16/6/17: Trumpery & Knavery: New Paper on Washington's Geopolitical Rebalancing

Not normally my cup of tea, but Valdai Club work is worth following for all Russia watchers, regardless of whether you agree or disagree with Moscow-centric worldview (and  whether you agree or disagree that such worldview even exists). So here is a recent paper on Trump's Administration and the context of the Washington's search for new positioning in the geopolitical environment where asymmetric influence moves by China, Russia and India, as well as by smaller players, e.g. Iran and Saudis, are severely constraining the neo-conservative paradigm of the early 2000s.

Making no comment on the paper and leaving it for you to read:  http://valdaiclub.com/files/14562/.

14/6/17: Unwinding the Mess: Fed's Road Map to QunE

As promised in the previous post, a quick update on Fed’s latest guidance regarding its plans to unwind the $4.5 trillion sized balance sheet, to the Quantitative un-Easing...

First, the size and the composition of the problem:

So, as noted in the post here: http://trueeconomics.blogspot.com/2017/06/13617-unwinding-mess-ecb-vs-fed.html, the Fed is aiming to gradually unwind the size of its assets exposures on both, the U.S. Treasuries and MBS (mortgage-backed securities). This is a tricky task, because simply dumping both asset classes into the markets (aka, selling them to investors) risks pushing yields on Government debt up and value of Government bonds down, as well as the value of MBS assets down. The problem with this is that all of these assets are systemically important to… err… systemically important financial institutions (banks, pension funds, investment funds and insurance companies).

Should yields on Government debt explode due to the Fed selling, the U.S. Government will simultaneously: 1) pay more on its debt; and 2) get less of rebates from the Fed (the returned payments on debt held by the Fed). This would be ugly. Uglier yet, the value of these bonds will fall, creating pressure on the assets valuations for assets held by banks, investment funds, insurance companies and pensions funds. In other words, these institutions will have to accumulate more assets to cover their capital cushions and/or sustain their funds valuations. Or they will have to reduce lending and provision of payouts.

Should MBS assets decline in value, there will be an assets write down for private sector financial institutions holding them. The result will be the same as above: less lending, more expensive credit and lower profit margins.

With this in mind, today’s Fed announcement is an interesting one. The FOMC “currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated,” according to today’s statement. And the FOMC provides some guidance to this normalization program:

Instead of dumping assets into the market, the Fed will try to gradually shrink the balance sheet by ‘rolling off’ a fixed amount of assets every month. At the start, the Fed will ‘roll off’ $10 billion a month, split between $6 billion from Treasuries and $4 billion from MBS. Three months later, the numbers will rise to $20 billion per month: $12 billion for Treasuries and $8 billion for MBS. Subsequently, ‘roll-offs’ will rise $10 billion per month ever three months ($6 billion for Treasuries and $4 billion for MBS). The ‘roll-off’ will be capped once it reaches $30 billion for Treasuries and $20 billion for MBS.

This modestly-paced plan suggests that the ‘roll off’ will concentrate on non-replacement of maturing instruments, rather than on direct sales of existent instruments.

What we do not know: 1) when the ‘roll off’ process will begin, and 2) when will it stop (in other words, what is the target level of both assets on Fed’s balance sheet in the long run. But the rest is pretty much consistent with my view presented here: http://trueeconomics.blogspot.com/2017/06/13617-unwinding-mess-ecb-vs-fed.html.




PS: A neat summary of Fed decisions and votes here: http://fingfx.thomsonreuters.com/gfx/rngs/USA-FED/010030ZL253/

14/6/17: The Fed: Bravely Going Somewhere Amidst Rising Uncertainty

Predictably (in line with the median investors’ outlook) the Fed raised its base rate and provided more guidance on their plans to deleverage the Fed’s balance sheet (more on the latter in a subsequent post). The moves came against a revision of short term forecast for inflation (inflationary expectations moved down) and medium turn sustainable (or neutral) rate of unemployment (unemployment target moved down); both targets suggesting the Fed could have paused rate increase.

Rate hike was modest: the Federal Open Market Committee (FOMC) increased its benchmark target by a quarter point, so the new rate range will be 1 percent to 1.25 percent, against the previous 0.91 percent. This marks the third rate hike in 6 months and the Fed signalled that it is on track to hike rates again before the end of the year (with likely date for the next hike in September). The forecast for 2018 is for another 75 basis points rise in rates, unchanged on March forecast.

Interestingly, the Fed statement highlights that inflation (short term expectations) remains subdued. “Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the committee’s 2 percent objective over the medium term,” the FOMC statement said. This changes the tack on previous months’ statements when the Fed described inflationary outlook as “broadly close” to target. Data released earlier today showed core consumer price inflation (ex-food and energy) slowed in May for the fourth straight month to 1.7 percent y-o-y. This is below the Fed target rate of 2 percent and suggests that monetary policy is currently running countercyclical to inflation. On expectations side, FOMC lowered its median forecast for inflation to 1.6 percent in 2017, from 1.9 percent forecast published in March. The FOMC left its forecasts for 2018 and 2019 unchanged at 2 percent.

