Rising Interest Rates Starting To Bite

We have long held that interest rates have been so low (especially real rates) that it will take some time to reach a level for them to really matter and impact markets. The 2-year yield crossing over the S&P500 dividend yield this past week for the first time in the last ten years is unlikely to slow the momentum driving risk markets. Nevertheless, they are getting closer to the zip code – after two years since the tightening cycle began – where they will begin to impact fundamental valuations (what is the fundamental value of Bitcoin?) and the relative pricing of risk assets. Keep it on your radar.
Long-term rates are so utterly distorted by the central banks we are not sure if the markets even pay attention anymore. Pancaking of the yield curve? Not the signal it used to be. Meh!

This post was published at Zero Hedge on Dec 18, 2017.

Explaining My Amazement About Those Turning Bullish On The Banking Sector Now

Recent price action
With the Nasdaq continuing higher this past week, it has now reached our minimum target we were looking for before a pullback may be seen. But, I think the XLF may be providing us with certain clues about how 2018 may turn out. And, it may not be as rosy as many believe. Well, at least the first half of the year.
Anecdotal and other sentiment indications
Interest rates are rising. Tax obligations will likely be dropping. And, many believe this could be a wonderful environment for our banks to thrive. In fact, I am seeing many Wall Street analysts picking the banking sector as one of their favorites for 2018. Well, I certainly cannot concur, based upon what I am seeing in my charts, which provide insight into market sentiment.
As markets move higher and higher, for some reason, people turn more and more bullish. I mean, the drive that most consumers have to find the best price for the goods and services they desire is conspicuously absent from the greater investor community.
Why is it that when you want to buy a high priced product, you will do extensive research to find the lowest price available, yet, when it comes to stocks, most will only buy after it has risen substantially? Have you ever considered this question?
For those of us who have studied markets, we would understand that the reason is because financial markets are emotionally driven, rather than logically driven. As prices rise, investors become more and more convinced that they will simply continue to rise in a linear manner. And, when the greatest percentage of investors maintain this belief, that is often the point in time when the market changes direction.
And, I am seeing a potential turn setting up into January of 2018.

This post was published at GoldSeek on Monday, 18 December 2017.

The Yield Curve And The Boom-Bust Cycle

The central bank is not the root cause of the boom-bust cycle. The root cause is fractional reserve banking (the ability of banks to create money and credit out of nothing). The central bank’s effect on the cycle is to extend the booms, make the busts more severe and prevent the investment errors of the boom from being fully corrected prior to the start of the next cycle. Consequently, there are some important relationships between interest rates and the performance of the economy that would hold with or without a central bank, provided that the practice of fractional reserve banking was widespread. One of these relationships is the link between a reversal in the yield curve from flattening to steepening and the start of an economic recession/depression.
Unfortunately, the data we have at our disposal doesn’t go back anywhere near as far as we’d like, where ‘as far as we’d like’ in this case means 150 years or more. For example, the data we have for the 10year-2year spread, which is our favourite indicator of the US yield curve, only goes back to the mid-1970s.
For a longer-term look at the performance of the US yield curve the best we can do on short notice is use the Fed’s data for the 10year-3month spread, which goes back to the early-1960s. However, going back to the early-1960s is good enough for government work and is still satisfactory for the private sector.
As explained in many previous commentaries, the boom phase of the cycle is characterised by borrowing short-term to lend/invest long-term in order to take advantage of the artificial abundance of cheap financing enabled by the creation of money and credit out of nothing. This puts upward pressure on short-term interest rates relative to long-term interest rates, meaning that it causes the yield curve to flatten.

This post was published at GoldSeek on Sunday, 17 December 2017.

Waiting for the Curve to Invert

One of the hallmarks of a Bull market is climbing a ‘Wall of Worry’. Certainly, there is plenty of longer-term optimism with Consumer and Small Business surveys showing extreme confidence. Yet analysts seem increasingly focused on what might go wrong. In the early days of 2009 – 2012 most were certain that the Trillions in money printing by central banks would cause massive inflation and thus contraction level node-bleed interest rates. Recently the worry du jour has been on rising short-term rates that is spiraling our Yield Curve towards inversion. It’s perhaps too widely know that Yield Curve inversion has always given an accurate warning of impending economic recession months later. In ‘waiting for the curve’ too many investors are cautious well before some unforeseeable inversion turning point. This chart clearly shows that historically the ‘current’ Yield Curve is not a concern, in fact, it will remain a positive factor as we approach inversion. Furthermore, even after the ominous flat yield spread is reached where short-term rates are equal to or above long-term yields, we often witness another year or more of positive growth before recessionary contraction pressures break the back of the expansion phase. Based on history, we have at least a couple years of expansion before push comes to shove in halting this 8+ year growth period.

