic growth going forward.

• Spending Hikes

• Demographics

• Surging health care costs

• Structural employment shifts

• Technological innovations

• Globalization

• Financialization 

• Global debt

These factors will continue to send the debt to GDP ratios to record levels. The debt, combined with these numerous challenges, will continue to weigh on economic growth, wages and standards of living into the foreseeable future. As a result, incremental tax and policy changes going forward will have a more muted effect on the economy as well.

Conclusion

The CBO’s latest budget projections confirm what we, and the CRFB, have been warning about. The current Administration has taken a path of fiscal irresponsibility which will take an already dismal fiscal situation and made it worse.

While the previous Administration was continually chastised by “conservative” Republicans for running trillion-dollar deficits, the Republicans have now decided trillion dollar deficits are acceptable.

That is simply hypocritical.

Given the flaws in the CBO’s calculations, their current projections of just $1 trillion in deficits next year, and only slightly exceeding that mark every year after, will likely turn out to be overly optimistic. Even the CBO’s Alternative Fiscal Scenario of $2 trillion deficits over the next decade could turn out worse.

As the Committee for a Responsible Federal Budget previously stated:

• Debt Is Rising Unsustainably. 

• Spending Is Growing Faster Than Revenue. 

• Recent Legislation Will Substantially Worsen the Long-Term Outlook if Extended. 

• High And Rising Debt Will Have Adverse and Potentially Dangerous Consequences (Will lead to another financial crisis.)

• Major Trust Funds Are Headed Toward Insolvency. 

• Fixing the Debt Will Get Harder the Longer Policymakers Wait. 

While the CRFB suggests that lawmakers need to work together to address this bleak fiscal picture now, so problems do not compound any further, there is little hope that such will actually be the case given the deep partisanship currently running the country.

As I have stated before, choices will have to be made either by choice or force.

The CRFB agrees with my assessment.

“CBO continues to remind us what we’ve known for a while and seem to be ignoring: the federal budget is on an unsustainable course, particularly over the long term. If policymakers make the tough decisions now – rather than wait until there’s a crisis point for action – the solutions will be fairer and less painful.”

But William Gale summed up the entirety of the problem nicely.

“Here’s the worse part: The conventional comparison is misleading.  The projected budget deficits in the coming decade are essentially ‘full-employment’ deficits. This is significant because, while budget deficits can be helpful in recessions by providing an economic stimulus, there are good reasons we should be retrenching during good economic times, including the one we are in now. In fact, CBO projects that, over the 2018-2028 period, actual and potential GDP will be equal.

As President Kennedy once said ‘the time to repair the roof is when the sun is shining.’  Instead, we are punching more holes in the fiscal roof. 

In order to do an ‘apples to apples’ comparison, we should compare our projected Federal budget deficits to full employment deficits. From 1965-2017, full employment deficits averaged just 2.3 percent of GDP, far lower than either our current deficit or the ones projected for the future. 

The fact that debt and deficits are rising under conditions of full employment suggests a deeper underlying fiscal problem.”

The CBO’s budget projections are a harsh reminder the fiscal largesse that Congress and the Administration lavished on the country in the recent legislation is not a free lunch.

It is just a function of time until the economic “train is derailed.”

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The White House is about to ratchet up tensions possibly far beyond what they already are amidst the ongoing US trade war with China.

At 11 a.m. eastern time Vice President Mike Pence will deliver at address at the neoconservative Hudson Institute where he’s expected to call China out on a number of explosive issues around the globe where Beijing’s increasingly aggressive actions are seen as a threat to the US, but will especially focus on the Sunday incident involving the USS Decatur which was dangerously intercepted by a Chinese naval vessel in the South China Sea. 

The Chinese ship reportedly came within a mere 45 yards of the American warship in international waters; however, it’s but the latest in a string of such threatening incidents intended by Beijing to lay claim to vast swathes of the South China Sea on the basis of its man-made island chains. 

According to Reuters, which has previewed the speech, Pence will say Beijing’s actions were dangerously provocative toward the USS Decatur “as it conducted freedom-of-navigation operations in the South China Sea, forcing our ship to quickly maneuver to avoid collision.”

“Despite such reckless harassment, the United States Navy will continue to fly, sail and operate wherever international law allows and our national interests demand. We will not be intimidated. We will not stand down,” Pence will say.

Pence is also expected to address the issue of the Chinese Communist Party of recently convincing three Latin American nations to sever ties with Taiwan and recognize China.