The Fed, therefore, sees inflation slump to be temporary, which prompted U.S. 2 year yields to move sharply up:

Source: @Schuldensuehner

Which means that today’s hike was not about inflationary pressures, but rather unemployment, which dropped to a 16-year low at 4.3 percent in May.

As labour markets continue to overheat (we are now at 4.2 percent forecast 2017 unemployment and with over 1 million vacancies postings in excess of jobs seekers, suggesting a substantial and rising gap between the low quality of remaining skills on offer and the demand for higher skills), the Fed dropped its estimate of the neutral rate of unemployment (or, in common terms, the estimated minimum level of unemployment that can be sustained without a major uptick in wages inflation), from 4.7 percent in march to 4.6 percent today. At which point, it is worth noting the surreality of this number: the estimate has nothing to do with realistic balancing out of skills supply and demand, and is mechanically adjusted to match evolving balance between actual unemployment trends and inflation trends. In other words, the neutral rate of unemployment is Fed’s voodoo metric for justifying anything. How do I know this? Ok, consider the following forecasts & outlook figures from FOMC:

• 2017 GDP growth at 2.2% compared to 2.1%, unemployment rate at 4.2% compared to 4.5% prior, and core inflation at 2.0%, same as prior. So growth outlook is, basically, stable, but unemployment is dropping and inflation not budging. 
• 2018 GDP growth unchanged at 2.1%, inflation unchanged at 2.0%, and unemployment 4.2% vs 4.5% prior. So unemployment drops significantly, but GDP drops too and inflation stays put.
• 2019 GDP 1.9% vs 1.9% prior, unemployment 4.2% vs 4.5% prior and inflation 2.0% vs 2.0% prior. Same story as in 2018. 

In other words, it no longer matters what the Fed forecasts for growth and unemployment, inflation stays put; and it doesn’t matter what it forecast for growth and inflation, unemployment drops, and you can stop worrying about joint forecast for inflation and unemployment, growth remains remarkably stable. It’s the New Normal of Alan Greenspan Redux.


The FOMC next meets in six weeks, on July 25-26. Here is the dots chart of Fed’s expectations on benchmark rate compared to previous:

Source: https://www.bloomberg.com/graphics/fomc-dot-plot/

The key takeaway from all of this is that the Fed is currently at a crossroads: the uncertainty about key economic indicators remains elevated, as the Fed is compressing 2017-2018 guidance on rates. In other words, more certainty signalled by the Fed runs against more uncertainty signalled by the economy. Go figure…

13/6/17: Unwinding the Mess: ECB vs Fed

My guest post on the potential paths to unwinding monetary policies excesses by the Fed and ECB is available on FocusEconomics : http://www.focus-economics.com/blog/the-fed-ecb-at-a-crossroads-unwinding-qe.

13/6/17: Four Months of the Invisible Fiscal Discipline

U.S Treasury latest figures (through May 2017) for Federal Government’s fiscal (I’m)balance are an interesting read this year for a number of reasons. One of these is the promise of fiscal responsibility and cutting of public spending and deficits made by President Trump and the Republicans during last year’s campaigns. The promise that remains, unfortunately, unfulfilled.

In May 2017, cumulative fiscal year-to-date Federal Government receipts amounted to $2.169 trillion, which is $30 billion higher than over the same period of 2016. However, Federal Government’s gross outlays in the first 8 months of this fiscal year stood at $2.602 trillion, of $57.345 billion above the same period of last year.As a result, Federal deficit in the first 8 months of FY 2017 rose to $432.853 billion, up 6.77% y/y or $27.44 billion.

Given that 4 out of the 8 months of FY 2017 were under the Obama Presidency tenure, the above comparatives are incomplete. So consider the four months starting February and ending May. Over that period of 2017, Federal deficit stood at $274.274 billion, up 11.17% or $27.569 billion on February-May for FY 2016. In this period, in 2017, Trump Administration managed to spend $51.9 billion more than his predecessor’s presidency.

You can see more detailed breakdown of expenditures and receipts here: https://www.fiscal.treasury.gov/fsreports/rpt/mthTreasStmt/mts0517.pdf but the bottom line is simple: so far, four months into his presidency, Mr. Trump is yet to start showing any signs of fiscal discipline. Which raises the question about his cheerleaders in Congress: having spent Obama White House years banging on about the need for responsible financial management in Washington, the Republicans are hardly in a rush to start balancing the books now that their party is in control of both legislative and, with some hefty caveats, the executive branches.

