Kevin Warsh to Lead the Fed in a New Direction

By: Doug Noland | Sat, Oct 7, 2017
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The threat of nuclear crisis with North Korea. Two destructive hurricanes. Puerto Rico devastated and about out of money. The start of a major comprehensive tax reform effort, along with general political mayhem in Washington. The worst mass shooting in U.S. history. In the midst of it all, the President is apparently about to make a potentially momentous decision: A Fed chair will be appointed with a new four-year term.

As has become the norm, markets are happy-go-lucky (at almost daily record highs). How could anything possibly rock the boat? Outside of the financial media, a change of the guard at the Fed is hardly newsworthy.

It's an interesting narrative leading up to the President's decision. Of course, there's the typical "hawk" vs. "dove" framework. The Wall Street Journal had an insightful op-ed: "Donald Trump's Fed Choice: Continuity or Disruption." And there was Friday's Krugman piece in the New York Times: "Will Trump Trumpify the Fed?" - that I will return to.

I am working to prepare myself for the President's decision. When it comes to the Fed, I have been consistently disappointed over the years. At every turn. Trumpeting the risk of deflation, the Greenspan Fed in the early-nineties took to interest-rate and yield curve manipulation as primary reflationary policy measures. Greenspan recognized how the clever exploitation of contemporary market-based finance yielded the Federal Reserve history's most potent monetary policy transfer mechanism.

Monkeying with the markets is always a slippery slope. And generations ago it was appreciated that the greatest risk associated with discretionary policymaking was that one mistake invariably leads to another (and another and...).

What began in 1987 with post-crash assurances of ample liquidity for the stock market - and then a few years later a surreptitious bank bailout (after late-eighties "decade of greed" excess) - evolved into a cycle of historic booms and busts. Ever more experimental reflationary measures were the inevitable responses.

It has been said that it took a "cold war hawk" like Ronald Reagan to break the ice in relations with the Soviet Union. In that vein, it was the subterfuge of the free-market disciple Alan Greenspan that got the inflationism ball rolling. Back in March 2000 I titled a CBB "John Law and Alan Greenspan - The Great Inflationists."

Another burst ("tech") Bubble and only more histrionic deflation fears. It was a bogey man, powerfully conjuring images of the Great Depression. The establishment brought in Dr. Ben Bernanke in 2002, replete with an inflationist doctrine that in most backdrops would have been designated the fringe of lunatic fringe. When it came time to replace Alan Greenspan, I argued "Anyone but Bernanke!" It was astonishing how the establishment - and conventional thinking more generally - had so readily adopted inflationist doctrine.

Sure, it was all seductive; but not even token pushback? The New Age Wall Street "money" machine - backstopped by the Fed, the GSEs and the Treasury - had transfixed the rich, the powerful and the levers of power in Washington. The seeds to our nation's drift toward socialism - and the counterrevolution that brought Donald Trump to the Whitehouse - were neglectfully scattered by Greenspan and then aggressively fertilized by "helicopter Ben."

Quality contemporaneous analysis is valuable for providing a historical account to be called upon in the future to counter historical revisionism. Especially in these days of record prices for most assets around the world (securities, real estate and otherwise), it's important to appreciate the unmitigated disaster that inflationism turned out to be. Bernanke was the lead instigator of "mortgage finance Bubble" reflation that culminated in the "greatest financial crisis since the Great Depression." No Credit is given for reflating Bubbles.

A top Wall Street executive was lauding the Fed's "brilliance" Friday morning on Bloomberg Television. Yet the Fed has done nothing close to brilliant for a long time now. The Bernanke Fed doubled-down on experimental inflationist monetary management. While there have been numerous zealous bouts of inflationism throughout history, I know of none that emerged from the test of time as esteemed policymaking. The proponents of contemporary central banking disregard a crucial fact: Now approaching a decade since the start of the crisis period, the world is more addicted than ever to ultra-low rates and massive QE. Inflationism is always a trap.

I was naïve. The degree to which the establishment would embrace inflationism caught me by surprise. Have they finally seen enough? Fed governor Jerome Powell has become the favorite candidate for those preferring to stay the course.

I would much prefer former Fed governor (2006-2011) Kevin Warsh at the helm of the Federal Reserve. He is viewed as the reformer candidate - somewhat of a disrupter that might shake things up a bit. From my perspective, he is more the outcast traditionalist in an age of monetary radicalism. Fed governor Warsh was the most outspoken member of the Fed's inner circle arguing against Bernanke's radical monetary doctrine.

Importantly, Warsh is not an inflationist - and for this he is on the receiving end of criticism from the left as well as the right. Willing to stand tall against the powerful consensus view, Warsh recognizes the great risks that come with monetary inflation. He was against QE and - despite the chorus of pundits convinced otherwise - Warsh was right.

Mr. Warsh is generally opposed to the Fed meddling in the markets. As Larry Kudlow suggested, the former Fed governor wants "the Fed out of the day trading business." Of course, overheated Bubble markets simply cannot contemplate a world where the Fed's number one priority is anything other than bolstering the markets - with routine assurances, low rates and QE on demand.

If things weren't already ludicrous enough, the Fed went off the deep end with Bernanke's 2013 assurances that the Fed would "push back against a tightening of financial conditions." With booming equities, corporate Credit and derivatives markets having come to dominate system financial conditions, the Fed at that point was basically pre-committing to zero tolerance for market disruptions, corrections, recessions and bear markets. This was a gross assault on free-market Capitalism - a twist of the knife - administered without protest.

