Of more immediate concern, is whatever is happening on the trade deal

Outlook:

We are likely doomed not to get that rise in yields that is the single bit of evidence that signals “no recession.” Yields continue to slide downward despite the fresh perspective of decent growth in the US, while at the same time, the S&P, Dow and Nasdaq all hit new record highs on that very same fresh perspective.

One issue is equity managers (as well as corporate treasurers) closing out their year-end at end-November. They take profit and stash it in bonds. In addition, Treasuries are getting competition from high-yield bonds, a new record high issuance of $17.6 billion in the latest week vs. the weekly average this year of $5.35 billion. If new economic data is facing a strong headwind like this, there’s almost no point in following it. Housing market developments and even anodyne comments from Fed chief Powell are not useful.

Of more immediate concern is whatever is happening on the trade deal. We see two Big Events. The first is the Hong Kong law sent to Trump by Congress that contains both implicit and explicit threats to China about restraining itself from interfering “wrongly” in Hong Kong. The bill is veto-proof, meaning it comes law in December unless Trump vetoes, in which case it gets passed again and becomes law. Trump will probably just sit on it and let it become law with the excuse to China that he was helpless.

The second Event is in Trump’s hands, too—the Dec 15 tariffs. Maybe the process is being dragged out for this issue alone—China can walk away if the deadline is honored. We still think Trump will postpone it from Dec 15. This ensures an equity rally into the New Year.  But going forward, nobody thinks there is actual consensus. Trump disclosed his stance long ago—the US wants to claw back advantages China has accumulated over the years and get up off the floor, while China is near the ceiling. In other words, the US believes China has to give up more than the US gives up.  China insists on a fair deal between equals. 

The US has yet to respond to China’s invitation to visit Beijing to finalize Phase One. That is potentially the third Big Event. If and when the US sets a date for that visit, we will all assume a deal is imminent. Again, stock market rally. In a binary world, this should be dollar-negative, but we continue to imagine the “no recession” story will outweigh the lack of evidence in the form of the longer-dated yields. We might even say the yield curve not inverting again is nice and will suffice.

Tidbit: The repo mystery rolls on. Yesterday the NY Fed did a 42-day repo that runs into the new year. The market wanted almost twice as much ($49 billion) as the Fed thought to offer ($25 billion). In contrast, demand for the overnight version was half what the Fed expected and offered.

The FT has a long article using the timeline of repo events and illustrated with some dandy charts. We like this one sentence: “Money sitting with the US Treasury is money that is not circulating in the financial system through the banks. As the Treasury filled its coffers, the repo market finally tipped over the edge.” In other words, blame QE. Or blame the newish minimum capital regulations that call for banks to hold more liquid assets, including cash and short-dated, that prevent them from making repo money available.

As year end approaches, banks will labor mightily to meet those capital requirements, suggesting the Fed is wise to offer longer-dated repos. We want to go back to core principles: if central banks are printing money like crazy, there should be no shortage of money. Ah, but we need to define “money.” The Austrian school has a definition of “broad true money” that includes all the usual M2 stuff like cash, checking and savings accounts, money market accounts, etc. but also Federal Reserve float and cash items in process of collection, US Treasury and governments deposits held at the Federal Reserve, and anything else that might be “money” (e.g., travelers checks).

An analyst named Acting Man at seekingalpha.com wrote in mid-Oct that “In August 2019, year-on-year growth of the broad true US money supply (TMS-2) fell to a fresh 12-year low of 1.87%. The 12-month moving average of the growth rate hit a new low for the move as well. The main driver of the slowdown in money supply growth over the past year was the Fed's decision to decrease its holdings of MBS and treasuries purchased in previous ‘QE’ operations. This was partly offset by bank credit growth in recent months, which has moved to 6.6% y/y after being stuck below 4% y/y throughout 2018.”

The chart is a stunner. If you look at the St. Louis Fed’s M2 chart, it shows steady and robust growth. However, our favorite offsetter, velocity, is floppy and failing. It’s almost as though the “broad true” money supply metric incorporates velocity... We don’t know how broad true is devised, but it’s sure interesting.

Something else basic we can deduce from this viewpoint: any and every time government intervenes in a market process, it results in misallocation of resources. We want interference in the form of regulations that restrain predation. Even Adam Smith recommended financial institutions be regulated for precisely this reason—to manage greed. The Dodd Frank and other regs now encircling the banks’ necks were designed to prevent over-leveraging and over-investment in subprime junk. For all we know from the stress tests, they succeeded. But the combination of QE and Dodd Frank and maybe some other mysterious process has had the result of starving the banking system of ready cash. Those who claim to understand this machinery say it’s just the plumbing, not the structure. Chandler says don’t confuse gasoline with transmission fluid. But the car comes to a halt without transmission fluid just as fast as without gas.

Politics: The Intelligence Committee report to the Justice Committee should come next week and form the basis of the articles of impeachment. Many observers say “Wait a minute! There’s more evidence to come!”

One big chunk of evidence is the money trail, something the Mueller investigation didn’t follow but got taken up by the New York branch of the Justice Dept. Two lower courts ruled Trump must release 8 years of tax returns and other financial documents that might disclose Russian money laundering and other Trump misdeeds, but yesterday the Supreme court delivered a stay, implying (but not guaranteeing it will take the case). If they take the case in Jan it might get heard in June. Since Supreme Court chief justice Roberts will preside over the Senate impeachment trial, we hope this is not a sign of siding with the Executive no matter what. There is fear that Trump’s violations of norms and laws can end up with the executive losing more privilege than is healthy and letting that ragtail mob in Congress get too much power, which could be used to bring the executive to a screeching halt.

But an offset is a ruling in federal district court that orders former White House lawyer McGahn to obey his subpoena and testify to Congress. The judge wrote a 2-page order plus a 130+-page essay that cable TV news commentators adored—it was full of comments like “no one is above the law” and the government’s case is “monarchical.” This, too, will almost surely go to the appeals court.

Meanwhile, one of the conspiracy guys who flipped to the government is offering all kinds of goodies about the Giuliani initiative, including pictures and documents. New subpoenas are blossoming to nail Rudy down, possibly to campaign finance violations and money laundering, among other charges. The court wants to know who paid him $500,000—the oligarch awaiting extradition to the US from Vienna?—and for what.

We might take comfort in the process developing the way the American system was designed to work—all three branches are involved. Those who approve the impeachment process this time—because Trump’s behavior is egregiously in violation of law as well as norms—point out that the founders’ biggest worry was exactly what Trump is charged with—involvement with foreign powers for domestic political gain. A good 20-30% of the concern in the Federalist Papers involves bribery/extortion. Trump’s stonewalling has worked, so far. That means obstructing Congress and obstructing justice will be among the articles of impeachment at the same time that obstruction seems to have been entirely effective—the Republicans still don’t get it, or perhaps don’t find it in their self-interest to get it.

 

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This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

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