This post was published at FinancialSense on 12/15/2017.

Canada Home Values Hit ‘First Quarterly Decline since Q1 2009’ as Household Debt Binge Hits New High

How exposed are over-indebted household to rising interest rates?
Household debt in Canada rose to a new record of C$2.11 trillion in the third quarter 2017, up 5.2% from a year ago and up 10.7% from two years ago, Statistics Canada said on Thursday in its quarterly report on national balance sheets. Mortgages accounted for 65.6% of the total. Canada’s infamous household-debt-to-disposable income ratio, one of the highest in the world, rose to a breath-taking record of 173.3%.
The ratio means that households, on average, owed C$173.3 for every dollar of after-tax income earned. This chart shows how the indebtedness in relationship to after-tax income has soared since 2001, when Canada’s housing boom took off in earnest:

This post was published at Wolf Street on Dec 14, 2017.

Bonds Versus Economists: Reality & The Echo Chamber

As part of its effort to stress its own self-importance, the Federal Reserve conducts a survey of the Primary Dealer members through its New York branch. A written questionnaire is sent out to each bank in advance of every monetary policy meeting. The purpose is for monetary policymakers to make sure that there aren’t any big surprises, that the market, or, in this case, orthodox Economists working for one part of the market, is seeing things consistent with how the Fed wants them to.
In September 2013, the Primary Dealer Survey questions included a few pertaining to the then ongoing ‘taper tantrum’ roiling markets around the world. It was ‘reflation’ #2 and like the others, both the one before and the one after, it came on rather quickly and harshly. On the issue of benchmark interest rates, in the form of the UST 10s, the Primary Dealers all saw interest rates rising still further into the foreseeable future.
Of those surveyed, 65% believed that the 10-year yield would be above 3% by the end of 2014; more than three-quarters, 78%, thought the same for the end of 2015, including 15% who were expecting the 10s to get above 4.50% compared to just 6% who guessed, correctly, 2.01% to 2.50%.

This post was published at Zero Hedge on Dec 14, 2017.

ECB Keeps Rates Unchanged, Sees Current Policy Stance “Contributing To Favorable Liquidity Conditions”

As expected, there was little surprise in the ECB monetary policy decision, which kept all three key ECB rates unchanged, and which announced that rates will “remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases.”
As it unveiled before, QE will run at 30BN per month from January 2018 until the end of September ‘or beyond, if necessary, and in case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim.’ The ECB also noted it can extend QE size or duration if needed.
The central bank repeated it will reinvest maturing debt for extended period after QE, and that the “reinvestment will continue for as long as necessary, will help deliver appropriate stance” and “will contribute both to favourable liquidity conditions and to an appropriate monetary policy stance.”
The market reaction to the statement which was completely in line with expectations, was modest, with the EURUSD hardly even moving on the news.
Full statement below

Monetary policy decisions At today’s meeting the Governing Council of the ECB decided that the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00%, 0.25% and -0.40% respectively. The Governing Council expects the key ECB interest rates to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases.

This post was published at Zero Hedge on Dec 14, 2017.

It’s Central Bank Bonanza Day: European Stocks Slide Ahead Of ECB; S&P Futs Hit Record High

One day after the Fed hiked rates by 25 bps as part of Janet Yellen’s final news conference, it is central bank bonanza day, with rate decisions coming from the rest of the world’s most important central banks, including the ECB, BOE, SNB, Norges Bank, HKMA, Turkey and others.
And while US equity futures are once again in record territory, stocks in Europe dropped amid a weaker dollar as investors awaited the outcome of the last ECB meeting of the year: the Stoxx 600 falls 0.4% as market shows signs of caution before the Bank of England and the European Central Bank are due to make monetary policy decisions as technology, industrial goods and chemicals among biggest sector decliners, while miners outperform, heading for a 5th consecutive day of gains. ‘The Federal Reserve raised interest rates last night, but they weren’t overly hawkish in their outlook. This has led to traders being subdued this morning,’ CMC Markets analyst David Madden writes in note.
The stronger euro pressured exporters on Thursday although overnight the dollar halted a decline sparked by the Fed’s unchanged outlook for rate increases in 2018, suggesting “Yellen Isn’t Buying Trump’s Tax Cut Talk of an Economic Miracle.”
That said, it has been a very busy European session due to large amount of economic data and central bank meetings, with the NOK spiking higher after the Norges Bank lifted its rate path, while the EURCHF jumped to session highs after SNB comments on CHF depreciation over last few months. The AUD holds strong overnight performance after a monster jobs report which will almost certainly be confirmed to be a statistical error in the coming weeks, while the Turkish Lira plummets as the central bank delivers less tightening than expected. Meanwhile, the USD attempts a slow grind away from post-FOMC lows.