Pence will address the issue in the following: “These actions threaten the stability of the Taiwan Strait – and the United States of America condemns them. And while our administration will continue to respect our One China Policy, as reflected in the three joint communiques and the Taiwan Relations Act, let me also say that Taiwan’s embrace of democracy shows a better path for all the Chinese people,” he will say.

Meanwhile President Trump signaled recently the he hopes to cool tensions by calling Chinese President Xi Jinping a friend even after he hit china with tariffs on $200 billion in goods. However, at a news conference last week in New York Trump said, “Maybe he’s not any more, I’ll be honest with you.” During a UN General Assembly meeting Trump had shocked diplomats and heads of state by leveling the charge of election meddling in November’s mid-term elections, a charge which Beijing rejected. 

Pence will further address China’s expanding economic influence world wide, which the White House accuses of using “debt diplomacy” to pressure countries to conform to Beijing’s policies: “Today, that country is offering hundreds of billions of dollars in infrastructure loans to governments from Asia to Africa to Europe to even Latin America. Yet the terms of those loans are opaque at best, and the benefits flow overwhelmingly to Beijing,” he is expected say.

This includes China extending up to $5 billion in loans to the “the corrupt and incompetent Maduro regime in Venezuela,” which can be repaid with oil. Globally, Pence will say, “It’s using wedge issues, like trade tariffs, to advance Beijing’s political influence.” 

Concerning recent charges of a massive uptick in Chinese spying on American soil, Pence will outline the goal of covert influence operations as shifting Americans’ perception of China by mobilizing “covert actors, front groups, and propaganda outlets.”

“As a senior career member of our intelligence community recently told me, what the Russians are doing pales in comparison to what China is doing across this country,” Pence will say. This will include specific accusations of unprecedented economic involving “leveraging their desire to maintain their operations in China.”

“In one recent example, they threatened to deny a business license for a major U.S. corporation if it refused to speak out against our administration’s policies,” Pence will say. However, it’s not expected that the particular corporation will be named. 

It appears that the White House is set to make the case Russia will now step aside as American “enemy #1” and will focus efforts on deterring the new more pervasive China threat. 

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It seems like it was just yesterday that Greek banks, which carry some €89BN of bad loans on their balance sheets, passed the ECB’s latest confidence building exercise, known as the “stress test.”

In retrospect that may have been premature, because as Bloomberg reports, over 8 years after its first bailout Greece is finally considering a plan to help banks speed up their bad-loan disposals, potentially including a government guarantee, in a bid to restore confidence in the battered sector, people familiar with the matter said.

At its core, the Greek plan is the now familiar “bad bank” structure, in which banks get to spin off their NPLs into a separate, government-guaranteed SPV (although in the case of Greece, it is not clear if a government guarantee is all that valuable). The SPV would then be funded by selling bonds to the market.

While the details are still being worked out, an asset protection plan would see lenders unload some bad loans into special purpose vehicles, taking them off banks’ balance sheets. The SPVs would issue bonds, some guaranteed by the state, and sell them to investors, the people said, asking not to be named as the information isn’t public.

The move came after a furious selloff in Greek stocks, and especially banks, which was the culmination of a YTD plunge which has seen Greek banks lose more than 40% this year amid doubts they can clean up their balance sheets fast enough. The banks, which amusingly all cleared the ECB’s stress test earlier this year despite being saddled with tens of billions of NPLs, have been under mounting pressure from supervisors to cut their bad-debt holdings.

According to Bloomberg, the plan appears to have been borrowed from Italy, which conducted a similar exercise to stabilize its own banking sector.

One person said that it could reduce the load of bad loans in Greek banks by up to 15 billion euros ($17.2 billion) from an overall burden of 88.6 billion euros reported by the four systemic lenders as of the end of June.

“The state guarantee proposed for Greece looks quite similar to the one successfully applied in Italy,” said Massimo Famularo, a board member at bad-loan secialist Frontis NPL. And “even though this measure may prove very helpful for banks that need to offload their non-performing loans, it will necessarily involve the placement of junior tranches to private investors, which at the moment may be the most relevant challenge.”

Still, these challenges will have to be overcome as the whole point of the plan is to shift the liability from the banks, to the government, and ultimately, to the buyers of this exposure in the open market.

The bonds would be traded, helping deepen the market for soured loans in Greece, the people said. The state-owned Hellenic Financial Stability Fund, which owns stakes in all four of the major lenders, is in talks with the European Commission to address potential state aid issues, as well as with the ECB’s Single Supervisory Mechanism, the people said.

With all other NPL-reducing paths now blocked, Greece may have no choice but to pursue the bad bank approach if it hopes to shrink bank NPL ratios to 2021 projections.

