Tag Archives: #helicoptermoney

Talk the Talk

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It seems that investors are waiting
For Powell, and so they’re debating
Will he be a hawk
And still talk the talk
Or will he be accommodating?

The punditry seems unpersuaded
Another rate hike could be slated
So, most views expressed
Say; time to invest!
And bearish ideas must be faded

It is almost as if we are still on holiday given the lack of price movement across most markets so far this week.  In fact, other than the Chinese markets (Hang Seng -1.0%), which are continuing to suffer from the ongoing implosion of their property bubble, market activity yesterday in the US, overnight through the rest of Asia and in Europe this morning has been quite muted.  Perhaps the tone has been very mildly bearish, with declines on the order of -0.25% or so, but that comes in the wake of gains as much as 10% or more through the month of November.  As such, it should be no surprise to see a bit of portfolio rebalancing.  Certainly, there is a lot more discussion about the soft/no-landing scenario and we are beginning to see S&P 500 prognostications for the end of 2024 being above 5000.  

The premise seems to be that inflation has been defeated, and that while the Fed may wait a few more months before cutting rates, by this time next year they will be celebrated for having achieved the elusive soft-landing.  The implication is that once they are more comfortable that inflation is dead, they will start to cut rates because…?  And that is where I get lost.  If the economy continues to grow with rates at 5%, exactly why should the Fed consider cutting them?  The only reason I can see is that the pressure from the administration grows too intense as the cost of refinancing the currently outstanding and growing debt continues to rise dramatically.  The problem with this outcome, however, is that if the Fed is seen to be cutting rates under pressure from the administration to reduce financing costs, it is likely to signal to the market that fiscal policy is in complete control (yesterday’s discussion on fiscal dominance is apropos here).  Historically, when that happens, inflation is not merely, not dead, it is ready to roar.

The implications of this policy direction are unlikely to be welcome in government, in boardrooms or in households, as rising inflation and a declining currency are a toxic mix for economic success.  Let’s think this through before cheering it on.

As we progress toward the 2024 presidential election, it is abundantly clear that the federal government is going to seek to spend as much money as possible.  Not only that but I am confident they learned the lessons from the GFC and Covid that QE simply pumps up asset prices while helicopter money is far more effective in getting cash into the hands of the voters.  Given the recent surveys that show 80% of the country believes they are worse off than prior to President Biden’s election, the recipe to address this is quite clear; give more money directly to the people.  And so, you can be sure that there will be numerous fiscal giveaways as 2024 unfolds.

The problem is that these giveaways do not create organic growth in the economy, rather they are the antithesis of organic growth.  As such, tax revenues will continue to lag, and the deficit will continue to grow ever larger.  Already, the cost of funding the outstanding ~$34 trillion in debt has reached $1 trillion, more than the government spends on defense, the largest non-entitlement program.  As well, the average tenor of US Treasury debt continues to decline with almost half needing to be refinanced by the end of 2025.  If interest rates remain at 5.5% and the Treasury continues to skew toward T-bills rather than coupons, that $1 trillion bill is going to grow to $2 trillion pretty quickly.  That will require even more debt issuance to repay, and the cycle will grow ever larger and faster.

It doesn’t take much imagination to see where this could be headed and there is a history of how it has worked in the past, notably with Weimar Germany in 1921-1923 and more recently, in Zimbabwe in 2008-2009 and again in 2019, and, of course, Argentina today.  The classic response to this problem is to institute yield curve control so that those debt payments are contained.  Of course, that means that government debt will pay negative real yields, and the Fed will wind up owning most of it*.  The natural consequence here will be that the dollar will likely decline sharply, at least against ‘real’ stuff like commodities, and a little less-so against quasi-real stuff** like equities.  Versus other currencies it is much harder to tell because if the US is in this situation, other countries are likely to be in difficult straits as well, so the FX value of the dollar may not collapse.  Of course, other countries may not have the same debt dynamics as the US, and those currencies will likely hold up better than the rest.