This post was published at Zero Hedge on Dec 14, 2017.

‘Replacement Demand’ from Hurricane Harvey Overhyped, Carmageddon Returns to US

Houston-area auto sales rise, but not nearly enough.
The total damage Hurricane Harvey inflicted on parts of Texas, particularly the vast Houston area, may never be fully known. In terms of vehicles, the estimates were all over the place. But one thing is known: Before the flood waters had even begun to recede, the entire industry, was salivating over that huge ‘replacement demand.’
This would come just in the nick of time, as total new vehicle sales in the US had already fallen by about 300,000 units for the year through July, despite record incentives, historically low interest rates, and muscular all-encompassing marketing. The industry’s elements on Wall Street propagated the idea that post-Harvey ‘replacement demand’ would boost auto sales in 2017, turn the year around, and possibly create another record year, with more booming sales in 2018.
The estimates I have come across at the time ranged from 300,000 vehicles at the low end to over 600,000 vehicles that would need to be replaced. Much of this replacement demand would occur over the remaining months in 2017 and early 2018. These sales would be so big that they would boost US sales overall to new highs.

This post was published at Wolf Street by Wolf Richter ‘ Dec 13, 2017.

Yellen’s Big Goodbye (And What She’s Leaving Behind)

The past three Fed Chairs before Yellen all had their own crisis to deal with.
Volcker had the disaster of the early 1980’s as he struggled to tame inflation with double digit interest rates. That helped contribute to the Latin American debt crisis, and the subsequent global bear markets in stocks.
He handed over the reins to Greenspan in the summer of ’87 and within months, the new Fed Chairman faced the largest stock market crash since the 1920’s. That trial by fire was invaluable for Greenspan, as he faced a second crisis when the DotCom bubble burst at the turn of the century.
His successor, Ben Bernanke also did not escape without a record breaking financial panic when the real estate collapse hit the global economy especially hard in 2007.
But Yellen? Nothing. Nada. She has presided over the least volatile, most steady, market rally of the past century. Was she lucky? Or was this the result of smart policy decisions? I tend to attribute it more to luck, but it’s tough to argue that she made any large mistakes. Sure you might quibble about the rate of interest rate increases. And her critics will argue that economic growth, and more importantly, wage increases have been especially anemic under her watch, but to a large degree, those variables are out of her hands.

This post was published at Zero Hedge on Dec 13, 2017.

Toronto’s Housing Bubble Is Crushing The Strip Club Industry

Until now, Canada’s soaring housing prices were just another innocent asset bubble spawned by low interest rates and an endless supply of Chinese cash that needed to get laundered. That said, massive bubbles are almost always followed by severe unintended consequences that can have a crippling impact on society as a whole…and in Toronto those unintended consequences are now manifesting themselves in the form of a rapidly deteriorating supply of strip clubs.
As Bloomberg points out today, the soaring value of Toronto real estate has made it all but impossible for strip club owners to turn down multi-million offers from condo developers leaving only a dozen strip clubs in a city whose purple neon lights used to be easily visible from the distant fringes of our solar system.
Condos are killing the Toronto strip club. In a city that once had more than 60 bars with nude dancers, only a dozen remain, the rest replaced by condominiums, restaurants, and housewares stores. Demand for homes downtown and for the retailers that serve them is driving land prices to records, tempting owners of the clubs, most of which are family-run, to sell at a time when business is slowing.
‘Sometimes I feel like the last living dinosaur along Yonge Street,’ says Allen Cooper, the second-generation owner of the famous – or infamous – Zanzibar Tavern. The former divorce lawyer says he has been approached by at least 30 suitors for his property in the past few years but is holding out for a ‘blow my socks off’ offer. ‘I don’t know how many condos we’re going to get, but it seems like just a wall’ of them, Cooper says.