The Fed needs to reverse course and return to traditional monetary management. It is imperative to rein in its discretionary power to manipulate markets and whimsically print "money." It is fundamental that the Fed ends its doctrine of the securities markets as "Too Big to Fail."

It is taken as fact that the U.S. (and the world more generally) is better off today because of the extreme crisis-era measures taken by the Fed and global central bankers. I vehemently disagree. Today's faux prosperity is built on a fragile foundation of electronic debits and Credits - contemporary (speculative) finance too often divorced from real economic wealth creation. Central banks have inflated the greatest Bubble in history, a Bubble that created only greater excesses and global imbalances. Already deep structural maladjustment worsened, and vital financial and economic reforms were forestalled.

I could only chuckle at the headline: "Paul Krugman: Trump Is About to Take a Wrecking Ball to the Last Competent Government Institution Left."

From Krugman's Friday New York Times piece: "What all this means is that if congressional Republicans play a large role in selecting the next Fed chair, they'll insist that it be someone who has been wrong about everything for the past decade. Kevin Warsh... certainly fits the bill. He warned about inflation in the midst of global economic collapse; he argued vigorously against doing anything, monetary or other, to fight 10% unemployment; he warned that the United States was about to turn into Greece, Greece I tell you. And he has shown no hint of being chastened by the failure of events to play out the way he expected. Now, I don't know who Trump will actually pick to head the Federal Reserve. It might actually end up being someone smart, knowledgeable and honest. Hey, there's a first time for everything. But surely it's possible, even probable, that the Federal Reserve, like other government agencies, is about to get Trumpified, that one of American policy's last remaining havens of competence and expertise will soon share in the general degradation. And won't that be fun when the next crisis hits?"

Regrettably, the Fed is anything but a "haven of competence." Their progressive policy radicalization has been fundamental to the repeated inflation of ever more destabilizing asset Bubbles - the great culprit when it comes to social strife and divisiveness. As candidate Trump stated unequivocally throughout the campaign, the Fed is in desperate need of new leadership and a new direction. Maybe it was all BS - or perhaps the administration has tied its agenda to equities and (seemingly like everyone else) became a serf to the markets. Yet I'm holding out hope that there is a behind the scenes groundswell of support for rescuing monetary policy from the quagmire of experimental inflationism.

This is not about "hawk" or "dove" - low rates or even actual normalization. And, in the grand scheme of things, I don't get all that worked up about modest financial deregulation. Responding to Krugman, the next crisis will be no fun whatsoever. A 1929-like systemic crisis of confidence event would not be a surprise.

I have argued that the Fed's balance sheet is likely on its way to $10 TN. This is a rough guesstimate - expecting that the unwind of unprecedented speculative leverage during the next serious market dislocation would see the Fed again doubling the size of its balance sheet (as it did even after formulating its so-called "exit strategy" in 2011). Such a scenario risks a full-fledged calamity. The fanciful notion of open-ended QE forever must be invalidated. A straight-shooter appealing to my analytical heart, Mr. Warsh authored a provocative 2016 paper titled, "Challenging the Groupthink of the [economics] Guild."

Adhering to the inflationist mindset, Yellen or Power would surely be willing to double-down on desperate "money" printing operations. Why not "helicopter money" - just toss it about to needy governments, businesses, consumers and securities markets alike? I hold out hope that a Chairman Warsh - along with some fresh faces on the committee - would be willing to hold back the printing presses. Such an incredibly important feat will require a rare combination of competence, communication skills and courage. In my eyes, Kevin Warsh is one of the few individuals associated with the Federal Reserve that has demonstrated much in the way of attributes that will be so vitally important come the next crisis.

Below are excerpts from two articles that help illuminate how Kevin Warsh has distinguished himself from other leading Fed chief contenders:

"The Federal Reserve Needs New Thinking - Its Models are Unreliable, its Policies Erratic and its Guidance Confusing. It is also Politically Vulnerable," Kevin Warsh, Wall Street Journal, August 24, 2016.

"The conduct of monetary policy in recent years has been deeply flawed... A robust reform agenda requires more rigorous review of recent policy choices and significant changes in the Fed's tools, strategies, communications and governance. Two major obstacles must be overcome: groupthink within the academic economics guild, and the reluctance of central bankers to cede their new power.

First, the economics guild pushed ill-considered new dogmas into the mainstream of monetary policy. The Fed's mantra of data-dependence causes erratic policy lurches in response to noisy data. Its medium-term policy objectives are at odds with its compulsion to keep asset prices elevated. Its inflation objectives are far more precise than the residual measurement error. Its output-gap economic models are troublingly unreliable.

The Fed seeks to fix interest rates and control foreign-exchange rates simultaneously—an impossible task with the free flow of capital. Its "forward guidance," promising low interest rates well into the future, offers ambiguity in the name of clarity. It licenses a cacophony of communications in the name of transparency. And it expresses grave concern about income inequality while refusing to acknowledge that its policies unfairly increased asset inequality.