After the news, Piraeus Bank SA jumped as much as 13% and was up 9% around noon in Athens trading. Alpha Bank also jumped 7.3% while Eurobank Ergasias SA climbed 9%. The FTSE/Athex Bank Index gained as much as 10%, largely wiping out its Wednesday losses.

The plan is far from a done deal; on previous occasions, the creation of a Greek bad bank had been considered and rejected by Greece’s European creditors in the past, even as various similar arrangements have been put in place in Italy, Spain and Cyprus.

Under Italy’s program, which was agreed with the European Union in 2016, banks can bundle their bad loans into securities for sale and buy state guarantees for the least-risky portions, provided they have an investment-grade credit rating. The guarantee has helped Italy’s lenders offload a substantial amount of their non-performing loans. It was used in Banca Monte dei Paschi di Siena SpA’s jumbo deal to remove about 24 billion euros of bad loans from its books.

The renewed push for an NPL bailout envisages the use of funds from Greece’s post-bailout cash buffer and from private investors to address concerns about state aid, the people said.

The Greek government said in a statement on Wednesday that it is in constant touch with the financial stability fund and the Hellenic Bank Association and is promoting “a specific plan of actions which includes — among others — the further reduction of bad loans.”

Leery of being rejected by its offshore creditors, Athens has been mum about the proposal, and a financial stability fund official declined to comment on the asset protection plan, saying that the HFSF exchanges plans and ideas with European authorities on a regular basis according to Bloomberg. Understandably, a finance ministry official said he has no knowledge of such plans.

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US equity markets are extending their Powell-plunge losses from after the close last night as FANG stocks (and tech broadly) is tumbling as banks are bid for a change.

Almost 70% of S&P stocks are lower…but it’s Nasdaq that is getting hammered…

 

FANG stocks no bid…

 

But banks are rebounding…

And while High Yield bond spreads have tumbled to cycle lows, High Yield Bond ETF prices are collapsing back below their 200DMA…

A sign of mass hedging in the only source of liquidity available.

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After tumbling in July, Factory Orders were expected to rebound in August (especially if you believe in the ISM survey data) and rebound they did – spiking 2.3% MoM, the biggest jump since Sept 2017.

Under the surface, it was clear where all the gains came from as New orders ex-trans. for August rose just 0.1% MoM…

Thanks to a 53% MoM spike in Aircraft and Parts)…

New orders ex-defense for Aug. rise 1.3% after falling 0.2% in July

But despite this orders rebound, the ‘reality’ gap between ‘soft’ survey data (thanks to this week’s ISM) and ‘hard’ real economic data continues to push back near post-Trump (and record) wides…

 

 

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Back in April, BofA analyst Barnaby Martin suggested that in order to mitigate the potential fallout from the end of the ECB’s QE, the European Central Bank could engage in an “Operation Twist” to flatten the curve and keep term premiums low, or in other words, to avoid chaos for the European bond market.

BofA: “Our economists have recently talked about the possibility of an “Operation Twist” to the ECB asset portfolio, to help keep term premiums low.”

— zerohedge (@zerohedge) April 13, 2018

Then, back in July, Reuters made it official with the first “trial balloon” that the ECB is indeed considering buying more long-dated bonds from next year as part of its bond reinvestment strategy to keep euro zone borrowing costs in check, effectively copycatting what the Fed did with its own Operation Twist first in 1961 and then again 2011, where the central bank replaced short-dated paper with longer-term debt to lower market interest rates and boost an ailing economy (which begs the question: is the European economy that ailing that the ECB is scrambling to come up with QE extensions even at a time when the Eurozone is supposedly recovering).

In this particular case, the “Twist” would be aimed at limiting the natural aging of its 2.6 trillion euro bond portfolio and keeping a lid on long-term bond yields, a key determinant of borrowing costs, bu maintaining a bid for long-term debt while short-term holdings are sold.

Fast forward to today when with Bund yields grinding higher into dangerous territory, Market News again reported that the ECB is considering a “Twist-like” operation.

As MNI details, the ECB may stick to current capital-key shares rather than aligning QE portfolio with new shares as capital key is due for rebalancing. It also notes that a “Fed-style” Operation Twist is not being evaluated, but there could be less rigid restrictions placed on what kind of bonds to be re-purchased.

What is more notable is that according to the report, ECB officials are turning increasingly bearish and see downside risks as mounting, including trade headwinds, a potential slowdown in emerging economies, Brexit and Italy’s growing budget deficit. That this is coming with less than 3 months left under the ECB’s QE mandate is especially troubling.