My fear is this is the new direction of travel.  It is not a given by any stretch, but it is going to seem quite attractive to politicians of every stripe, regardless of their political affiliation or ostensible principals because, remember, to an elected politician, the most important policy is one that gets them re-elected and they will vote for anything that they believe will help them in that cause, principals be damned. 

Will this have any impact today?  Very unlikely.  But it is important to remember this possible path as we await to hear more Fed speakers, but notably Chairman Powell on Thursday morning.  Any hint that the pressure to cut is working (and I am sure there is plenty of pressure for that from Treasury and the executive branch) and we will see a massive rally in equities, bonds and commodities as the dollar declines.  At least at first.  In fact, it is for this reason that I believe that we are going to hear much more hawkish rhetoric from all the Fed speakers this week, and that Powell will be particularly so.  They understand the potential ramifications of capitulation and are not yet ready to allow it.

As to today’s markets, bond yields are within 1bp of yesterday’s closes but leaning lower right now, US equity futures are basically unchanged as are gold and the entire metals complex although oil is edging higher on the news that Saudi Arabia is pushing for another 1mm bbl/day production cut at Thursday’s OPEC+ meeting.

On the data front, yesterday’s New Home Sales data was quite weak, with both prices and volumes falling.  This morning we see Case Shiller Home Prices (exp 4.0%) and Consumer Confidence (101.0) and we hear from four Fed speakers, Goolsbee, Waller, Bowman and Barr.  Look for that hawkish tilt.  It is also supomatsu, the day when spot FX settles on month end, so I expect FX volumes to pick up a bit, but historically, this is more of a swap exercise than a directional one, and so looking for directional movement based on this would be a mistake in my view.  

If I am correct and hawkishness is the Fed mantra today, I expect the dollar will be able to edge a bit higher along with yields, but until Powell speaks, I suspect we will remain fairly muted overall.

Good luck

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*There is another possibility with regards to ownership of treasury debt to prevent the Fed from owning all of it, new rules can be instituted that require banks, insurance companies and even your 401K or IRA accounts to maintain a certain percentage of assets in treasury bonds.  So, in the latter case, which has already been discussed in Washington, you could see 20% or 30% of your retirement next egg forced into negative real yielding assets for a long time.  I assure you that will not help your retirement situation!  

** I use the term quasi-real stuff as equities represent shares in a real business, so there is underlying value to that business and its assets, although not quite the same as owning the actual hard assets they represent.

Cash Is Undoubtedly King!

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Historically bonds were the thing
To own in a market downswing
But lately it seems
Those days were just dreams
Now cash is undoubtedly king!

While this note is focused on the FX markets, where once again the dollar is top dog, I think a quick discussion of government bonds is in order to help try to make some sense of the overall market situation.

Clearly, the lead story in financial markets has been equities, which have proven that volatility is not dead. In fact, these constant +/- 5% days are exhausting for both investors and traders. And of course, most of us have at least some portion of our investment in the equity markets and are afraid to look at our accounts these days. But the behavior that has really been at odds with what had become the overriding narrative is the incredibly abrupt sell-off in Treasuries and other government bond markets during the past week. The idea that government bonds are a safe haven has been underpinning financial markets since long before the financial crisis in 2008. Yesterday I highlighted two of the issues that I think are driving recent price action; the prospect of staggeringly high new issuance to pay for all the proposed and enacted fiscal stimulus that is coming; and the fact that when yields reach a low enough point, the idea that holding bonds will guarantee the return of principal starts to diminish.

But I don’t think those explanations are sufficient to explain the speed and size of the movement that we have experienced since last Monday. Instead, movement like that can only be caused by massive position liquidation. Consider, 10-year Treasury yields rallied 36bps on Monday while 30-year yields closed 40bps higher after touching levels a further 15bps higher than that earlier in the session. So the real question is; who is liquidating their position(s)?