The Fed often treats financial markets as a beast to be tamed, a cub to be coddled, or a market to be manipulated. It appears in thrall to financial markets, and financial markets are in thrall to the Fed, but only one will get the last word. A simple, troubling fact: From the beginning of 2008 to the present, more than half of the increase in the value of the S&P 500 occurred on the day of Federal Open Market Committee decisions.

The groupthink gathers adherents even as its successes become harder to find. The guild tightens its grip when it should open its mind to new data sources, new analytics, new economic models, new communication strategies, and a new paradigm for policy.

The second obstacle to real reform is no less challenging. Real reform should reverse the trend that makes the Fed a general purpose agency of government. Many guild members believe that central bankers—nonpartisan, high-minded experts—are particularly well-suited to expand their policy remit. They fail to recognize that central bank power is permissible in a democracy only when its scope is limited, its track record strong, and its accountability assured."

"The Fed Has Hurt Business Investment - QE is Partly to Blame for Record Share Buybacks and Meager Capital Spending," Michael Spence And Kevin Warsh, Wall Street Journal, October 26, 2015.

"We believe that QE has redirected capital from the real domestic economy to financial assets at home and abroad. In this environment, it is hard to criticize companies that choose 'shareholder friendly' share buybacks over investment in a new factory. But public policy shouldn't bias investments to paper assets over investments in the real economy.

How has monetary policy created such a divergence between real and financial assets?

First, corporate decision-makers can't be certain about the consequences of QE's unwinding on the real economy. The resulting risk-aversion translates into a corporate preference for shorter-term commitments—that is, for financial assets.

Second, financial assets are considerably more liquid than real assets. Trade among financial assets like stocks is far easier than buying and selling real assets like capital equipment. The financial crisis taught an important lesson to investors of all sorts: Illiquidity can be fatal. Financial assets have large liquidity benefits over real assets...

Third, QE reduces volatility in the financial markets, not the real economy. By purchasing long-term securities, the Fed removes significant market volatility from stocks and bonds. Any resulting reduction in macroeconomic volatility—affecting real asset prices—is far more speculative. In fact, much like 2007, actual macroeconomic risk may be highest when market measures of volatility are lowest. Central banks have been quite successful in stoking risk-taking by investors in financial markets... Clearly, market participants believe central bankers use QE, among other reasons, to put a floor under financial asset prices."

 


For the Week:

The S&P500 gained 1.2% (up 13.9% y-t-d), and the Dow rose 1.6% (up 15.2%). The Utilities increased 1.0% (up 9.8%). The Banks jumped another 1.5% (up 9.8%), and the Broker/Dealers surged 2.7% (up 20.8%). The Transports slipped 0.3% (up 9.3%). The S&P 400 Midcaps gained 1.3% (up 9.5%), and the small cap Russell 2000 rose 1.3% (up 11.3%). The Nasdaq100 advanced 1.4% (up 24.7%). The Semiconductors jumped 1.7% (up 31.4%). The Biotechs rose 1.9% (up 39.3%). While bullion dipped $4, the HUI gold index rallied 2.8% (up 10.9%).

Three-month Treasury bill rates ended the week at 105 bps. Two-year government yields added two bps to 1.51% (up 32bps y-t-d). Five-year T-note yields increased two bps to 1.96% (up 3bps). Ten-year Treasury yields gained three bps to 2.36% (down 9bps). Long bond yields rose three bps to 2.89% (down 17bps).

Greek 10-year yields dipped five bps to 5.55% (down 147bps y-t-d). Ten-year Portuguese yields jumped 13 bps to 2.41% (down 133bps). Italian 10-year yields gained four bps to 2.15% (up 34bps). Spain's 10-year yields rose 11 bps to 1.71% (up 33bps). German bund yields slipped a basis point to 0.46% (up 26bps). French yields slipped one basis point to 0.74% (up 5bps). The French to German 10-year bond spread was little changed at 28 bps. U.K. 10-year gilt yields were unchanged at 1.36% (up 13bps). U.K.'s FTSE equities index jumped 2.0% (up 5.3%).

Japan's Nikkei 225 equities index rose 8.2% (up 8.2% y-t-d). Japanese 10-year "JGB" yields dipped one basis point to 0.06% (up 2bps). France's CAC40 added 0.6% (up 10.2%). The German DAX equities index rose 1.0% (up 12.8%). Spain's IBEX 35 equities index sank 1.9% (up 10.2%). Italy's FTSE MIB index dropped 1.3% (up 16.4%). EM equities were mixed. Brazil's Bovespa index rallied 2.4% (up 26.3%), while Mexico's Bolsa was little changed (up 10.2%). India's Sensex equities index advanced 1.7% (up 19.5%). China's Shanghai Exchange was closed for holiday (up 7.9%). Turkey's Borsa Istanbul National 100 index gained 1.2% (up 33.3%). Russia's MICEX equities index rose 0.8% (down 6.2%).

Junk bond mutual funds saw inflows of $646 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates added two bps to 3.85% (up 43bps y-o-y). Fifteen-year rates gained two bps to 3.15% (up 43bps). The five-year hybrid ARM rate dipped two bps to 3.18% (up 37bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates unchanged at 4.15% (up 57bps).

Federal Reserve Credit last week declined $3.7bn to $4.420 TN. Over the past year, Fed Credit was little changed. Fed Credit inflated $1.609 TN, or 57%, over the past 256 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt declined $5.7bn last week to $3.366 TN. "Custody holdings" were up $214bn y-o-y, or 6.8%.