This post was published at Zero Hedge on Dec 12, 2017.

Five European Nations Issue Warning To America On Tax Reform

First it was the Chinese, now it’s the Europeans, as the rest of the world is suddenly very unhappy with the prospect of US tax reform (or maybe it is an unexpectedly strong US economy). As we discussed yesterday, with the historic Trump tax reforms on the verge of passage and the Fed’s dot plot signalling another 7-8 rate hikes (soon to be revised much lower), China is nervous that the capital outflows, which it thought it had bottled up, might be about to return. China is preparing a contingency plan which includes ‘higher interest rates, tighter capital controls and more-frequent currency intervention to keep money at home and support the yuan’.
Amusingly, the Wall Street Journal quoted a Chinese official who described Washington’s tax plan as a ‘gray rhino’. The latter is a combination of an ‘elephant in the room’ and a ‘black swan’, i.e. a high probability threat which people should see coming, but don’t. The focal point of China’s fears is the Yuan, which the authorities have spent so much time and effort stabilising during the last two years. Speaking to the WSJ, the Chinese official sounded a warning: ‘We’ll likely have some tough battles in the first quarter.’
Switching to Europe and five European finance ministers have sent a letter criticising the US for undermining the ‘rules of the game’ and international trade. Notwithstanding Brexit, the signatories included the UK Chancellor, Philip Hammond, as well as his counterparts in Germany, France, Italy and Spain. Essentially, the European nations are warning the US that it risks starting a trade dispute.

This post was published at Zero Hedge on Dec 12, 2017.

Jim Grant: “Markets Trust Too Much In The Presence Of Central Banks”

James Grant, Wall Street expert and editor of the renowned investment newsletter Grant’s Interest Rate Observer, warns of the unseen consequences of super low interest rate and questions the extraordinary actions of the Swiss National Bank.
Nearly ten years after the financial crisis, extraordinary monetary policy has become the norm.
The financial markets seem to like it: Stocks are close to record levels and the global economy is finally picking up. Nonetheless, James Grant sees no reason to sound the all-clear signal. The sharp thinking and highly regarded editor of the iconic Wall Street newsletter Grant’s Interest Rate Observer argues that historically low interest rates are distorting the perception of investors.
Principally, Mr. Draghi has robbed the marketplace of essential information, he criticizes the head of the European Central Bank for example. Highly proficient in financial history, Mr. Grant also questions the strategy of the Swiss National Bank. He fears that the voluntary depreciation of the Franc undermines the status of Switzerland as a global financial center.

This post was published at Zero Hedge on Dec 12, 2017.

For Clues On The Economy, Follow The Money

‘There is nothing new on Wall Street or in stock speculation. What has happened in
the past will happen again, and again, and again. This is because human nature does
not change, and it is human emotion, solidly built into human nature, that always
gets in the way of human intelligence. Of this I am sure.’ – Jesse Livermore
The profitability of lending/investing money is a function of both the rate of return on the money loaned/invested and the return (payback) of the money. The historically low interest rates are squeezing lenders by driving the rate of return on the loan toward zero (note: ‘lenders’ can be banks or non-bank lenders, like pension funds investing in bonds).
As the margin on lending declines, lenders, begin to take higher risks. Eventually, the degree of risk accepted by lenders is not offset by the expected return on the loan – i.e. the probability of partial to total loss of capital is not offset by a corresponding rate of interest that compensates for the risk of loss. As default rates increase, the loss of capital causes the rate of return from lending to go negative. Lenders then stop lending and the system seizes up. This is what occurred, basically, in 2008.
This graphic shows illustrates this idea of lenders pulling away from lending:

This post was published at Investment Research Dynamics on December 12, 2017.

The Process Through Which the First Major Central Bank Goes Bust Has Begun

In the aftermath of the Great Financial Crisis, Central Banks began cornering the sovereign bond market via Zero or even Negative interest rates and Quantitative Easing (QE) programs.
The goal here was to reflate the financial system by pushing the ‘risk free rate’ to extraordinary lows. By doing this, Central Bankers were hoping to:
1) Backstop the financial system (sovereign bonds are the bedrock for all risk).
2) Induce capital to flee cash (ZIRP and NIRP punish those sitting on cash) and move into risk assets, thereby reflating asset bubbles.
In this regard, these policies worked: the crisis was halted and the financial markets began reflating.
However, Central Banks have now set the stage for a crisis many times worse than 2008.
Let me explain…
The 2008 crisis was triggered by large financial firms going bust as the assets they owned (bonds based on mortgages) turned out to be worth much less (if not worthless), than the financial firms had been asserting.
This induced a panic, as a crisis of confidence rippled throughout the global private banking system.
During the next crisis, this same development will unfold (a crisis in confidence induced by the underlying assets being worth much less than anyone believes), only this time it will be CENTRAL banks (not private banks) facing this issue.