10/6/2017: And the Ship [of Monetary Excesses] Sails On...

The happiness and the unbearable sunshine of Spring is basking the monetary dreamland of the advanced economies... Based on the latest data, world's 'leading' Central Banks continue to prime the pump, flooding the carburetor of the global markets engine with more and more fuel.

According to data collated by Yardeni Research, total asset holdings of the major Central Banks (the Fed, the ECB, the BOJ, and PBOC) have grown in April (and, judging by the preliminary data, expanded further in May):

May and April dynamics have been driven by continued aggressive build up in asset purchases by the ECB, which now surpassed both the Fed and BOJ in size of its balancesheet. In the euro area case, current 'miracle growth' cycle requires over 50% more in monetary steroids to sustain than the previous gargantuan effort to correct for the eruption of the Global Financial Crisis.

Meanwhile, the Fed has been holding the junkies on a steady supply of cash, having ramped its monetary easing earlier than the ECB and more aggressively. Still, despite the economy running on overheating (judging by official stats) jobs markets, the pride first of the Obama Administration and now of his successor, the Fed is yet to find its breath to tilt down:

Which is clearly unlike the case of their Chinese counterparts who are deploying creative monetarism to paint numbers-by-abstraction picture of its balancesheet.

To sustain the dip in its assets held line, PBOC has cut rates and dramatically reduced reserve ratio for banks.

And PBOC simultaneously expanded own lending programmes:

All in, PBOC certainly pushed some pain into the markets in recent months, but that pain is far less than the assets account dynamics suggest.

Unlike PBOC, BOJ can't figure out whether to shock the worlds Numero Uno monetary opioid addict (Japan's economy) or to appease. Tokyo re-primed its monetary pump in April and took a little of a knock down in May. Still, the most indebted economy in the advanced world still needs its Central Bank to afford its own borrowing. Which is to say, it still needs to drain future generations' resources to pay for today's retirees.

So here is the final snapshot of the 'dreamland' of global recovery:

As the chart above shows, dealing with the Global Financial Crisis (2008-2010) was cheaper, when it comes to monetary policy exertions, than dealing with the Global Recovery (2011-2013). But the Great 'Austerity' from 2014-on really made the Central Bankers' day: as Government debt across advanced economies rose, the financial markets gobbled up the surplus liquidity supplied by the Central Banks. And for all the money pumped into the bond and stock markets, for all the cash dumped into real estate and alternatives, for all the record-breaking art sales and wine auctions that this Recovery required, there is still no pulling the plug out of the monetary excesses bath.

10/6/17: Visualizing Cyber Security Attacks

Here is a brilliant visualization of data breaches over time and by size: http://www.visualcapitalist.com/worlds-biggest-data-breaches/.

As the chart above clearly shows, the number of reporter/disclosed attacks has exploded, staring with 2014, and the volume of attacks (data files impacted) has blown out starting 2010 (note: Yahoo attacks were severely lagged in reporting). In part, the two factors are down to changes in reporting and disclosure rules, and in part they are down to changes in reporting practices. But, as we observe econometrically in our recent papers on the subject: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2892842 and https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2904749, the pattern on frequency, severity and impact of attacks, as well as their typology, are richer than the chart above provides.

Starting with 2010s, the typology of cyber security risks and attacks has been shifting from malicious and accidental losses of hardware and accidental disclosures of data to malware-based hacks, direct hacks, and illegal disclosures. The distribution of attacks has been changing since 2014, with smaller and larger, state and private sector players being hit with higher frequency, as opposed to the 2000s-early 2010s when we had more concentrated distribution of attacks. And, crucially, the impact of the attacks is also changing: starting with 2014, we are witnessing systemic shocks contagion propagating from individual attack targets to their exchanges and even to other exchanges.

10/6/17: Cart & Rails of the U.S. Monetary Policy

So, folks, what’s wrong with this picture, eh?

Let’s start thinking. The U.S. Treasury yields are underlying the global measure of inflation since the onset of the global ‘fake recovery’. Both have been and are still trending to the downside. Sounds plausible for a ‘hedge’ asset against global economic stagnation. And the U.S. Treasuries can be thought of as such, given the U.S. economy’s lead-timing for the global economy. Except for a couple of things:

1. U.S. Treasury is literally running out of money (by August, it will need to issue new paper to cover arising obligations and there is a pesky problem of debt ceiling looming again);
2. U.S. Fed is signalling two (or possibly three) hikes over the next 6 months and (even more importantly) no willingness to restart buying Treasuries again;
3. U.S. political risks are rising, not abating, and (equally important) these risks are now evolving faster than global geopolitical risks (the hedge’ is becoming less ‘safe’ than the risks it is supposed to hedge);
4. U.S. Fed is staring at the prospect of potential increase in decisions uncertainty as it is about to start welcoming new members ho will be replacing the tried-and-trusted QE-philes;
5. Meanwhile, the gap between the Fed policy’s long term objectives and the reality on the ground is growing: private debt is rising, financial assets valuations are spinning out of control and 

So as the U.S. 10-year paper is nearing yields of 2%, and as the premium on Treasuries relative to global inflation is widening once again, the U.S. Fed is facing a growing problem: tightening rates is necessary to restore U.S. dollar (and U.S. Treasuries) credibility as a global risk hedge (the key reason anyone wants to hold these assets), but raising rates is likely to take the wind out of the sails of the financial markets and the real economy. Absent that wind, the entire scheme of debt-fuelled growth and recovery is likely to collapse. 