M2 (narrow) "money" supply last week expanded $15.4bn to $13.696 TN. "Narrow money" expanded $664bn, or 5.1%, over the past year. For the week, Currency increased $2.8bn. Total Checkable Deposits slipped $4.0bn, while Savings Deposits rose $15.3bn. Small Time Deposits added $2.5bn. Retail Money Funds dipped $1.0bn.

Total money market fund assets were about unchanged at $2.741 TN. Money Funds increased $86bn y-o-y, or 3.2%.

Total Commercial Paper rose another $10bn to a 16-month high $1.069 TN. CP gained $153bn y-o-y, or 16.7%.

Currency Watch:

The U.S. dollar index gained 0.8% to 93.8 (down 8.4% y-t-d). For the week on the upside, the Swedish krona increased 0.4% and the Brazilian real gained 0.2%. For the week on the downside, the British pound declined 2.5%, the New Zealand dollar 1.6%, the Mexican peso 1.5%, the South African rand 1.4%, the Swiss franc 1.2%, the Australian dollar 0.9%, the euro 0.7%, the Singapore dollar 0.5%, the Norwegian krone 0.5%, the Canadian dollar 0.5%, and the Japanese yen 0.1%. The Chinese renminbi was unchanged versus the dollar this week (up 4.39% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index declined 1.9% (down 1.7% y-t-d). Spot Gold slipped 0.3% to $1,277 (up 10.8%). Silver gained 0.7% to $16.79 (up 5.1%). Crude dropped $2.38 to $49.29 (down 8%). Gasoline fell 2.0% (down 7%), and Natural Gas sank 4.8% (down 23%). Copper jumped 2.5% (up 21%). Wheat fell 1.1% (up 9%). Corn dropped 1.5% (down 1%).

Trump Administration Watch:

October 1 - Wall Street Journal (Felicia Schwartz): "President Donald Trump said he didn't think it was worth pursuing negotiations with North Korean leader Kim Jong Un, a day after his secretary of state revealed the U.S. was in direct contact with Pyongyang. 'I told Rex Tillerson, our wonderful Secretary of State, that he is wasting his time trying to negotiate with Little Rocket Man,' Mr. Trump said on Twitter... 'Save your energy Rex, we'll do what has to be done!'"

October 5 - Bloomberg (Erik Wasson): "House and Senate Republicans took their first concrete steps... toward enacting a major U.S. tax cut by advancing budget resolutions for fiscal 2018 -- and it only gets harder from here. 'It's uphill, there's no doubt about that,' Senator Orrin Hatch of Utah, chairman of the tax-writing Finance Committee, told reporters... Republicans are arguing over the size of proposed tax cuts, whether those cuts should add to the federal deficit, and which tax breaks to eliminate -- in particular the deduction for state and local taxes. Lawmakers say there will be more fights ahead on other tax breaks for individuals and businesses as the GOP tries to reach its longtime tax-cut goals. 'I think every one of these is going to be hard,' said Senator John Thune of South Dakota, a member of Republican leadership and the Finance Committee."

October 4 - Reuters (David Morgan and Susan Cornwell): "The U.S. budget deficit is proving to be a major obstacle to the tax reform plan being offered by President Donald Trump and top congressional Republicans, with one leading Senate hawk saying a week after the plan was introduced that any enlarging of the fiscal gap could kill his support. From proposed infrastructure enhancements to a military build-up, the deficit long ago put the brakes on major new federal spending programs; now Trump's tax-cut proposal is threatened. 'It looks to me like the administration's already running for the hills. It looks to me like some of the tax-writing chairmen are already running for the hills ... I'm disheartened by the lack of intestinal fortitude I'm seeing,' Sen. Bob Corker said. The main problem is that the federal government is swimming in red ink with an annual deficit of $550 billion and a national debt -- the accumulation of past deficits and interest due to lenders to the U.S. Treasury -- exceeding $20 trillion."

October 4 - The Hill (Scott Wong and Naomi Jagoda): "Republicans are feeling antsy over a key provision in their tax plan that could put some of the party's most vulnerable members in the House in deeper jeopardy. The GOP tax plan would raise $1.3 trillion over the next decade by eliminating a deduction for state and local taxes. The provision would help Republicans pay for lower rates, but could hit people hard in high-tax states such as New York, New Jersey and California. In the House, Republicans in swing districts disproportionately represent constituencies where the tax deduction is important, creating an immediate campaign ad for Democrats. A few Republicans are already warning that they'll oppose their party's tax overhaul if the deduction is a part of the plan."

October 3 - CNBC (Ben White): "Tax reform, we have a problem. President Donald Trump and the Republican Congress are betting their 2018 electoral fortunes on getting a big tax bill signed into law by the end of the year. Without it, the GOP will be zero-for-two on big-ticket items following the Obamacare repeal failure. But significant problems are already emerging that could turn their hopes into disaster — or at least into a much less ambitious, temporary tax cut bill. The problems begin with Senate Republicans, who also torched Obamacare repeal. Last week, Sen. Bob Corker, the Tennessee Republican now unchained from political considerations after announcing he won't run again, said he would not vote for a bill that significantly adds to the deficit. 'With realistic growth projections, it cannot produce a deficit' Corker said. 'There is no way in hell I'm voting for it.' That 'realistic growth projections' line is key."