To answer that question we have to consider who holds large positions in Treasuries. The largest holder is likely the Fed, but obviously, they are not sellers. China and Japan come next on the list of holders, and while Japan would never be selling, there continue to be rumors that China has wanted to do that. I have never been a believer that China would sell their holdings for two reasons; first that they couldn’t get rid of them all at once, so a large sale would devalue their remaining holdings; and second because they would still have USD in their account and need to find something to do with them. Now that rates are back to 0.0%, what would they do with the money? After all, that’s a really big mattress they would need. And given the fact that the price of gold has fallen sharply through all this, it would imply there is no big bid for gold either. This leads me to believe that the Chinese have not touched their Treasury portfolio.

After those central banks, the biggest holders are leveraged fund managers with Risk Parity strategies having been an extremely popular investment product for the past decade. The idea was that by holding a certain percentage of different asset classes (e.g. 60% stocks/40% bonds), one could target a specific risk/return ratio. But nothing is simple these days, and as bond yields continued to grind lower over time, hedge fund managers started levering up to buy more and more Treasuries to hold against a given portfolio of stocks. However, what appears to have happened in the past week is that many of those highly levered Treasury positions needed to be reduced given the dramatic decline in the equity portion of the portfolio. Thus, the only explanation that I can see to explain this type of unprecedented Treasury bond movement is a massive liquidation trade by the hedge fund community. My sense is that we will hear of a number of funds closing shop over the next month or so. As an aside, this reinforces the idea that we are still paying the price for the Fed’s actions in 2008-09 and the fact that they never returned market conditions to pre-crisis settings. In the end, once these positions are liquidated, we are likely to see bonds show a little more stability and perhaps, they will regain their haven status. But for now, they are as tough a place to be as stocks.

Now to today’s session. The equity euphoria felt after the US announcement of substantial stimulus coming, measured right now at $1.2 trillion, and very likely taking the shape of true helicopter money with checks cut to all Americans earning less than a given amount, has ended as quickly as it formed. Asian equities got killed (Nikkei -1.7%, Hang Seng -4.2%, Australia -6.4%) and European indices are also tumbling (DAX -5.5%, CAC -5.5%, FTSE100 -5.0%). US equity futures are limit down (-5.0%) at this point, so a lower opening seems likely.

In the FX world, as I mentioned, the dollar is top dog. Today’s worst performer is MXN, which has fallen a further 4% to yet another new low (dollar high) with USDMXN now trading near 24.00. Vacations there will be cheap when we can travel again! But RUB is lower by 3.6% as oil continues to slide, and ZAR is down 2.0% on the weakness in gold and all metals. APAC currencies were all weaker by between 0.2% and 0.6% except for PHP, which actually rallied 0.7% today after the government reopened the Philippine stock market. Yesterday, they had closed trading completely and the decision was not well received at all, so now they are all working remotely and that seemed to cheer the FX market as some funds flowed back into the country.

In the G10, the pound is the leading decliner, down 1.5% as I type and looking for all the world like it is going to test its historic 1985 lows of 1.06! Today was the day that Brexit negotiations were to begin with the EU, with plans for a large group of negotiators on both sides. Obviously, in the current situation, that is no longer viable and it seems inevitable that Boris is going to need to postpone the eventual exit. Of course, he will pay no political price for that given the circumstance. But the rest of the G10 is also sliding, and the slide has accelerated since NY walked in at 7:00. For instance, the euro had actually been a bit higher earlier this morning, but is now down 0.25%. But it is Aussie and Kiwi (-1.4% each) as well as SEK (-1.3%) and CAD (-0.8%) that are pacing the blocs decline. The only exception is the one we would expect, JPY which has edged 0.2% higher this morning. While dollar needs remain substantial worldwide, yen investors continue to liquidate internationally and bring home their money.

On the data front, we do see Housing Starts (exp 1500K) and Building Permits (1500K), but again, nobody really cares. The focus will remain on Fed and Administration policies and market responses to those announcements will continue to be the primary drivers going forward.

Good luck and stay safe
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