To address this, the ECB’s enhanced guidance should give an indication of ECB thinking as to how it could respond to events over a one to two-year horizon, MNI notes.

In kneejerk response to the MNI report, bund futures promptly trimmed declines, with the 10Y yield dropping to session lows below 0.51%, while Germany 5s30s curve flattened 2bps to the narrowest in almost 2 years.

The news also helped the euro hold above a key pivot area, with the EURUSD matching earlier gains in the pound after European Council President Donald Tusk said the EU is serious about getting a Brexit deal, though he rebuked U.K. Foreign Secretary Jeremy Hunt for likening the EU to the Soviet Union.

Whether this renewed attempt to flatten the yield curve and push long-dated yields lower will succeed will ultimately depend on what happens with US Treasurys, where – for now at least – the furious selloff of the past 24 hours appears to have stabilized for the time being.

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White House deputy press secretary Raj Shah told CNN’s “New Day” that the FBI contacted 10 people as part of its reopened investigation into allegations against Brett Kavanaugh, and interviewed nine of them – none of whom corroborated claims levied against the Supreme Court nominee. 

Shah added that “Without getting in to the details, we feel very confident that when the senators have the opportunity to review this material, as they’re just beginning to right now, that they are going to be comfortable confirming Judge Kavanaugh” after they see the results of the investigation. 

On CNN, White House spox @RajShah45 says FBI “contacted” 10 people as part of its investigation of Kavanaugh. Adds that senators will be “comfortable voting to confirm” him. pic.twitter.com/J2sZbYrj1u

— Aaron Rupar (@atrupar) October 4, 2018

Late Wednesday night, Shah confirmed that the White House had received the FBI’s supplemental report, tweeting in a three part statement: 

The White House has received the Federal Bureau of Investigation’s supplemental background investigation into Judge Kavanaugh, and it is being transmitted to the Senate. With Leader McConnell’s cloture filing, Senators have been given ample time to review this seventh background investigation. This is the last addition to the most comprehensive review of a Supreme Court nominee in history, which includes extensive hearings, multiple committee interviews, over 1,200 questions for the record and over a half million pages of documents. With this additional information, the White House is fully confident the Senate will vote to confirm Judge Kavanaugh to the Supreme Court.” – White House Spokesman Raj Shah

Senate Judiciary Committee Chairman Chuck Grassley (R-IA) confirmed delivery early Thursday morning, where he tweeted the details of how the document would be handled;  

Supplemental FBI background file for Judge Kavanaugh has been received by @senjudiciary Ranking Member Feinstein & I have agreed to alternating EQUAL access for senators to study content from additional background info gathered by non-partisan FBI agents. FBI supplement requested Friday sept 28 by bipartisan group of senators w specific scope of current/credible allegations. Dr Ford & Judge Kavanaugh had opportunity to testify under oath b4 public/cmte to tell senators what they know. This FBI material will b handled per 2009 memorandum of understanding/MOU signed btwn Obama WHCounsel & then-SJC Chairman Leahy. Thats latest memorialization of this “loan agreement” of ExecBranch material. Feinstein, Durbin, Schumer, & others were on SJC in 09 & didnt object.

The hasty completion of the report to the Senate drew the ire of some Democrats, including high-profile attorney Michael Avenatti, who says that the agency did not contact a sufficient number of witnesses in the probe. 

“The FBI investigation was no investigation at all. @realDonaldTrump, @senatemajldr and @ChuckGrassley ensured that numerous key witnesses, including six very damaging witnesses I am aware of, were never even interviewed. Their conduct is a disgrace – they never wanted the truth,” Avenatti tweeted Thursday morning.

The FBI investigation was no investigation at all. @realDonaldTrump, @senatemajldr and @ChuckGrassley ensured that numerous key witnesses, including six very damaging witnesses I am aware of, were never even interviewed. Their conduct is a disgrace – they never wanted the truth.

— Michael Avenatti (@MichaelAvenatti) October 4, 2018

Earlier in the week after news emerged that the White House was limiting the scope of the FBI review, Democrats on the Senate Judiciary Committee sent a letter to the Trump administration, urging White House counsel Don McGahn to ensure that there were no limits to the investigation. 

“We ask that you confirm that the FBI background investigation will include the allegations of Christine Blasey Ford, Deborah Ramirez and Julie Swetnick and that the FBI will perform all logical steps related to these allegations, including interviewing other individuals who might have relevant information and gathering evidence related to the truthfulness of statements made in relation to these allegations,” wrote the senators. 

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