October 2 - CNBC (Jeff Cox): "Profits that companies are holding overseas would be brought back home at a tax rate that looks to be around 10%, according to current White House estimates. Gary Cohn... said the tax reform plan the administration supports seeks to bring back what could be $3 trillion in offshore wealth, but at a reasonable rate. 'We are not giving companies the choice. They are going to pay the rate if they have the money overseas,' Cohn said... 'That's how we catch up from the worldwide system to the territorial system.'"

China Bubble Watch:

October 3 - Financial Times (Lucy Hornby): "China's Communist party is making clear that it expects to dictate business decisions — not only at state-owned enterprises, but also at private companies and joint ventures with foreign partners. Under President Xi Jinping, the party has become more assertive, reclaiming functions that the civil government and industrial groups carved out during decades of liberalisation. Beijing has largely abandoned a list of promised economic liberalisation issued four years ago, opting instead for greater control by the party and state over the economy and civil society. For businesses, that control takes the form of party cells, long a feature of SOEs but increasingly a part of corporate life at private companies and foreign joint ventures. In the past week, the party has moved to define its role in business. A government statement laid out Beijing's definition of 'entrepreneurship', saying it involves patriotism and professionalism, followed by observing discipline, obeying laws, innovation and serving society."

October 1 - Bloomberg: "China's official factory gauge rose to a five-year high, signaling that efforts to clean up the financial sector and the environment aren't damping economic growth yet. The manufacturing purchasing managers index rose to 52.4 in September, compared with a projected 51.6... and 51.7 in August. The non-manufacturing PMI stood at 55.4 compared with 53.4 a month earlier."

October 1 - Financial Times (Xinning Liu and Gabriel Wildau): "Chinese banking regulators have told lenders to crack down on the use of consumer loans to finance home purchases, the latest effort to cool down the overheated property market and rein in financial risk. In principle, Chinese banks enforce a stringent minimum downpayment of 20% on first mortgages. For second homes, the requirement is about 60% in big cities. But this can, in effect, drop to zero if homebuyers use other sources of credit to finance the downpayment. Chinese lenders issued a net Rmb1.28tn ($192bn) in short-term household loans — the category targeted by the latest crackdown — in the first eight months of this year, up from Rmb651bn for all of 2016..."

October 2 - Wall Street Journal (Nathaniel Taplin): "It's not easy being an entrepreneur in China. A high-level document published last week by China's cabinet emphasized that entrepreneurs are important contributors to growth—but also that they need to be more patriotic and approach their role with the mind-set of serving society. Little wonder private investment has been weak for years. This weekend's move by China's central bank... is unlikely to do much to lift the dark mood of China's private sector. That's especially given the clear tilt of China's 'reform' agenda back toward the state under President Xi Jinping."

October 1 - Bloomberg: "China's central bank said it will reduce the amount of cash lenders must hold as reserves from next year, with the size of the cut linked to the flow of funding to parts of the economy where credit is scarce. The targeted measures apply to all major banks, 90% of city commercial banks, and 95% of rural commercial lenders, the People's Bank of China said... Cuts will range from 0.5 percentage point to 1.5 percentage point depending on how much business banks do with small enterprises, agricultural borrowers and startups. Foreign banks will also be eligible for the cut should they meet the requirements."

Central Banker Watch:

October 4 - Financial Times (Claire Jones): "The European Central Bank's policymakers are keen to press ahead with plans to end their bond-buying spree next year — despite some reservations on wage inflation and the strength of the euro. Accounts of the bank's September vote... suggest members of its governing council were increasingly confident that the region's economic recovery would last. Market developments were favourable, while there were 'nascent' signs of reflationary forces. 'A view was put forward that conditions were increasingly falling into place that would allow the intensity of monetary policy accommodation to be adapted and would provide an opportunity to scale back the Eurosystem's net asset purchases,' the accounts read. The ECB is widely expected to announce that it will wind down QE from January 2018 at its October 26 vote."

October 3 - Financial Times (Adam Samson): "As central banks begin shrinking their balance sheets, they risk triggering another financial crisis, something that may be sharpened by the shift away from active investing, JPMorgan's top quant strategist has warned. Central banks are expected to begin next year the process of unwinding the $15tn or so in financial assets they purchased over the past decade, said Marko Kolanovic, global head of macro quantitative and derivatives research... 'Such outflows (or lack of new inflows) could lead to asset declines and liquidity disruptions, and potentially cause a financial crisis,' said Mr Kolanovic... 'The timing will largely be determined by the pace of central bank normalisation, business cycle dynamics and various idiosyncratic events, and hence cannot be known accurately.' Mr Kolanovic pointed out that 'this is similar to the 2008 [Great Financial Crisis], when those that accurately predicted the nature of the GFC started doing so around 2006.'"

Global Bubble Watch:

October 1 - Bloomberg (David Welch): "Here are two facts that defy logic: By the end of the year, electric-car maker Tesla Inc. will have burned through more than $10 billion without ever having made 10 cents. Yet companies around the world are lining up to compete with it. Almost 50 new pure electric-car models will come to market globally between now and 2022, including vehicles from Daimler AG and Volkswagen AG. General Motors Co. raised the stakes Monday by pledging to sell 20 all-electric vehicles by 2023, including launching two new EVs in the next 18 months. Even British inventor James Dyson is getting into the game, announcing last week that he's investing two billion pounds ($2.7bn) to develop an electric car and the batteries to power it."