This post was published at GoldSeek on 11 December 2017.

The Saudi-Qatar Diplomatic Dispute, Six Months Later

Six months ago, the Gulf Cooperation Council, helmed as always by its de facto leader Saudi Arabia, severed diplomatic ties with Qatar. This move was apparently meant to punish the country for its supposed support of terrorism. Riyadh announced the closure of its shared land border with Qatar. The remaining GCC members denied Qatar use of their airspace and ports. The measures were meant to bring the Qatari economy to its knees by isolating the government in Doha.
Why the Measures Failed
At first, these measures seemed as though they might succeed. They quickly sent a shock through the economy, particularly in banking and trade.
Since the Saudi announcement, an estimated $30 billion has been removed from Qatari banks, interest rates have risen, and deposits have declined. Foreign customers with deposits at Qatari banks have withdrawn and relocated their money. Deposits totaled 184.6 billion riyals ($50.7 billion) at the start of June; they have since declined to 137.7 billion riyals.
Trade initially suffered too.

This post was published at Mauldin Economics on DECEMBER 11, 2017.

The Fed’s Fantasy on Neutral Interest Rates

In her testimony to the Congress Economic Committee on November 29, 2017, the Fed Chair Janet Yellen said that the neutral rate appears to be quite low by historical standards. From this, she concluded that the federal funds rate would not have to increase much to reach a neutral stance.
The neutral rate currently appears to be quite low by historical standards, implying that the federal funds rate would not have to rise much further to get to a neutral policy stance. If the neutral level rises somewhat over time, as most FOMC participants expect, additional gradual rate hikes would likely be appropriate over the next few years to sustain the economic expansion.
It is widely accepted that by means of suitable monetary policies the US central bank can navigate the economy towards a growth path of economic stability and prosperity. The key ingredient in achieving this is price stability. Most experts are of the view that what prevents the attainment of price stability are the fluctuations of the federal funds rate around the neutral rate of interest.
The neutral rate, it is held, is one that is consistent with stable prices and a balanced economy. What is required is Fed policy makers successfully targeting the federal funds rate towards the neutral interest rate.
This framework of thinking, which has its origins in the 18th century writings of British economist Henry Thornton1, was articulated in late 19th century by the Swedish economist Knut Wicksell.

This post was published at Ludwig von Mises Institute on December 11, 2017.

Bitcoin Mania Shows The World Financial System Is a Con

The hidden agenda in the so-called tax reform bill is to act as stop-gap quantitative easing to plug the ‘liquidity’ hole that is opening up as the Federal Reserve (America’s central bank) makes a few gestures to winding down its balance sheet and ‘normalizing’ interest rates. Thus, the aim of the tax bill is to prop up capital markets, and the apprehension of this lately is what keeps stocks making daily record highs. Okay, sorry, a lot to unpack there.
Primer: quantitative easing (QE) is a the Federal Reserve’s weasel phrase for its practice of just creating ‘money’ out of thin air, which it uses to buy US Treasury bonds (and other stuff). The Fed buys this stuff through intermediary Too Big To Fail banks which allows them to cream off a cut and, theoretically, pump the ‘money’ into the economy. This ‘money’ is the ‘liquidity.’ As it happens, most of that money ends up in the capital markets. Stocks go up and up and bond yields stay ultra low with bond prices ultra high. What remains on the balance sheets are a shit-load of IOUs.
The third round of QE was officially halted in 2014 in the USA. However, the world’s other main central banks acted in rotation – passing the baton of QE, like in a relay race – so that when the US slacked off, Japan, Britain, the European Central Bank, and the Bank of China, took over money-printing duties. And because money flies easily around the world via digital banking, a lot of that foreign money ended up in ‘sure-thing’ US capital markets (as well as their own ). Mega-tons of ‘money’ were created out of thin air around the world since the near-collapse of the system in 2008.

This post was published at Wall Street Examiner on December 8, 2017.