Cart is flying one way. Rails are pointing the other. And no one is calling it a crash… yet…

7/6/17: TrueEconomics Makes Top 100 List... again

A quick note: delighted to see the blog profiled in Top 100 Economics Blogs of 2017 by the Intelligent Economist : https://www.intelligenteconomist.com/economics-blogs/.

7/6/17: European Policy Uncertainty: Still Above Pre-Crisis Averages

As noted in the previous post, covering the topic of continued mis-pricing by equity markets of policy uncertainties, much of the decline in the Global Economic Policy Uncertainty Index has been accounted for by a drop in European countries’ EPUIs. Here are some details:

In May 2017, EPU indices for France, Germany, Spain and the UK have dropped significantly, primarily on the news relating to French elections and the moderation in Brexit discussions (displaced, temporarily, by the domestic election). Further moderation was probably due to elevated level of news traffic relating to President Trump’s NATO visit. Italy’s index rose marginally.

Overall, European Index was down at 161.6 at the end of May, showing a significant drop from April 252.9 reading and down on cycle high of 393.0 recorded in November 2016. The index is now well below longer-term cycle trend line (chart below). 

However, latest drop is confirming overall extreme degree of uncertainty volatility over the last 18 months, and thus remains insufficient to reverse the upward trend in the ‘fourth’ regime period (chart below).

Despite post-election moderation, France continues to lead EPUI to the upside, while Germany and Italy remain two drivers of policy uncertainty moderation. This is confirmed by the period averages chart below:

Overall, levels of European policy uncertainty remain well-above pre-2009 averages, even following the latest index moderation.

7/6/17: Equity Markets Continue to Mis-price Policy Risks

There has been some moderation in the overall levels of Economic Policy Uncertainty, globally, over the course of May. The decline was primarily driven by European Uncertainty index falling toward longer-term average (see later post) and brings overall Global EPU Index in line with longer term trend (upward sloping):

This meant that short-term correlation between VIX and Global EPUI remained in positive territory for the second month in a row, breaking negative correlations trend established from October 2015 on.

The trends in underlying volatility of both VIS and Global EPUI remained largely the same:

The key to the above data is that equity markets risk perceptions remain divorced from political risks and uncertainties reflected in the Global EPUI. This is even more apparent when we consider actual equity indices as done below:

Both, on longer-run trend comparative and on shorter term level analysis bases, both S&P 500 and NASDAQ Composite react in the exactly opposite direction to Global Economic Policy Uncertainty measure: rising uncertainty in the longer run is correlated with rising equities valuations.

7/6/17: Markets, Investors Exuberance and Fundamentals

Latest data from FactSet on S&P500 core metrics is an interesting read. Here are a couple of charts that caught my attention:

Look first at the last 6 months worth of EPS data through estimated 2Q 2017 (based on 99% of companies reporting). The trend continues: EPS is declining, while prices are rising. On a longer time scale, EPS have been virtually flat in 2014-2016, but are forecast to rise nicely in 2017 and 2018. Whatever the forecast might be for 2018, 2017 increase would do little to generate a meaningful reversion in EPS to price trend

However, the good news is, expectations on rising EPS are driven by rising sales for 2017, and to a lesser extent in 2018. This would be (if materialised) an improvement on the 2014-2016 core drivers, including shares repurchases (chart below).

Next, consider P/E ratios:

As the chart above indicates, P/E ratios are expected to continue rising in the next 12 months. In other words, the markets are going to get more expensive, relative to underlying earnings. Worse, on a 5-year average basis, all sectors, excluding Financials, are at above x14. Hardly a comfort zone for 'go long' investors. The overvalued nature of the market is clearly confirmed by both forward and trailing P/E ratios over the last 10 years:

Forward expectations are now literally a run-away train, relative to the past 10 years record (chart above), while trailing (lagged) P/Es are dangerously close to crisis-triggering levels of exuberance (chart below).

In summary, thus, latest data (through end-of-May) shows continued buildup of risks in the equity markets. At what point the dam will crack is not something I can attempt to answer, but the lake of investors' expectations is now breaching the top, and the spillways aren't doing the trick on abating them.