October 4 - Bloomberg (James Crombie): "President Donald Trump's starting point for repaying Puerto Rico's $74 billion in debt -- zero -- isn't just hallmark behavior from the man who wrote 'The Art of the Deal.' It recalls some classic emerging-market sovereign debt restructurings of recent years. Think Argentina, which long argued that its ability to repay $100 billion in debt was next to nothing. Every time the populist president spoke about the country's liabilities, creditors were cast as 'vultures' ... And there's Ecuador, where populist President Rafael Correa rose to power in 2007 on an anti-investor platform and declared the national debt illegitimate. True, Puerto Rico is a commonwealth and the liabilities are municipal bonds, not U.S. sovereign debt, but Trump's suggestion that 'you can say goodbye to that' debt bears the hallmarks of a populist leader facing tumult in the streets."

October 3 - Bloomberg (Shaji Mathew): "It's a bumper bond harvest in the Middle East and North Africa, with governments raking in $23.5 billion in the past week alone. Not only do the sales boost 2017's offerings to a new record, it also firms up JPMorgan Chase & Co.'s lead as the region's top manager for a second straight year... The borrowing binge pushes sales from the Middle East and North Africa to a record $89 billion this year."

October 4 - Bloomberg (Emily Cadman): "Home ownership among young Australians has fallen to the lowest level on record, as an explosive property boom squeezes out all but the wealthiest. Supercharged by record low interest rates, a lack of supply and a tax system that favors property investors, home prices have surged more than 140% in the past 15 years, propelling Sydney past London and New York to rank as the world's second-most expensive housing market... In response, home ownership among the young has plunged: only 45% of 25-to-34 year-olds own their own home, down 16 percentage points from the 1980s, with almost half the decline coming in the past decade."

Fixed-Income Bubble Watch:

October 4 - Bloomberg (Brian Chappatta): "Even before Wall Street awoke, Wednesday looked like a wild day for the nation's $3.8 trillion municipal-bond market. Few might have predicted just how wild things would get. President Donald Trump had suggested late the previous night... that the beleaguered U.S. commonwealth of Puerto Rico -- bankrupt even before Hurricane Maria hit last month -- might simply wipe out its $74 billion of municipal debt. On Wednesday, Puerto Rico's beaten-down benchmark bonds plummeted from an already unprecedented 44 cents on the dollar to as little as 30.25 cents. 'It may possibly be the end of the municipal bond market as we know it,' Harry Fong, an analyst at MKM Partners, wrote..."

October 4 - Bloomberg (Justin Sink and Jennifer Epstein): "President Donald Trump's budget chief said not to take literally the president's suggestion that Puerto Rico's debt would be 'wiped out,' even as the territory's bonds plunged to a record low on Wednesday: 32 cents on the dollar. 'I think what you heard the president say is that Puerto Rico is going to have to figure out a way to solve its debt problem,' Mick Mulvaney, director of the White House budget office, said... Puerto Rico... is dealing with a disaster worsened by the long-term debt crisis that led it to declare a form of bankruptcy this year. The commonwealth's government for decades has been plagued by budget deficits and borrowed $74 billion in a spree enabled by a yield-hungry Wall Street. After the president suggested that the debt must be erased, a benchmark general-obligation bond due in 2035 plunged 12 cents on the dollar..."

October 2 - CNBC (Lauren Hirsch): "The percentage of U.S. retailers with high-risk CCC ratings has doubled since the beginning of the year, according to a new report by S&P. Eighteen percent of U.S. retail ratings are in the CCC range... A CCC rating indicates that an obligation is vulnerable to nonpayment and that the ability to pay the obligation could hinge on whether business conditions are favorable. The bankruptcy filing of iconic Toys R Us last month, which took many insiders by surprise, further spooked an already rattled industry."

Federal Reserve Watch:

October 4 - Financial Times (Sam Fleming): "Central bankers are steering the economy without the benefit of a reliable theory of what drives inflation, a former top Federal Reserve policymaker said, as he called for policymakers to pay less attention to theoretical models and more to actual data. Daniel Tarullo... said economists displayed a paradoxical faith in the usefulness of unobservable concepts such as the natural rate of unemployment or neutral real rate of interest, even as they expressed doubts about how robust those concepts were. He was particularly doubtful about the weight inflation expectations play in rate-setting policy, given the 'range and depth of unanswered questions' about how they are formed and measured. 'The substantive point is that we do not, at present, have a theory of inflation dynamics that works sufficiently well to be of use for the business of real-time monetary policymaking,' said Mr Tarullo in a speech..."

October 4 - Bloomberg (Christopher Condon and Craig Torres): "On a Wednesday in mid-September, a group of progressive activists concerned about the stewardship of the American economy packed a meeting room on Capitol Hill with staff of Senate Democrats. Part strategy session and part pep talk, the gathering had a very specific aim. 'We'll do whatever we can do to prevent Kevin Warsh from taking on the role of chair of the Federal Reserve,' Jennifer Epps-Addison, president of the Center for Popular Democracy, told the gathering. The attack from the liberal group on the Republican former Fed governor wasn't surprising. But a few days later, a group closer to him on the political spectrum weighed in. Karl Smith, director of economic research at the libertarian Niskanen Center, assembled a blog for the Washington-based think tank entitled, 'Just Say No to Kevin Warsh.'"

U.S. Bubble Watch:

October 5 - Bloomberg (Piotr Skolimowski): "Puerto Rico faces a government shutdown on Oct. 31, including halting its hurricane recovery, if Congress doesn't provide billions in emergency funds, said Treasury Secretary Raul Maldonado. The U.S. commonwealth's bankrupt government is burning through the $1.6 billion it had on hand before Hurricane Maria ravaged the island... With widespread damage to telecommunications systems and the electricity grid, Maldonado doesn't expect to begin collecting sales tax for at least another month, he said... 'I don't have any collections, and we are spending a lot of money providing direct assistance for the emergency,' he said..."

October 2 - Financial Times (Eric Platt): "Puerto Rico will need 'tens of billions' of dollars in aid from Washington as it struggles to stabilise a humanitarian crisis in the wake of Hurricane Maria, according to the island's treasury secretary... The hurricane crippled the bankrupt US territory's electric grid, plunging much of the island into darkness, knocking out its communication network and leaving many of its 3.4m residents without drinking water. While relief workers have fanned out across Puerto Rico, the governor warned on Monday that 75% of the island would still not have electricity restored through the power grid by the end of the month."

October 2 - Reuters (Lucia Mutikani): "A measure of U.S. manufacturing activity surged to a near 13-1/2-year high in September as disruptions to the supply chains caused by Hurricanes Harvey and Irma resulted in factories taking longer to deliver goods and boosted raw material prices. Still, details of the Institute for Supply Management's (ISM) survey... underscored the economy's underlying momentum, with factories reporting stronger order growth last month. A measure of factory employment hit its highest level since 2011."

October 2 - Reuters (Richard Leong): "The U.S. economy is on track to grow at a 2.7% annualized pace in the third quarter, based on the stronger-than-forecast rise on construction spending in August and a surprise acceleration in factory activity in September, the Atlanta Federal Reserve's GDP Now forecast model showed..."

October 3 - Reuters (Nick Carey): "Major automakers... posted higher U.S. new vehicle sales in September as consumers in hurricane-hit parts of the country replaced flood-damaged cars, extending a rally in their shares that began when Hurricane Harvey hit southeast Texas in late August. Analysts and industry consultants had predicted hurricanes Harvey and Irma would provide automakers with their first monthly gains in 2017. Sales had been weak after a strong run since 2010 that culminated in record sales of 17.55 million units in 2016... The seasonally adjusted annualized rate of U.S. car and light truck sales in September rose to 18.57 million units from 17.72 million units a year earlier..."

October 3 - Wall Street Journal (Laura Kusisto): "A chill that started in the New York and San Francisco rental-apartment markets last year is spreading to less expensive cities. Several metros that enjoyed strong rent growth last year dropped off sharply in the third quarter of 2017. Dallas posted annual rent growth of 2.8% in the third quarter, down from 5% in the same quarter a year earlier... In the urban core... rent growth was essentially flat. Likewise, rents in Charlotte, N.C., grew just 2.5% year-over-year in the third quarter, down from 4.2% in the same quarter a year earlier. Higher-flying markets slowed as well."

October 2 - CNBC (Oshrat Carmiel): "Manhattan condo buyers who rent out their apartments are getting little more yield than they would with government debt. Newly purchased condos that were listed for lease in the second quarter brought their owners a median return of 2.5%, according to... StreetEasy. It's been stuck at that level since the end of last year, the lowest in data going back to 2010. The median yield on relatively risk-free 10-year Treasury notes was 2.25% in the second quarter. 'This is the lowest point we've seen in history,' Grant Long, a senior economist at StreetEasy, said... 'It's a steady downward trend.'"

Europe Watch:

October 4 - Bloomberg (Angus Berwick and Sonya Dowsett): "Catalonia will move on Monday to declare independence from Spain after holding a banned referendum, pushing the European Union nation toward a rupture that threatens the foundations of its young democracy. Catalan President Carles Puigdemont said he favored mediation to find a way out of the crisis but that Spain's central government had rejected this. Prime Minister Mariano Rajoy's government responded by calling on Catalonia to "return to the path of law" first before any negotiations."

October 1 - Financial Times (Tony Barber): "After Catalonia's chaotic, disputed referendum on independence, Mariano Rajoy, Spain's prime minister, will have to display political skills of the highest order. Sunday's illegal vote has drastically polarised Catalonian society. It has fuelled tensions between the region's government and the authorities in Madrid to an intensity unseen since Spain's return to democracy in the late 1970s. Mr Rajoy faces an extraordinarily difficult task. He is adamant that it is his government's fundamental duty to uphold the law and preserve the integrity of the Spanish state."

Brexit Watch:

October 5 - Bloomberg (Tim Ross and Kitty Donaldson): "U.K. Prime Minister Theresa May is losing the confidence of her colleagues and should consider stepping down, a former minister suggested, after a key speech aimed at revitalizing her leadership descended into chaos. Conservative lawmaker Ed Vaizey is the first member of Parliament since the speech to publicly air concerns about May continuing as leader, adding that he believed many of his colleagues feel the same. Vaizey was a culture minister under May's predecessor and left when David Cameron resigned. If more Tories join him on the record in asking her to go, May's position could become untenable."

Japan Watch:

October 1 - Bloomberg (Isabel Reynolds and Maiko Takahashi): "Support for Japanese Prime Minister Shinzo Abe fell in two polls..., three weeks before a general election where Tokyo Governor Yuriko Koike's new Party of Hope threatens to eat into his majority. The premier's approval rate dropped below his disapproval rate in polls... Almost 46% of respondents to the Kyodo survey said they saw Abe as an appropriate person to be prime minister, compared with 33% who chose Koike..."

October 1 - Bloomberg (Toru Fujioka): "Confidence among Japan's big manufacturers has improved to the highest level in a decade... Sentiment among large manufacturers rose to 22 from 17 three months ago, the highest level since September 2007, (estimate 18), according to the quarterly Tankan survey..."

Emerging Market Watch:

October 3 - Wall Street Journal (Georgi Kantchev): "The amount of money flowing into emerging markets is set to top $1 trillion in 2017, the biggest flow of funds in three years... Nonresident capital flows to emerging markets are likely to rise to $1.1 trillion in 2017 and edge up to $1.2 trillion in 2018, according to the Institute of International Finance... Geopolitical tensions could escalate, while central banks in the developed world might move faster than expected when tightening the monetary policies that have damped returns in home markets. Investors could also be put off emerging markets if the dollar continues its recent upswing or if President Donald Trump follows through on plans to implement protectionist policies. For now, though, money is continuing to move into emerging markets."

October 3 - Wall Street Journal (Peter Grant): "Investors are showing more interest in commercial real estate in Asia, South America and other emerging markets, where growth trends and the lure of outsize returns overshadow the additional political and financial risks these regions can pose. From 2012 to 2016, investors mostly were fleeing markets like Brazil, Russia and India as those countries were hit by political turmoil, weak growth and shaky values. But in the last 18 months, some of the biggest names in real-estate investing have become more bullish on emerging markets as growth has picked up and some governments implement reforms."

Leveraged Speculator Watch:

October 3 - Financial Times (Lindsay Fortado): "Private equity and hedge fund firms are lending to companies at the highest rate ever, driving up competition in the sector and forcing funds to look outside the US for more opportunities. Private credit, which has sprouted while post-crisis regulation curtailed the amount that banks were willing to lend, is growing at a rate not seen since the hedge fund industry boom in the 1990s. Private credit funds managed about $600bn at the end of last year, according to... Preqin. That figure could grow to $1tn by 2020, according to two industry lobby groups..."

Geopolitical Watch:

September 30 - Reuters (Dirimcan Barut): "Turkey's President Tayyip Erdogan said... Iraqi Kurdish authorities would pay the price for an independence referendum which was widely opposed by foreign powers. Iraq's Kurds overwhelmingly backed independence in Monday's referendum, defying neighboring countries which fear the vote could fuel Kurdish separatism within their own borders and lead to fresh conflict. 'They are not forming an independent state, they are opening a wound in the region to twist the knife in' Erdogan told members of his ruling AK Party..."

 


 

Doug Noland

Author: Doug Noland

Doug Noland
Credit Bubble Bulletin

Doug Noland

I just wrapped up 25 years (persevering) as a "professional bear." My lucky break came in late-1989, when I was hired by Gordon Ringoen to be the trader for his short-biased hedge fund in San Francisco. Working as a short-side trader, analyst and portfolio manager during the great nineties bull market - for one of the most brilliant individuals I've met - was an exciting, demanding and, in the end, a grueling and absolutely invaluable learning experience. Later in the nineties, I had stints at Fleckenstein Capital and East Shore Partners. In January 1999, I began my 16 year run with PrudentBear, working as strategist and portfolio manager with David Tice in Dallas until the bear funds were sold in December 2008.

In the early-nineties, I became an impassioned reader of The Richebacher Letter. The great Dr. Richebacher opened my eyes to Austrian economics and solidified my lifetime passion for economics and macro analysis. I had the good fortune to assist Dr. Richebacher with his publication from 1996 through 2001.

Prior to my work in investments, I worked as a treasury analyst at Toyota's U.S. headquarters. It was working at Toyota during the Japanese Bubble period and the 1987 stock market crash where I first recognized my love for macro analysis. Fresh out of college I worked as a Price Waterhouse CPA. I graduated summa cum laude from the University of Oregon (Accounting and Finance majors, 1984) and later received an MBA from Indiana University (1989).

By late in the nineties, I was convinced that momentous developments were unfolding in finance, the markets and policymaking that were going unrecognized by conventional analysis and the media. I was inspired to start my blog, which became the Credit Bubble Bulletin, by the desire to shed light on these developments. I believe there is great value in contemporaneous analysis, and I'll point to Benjamin Anderson's brilliant writings in the "Chase Economic Bulletin" during the Roaring Twenties and Great Depression era. Ben Bernanke has referred to understanding the forces leading up to the Great Depression as the "Holy Grail of Economics." I believe "The Grail" will instead be discovered through knowledge and understanding of the current extraordinary global Bubble period.

Disclaimer: Doug Noland is not a financial advisor nor is he providing investment services. This blog does not provide investment advice and Doug Noland's comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. The Credit Bubble Bulletins are copyrighted. Doug's writings can be reproduced and retransmitted so long as a link to his blog is provided.

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