Spot Markets Live Transcript, 27/10/23 (YCC US edition, Geopolitical risk premium and Fungi)

and welcome back our founder, mentor, guide, spiritual guru, wellness adviser etc etc, Izzy Kaminska

Have you been engaging in any funghi retrieval?

Apparently (i was told yesterday) in france you can take your pickings to the chemist, and they will tell you which ones are safe and which ones are not.

I just depend on my dad.

 I’m watching a consumer slowdown in real time. I’m the living embodiment of ‘death of the high street’

death ON the high st

(Mead is very popular in Poland btw)

people ask for the strangest things… Himalayan malbec

 (long and tortuous investigation, revealed the person had misheard the name of a brand)

it was Amalayan malbec

butterscotch schnapps, a woman with a picture of some obscure local bellywash she’d had on holiday in Benidorm 5 yrs ago. Where could I find it? Answer: probably Benidorm is your best bet

as i said, they ask for the strangest things

you’d be a good wine merchant, Izzy

Right after an uneventful ECB announcement, US GDP figures beat estimates and confirmed the growth differential between the US and its key developed peers is significantly wide – and widening. As discussed in this analysis by our US economist, the GDP surge to an annualised 4.9% in 3Q was primarily due to consumer and government spending. We don’t expect such strong performance to be repeated in the fourth quarter, where we’re forecasting 1.5% growth. For now, the evidence of the strong growth momentum into the last part of the year is adding fuel to the higher-for-longer rate narrative.

The dollar’s reaction was quite muted: we don’t think this was due to any impact from the ECB, but rather to the 3Q US PCE figures, which came in lower than expected at 2.4%, and potentially jobless claims climbing back to 210k. There is also a building trend for the dollar to find less and less upward momentum after some strong releases. That is consistent with the overbought condition of the greenback and the notion that we might be close to the peak in US activity data optimism. In this sense, we could see data outside of the US (i.e. in the eurozone or in China) having a greater impact on global market dynamics as they have done in the past few weeks.

wine merchant to the bourgeoisie

Yellen Says Yield Surge Is Due to Strong Economy, Not Deficits

https://www.bloomberg.com/news/articles/2023-10-26/yellen-says-increase-in-yields-reflects-higher-for-longer-rates

The actual quotes were:

“I don’t think much of that is connected” to the US budget deficit, Yellen said at an event in Bloomberg’s Washington office Thursday. “We’re seeing yields go up in most advanced countries.”

The increase in yields — which has taken benchmark Treasury rates to the highest levels since before the global financial crisis — is instead “largely a reflection of the resilience people are seeing in the economy,” she said.

“The economy is continuing to show tremendous robustness and that suggests that interest rates are likely to stay higher for longer,” she said.

So what do you reckon Julian? Stunning success show? Or Potemkin Village?

 as Mandy Rice Davies once pointed out, ‘She would say that, wouldn’t she?’

The death of the US consumer has been predicted many times before. The resilience is astonishing.

The economy’s main growth engine — personal spending — jumped 4%, also the most since 2021.

It’s not just the consumer, though, in the US, 78% of companies reporting beat 3Q consensus, compared with 57% in Europe.

Pasquariello, my GS guy, (although I doubt he describes himself as such) wrote this week about how govt data seemed to be a lot better than corporate data but 3Q results from the S&P have  given the latter some impetus and the overall performance of Big Tech largely justified the higher valuations. The crowded trade was crowded for a reason.

big tech delivered

 (I’m thinking the Chinese and Russians here) looking to diversify. When DXY turns lower, I expect gold to rip because that’s the direction in whicch they are diversifying

i was searching online for mead

It was down about 35 percent yesterday on news it was now negotiating with the German government for guarantees for its long-term projects.

So, I suspect, somebody told some porky pies when they argued that renewable energy was cost-competitive with fossil fuels. If it was, the above shouldn’t be happening.

 In reality, many of these long term projects aren’t viable at 5% interest rates. (Which is why some are calling for central banks to introduce a two-tier rate market, with the idea that green projects get cheaper funding on the basis that they will ease supply-side constraints more quickly.)

(Tho JR would know all about this I understand since he has the paperwork to prove his expertise in ESG)

I got 3 modules in, realised the answer to every question is ‘what would Greta say?’

and lost the will to live

I gave up

The summit next month is very important for both presidents.

botyh of them need to look, well, erm, presidential and successful n stuff

Fentanyl is high on the agenda, apparently. The drug behind the opioid epidemic mostly comes from Mexico which I knew but I didnt realise most of it originates in China.

(eek, that didn’t link very well)

I’m going to enforce better compartmentalization for the purposes of a streamlined transcript: DIVIDER

Here’s a  good little round up from UBS on the earnings performance to date:

A combination of disappointing mega-cap tech earnings, weaker guidance,

and elevated bond yields has weighted on equities. The decline has been

fairly broad-based with nearly 64% of S&P 500 constituents falling since

last Friday. Since last Friday’s US equity market close, the S&P 500 has fallen

2.1% and the tech-heavy Nasdaq has declined 2.9%. The S&P 500 index

has now dropped by almost 9% since its July peak.

• The average week-to-date move for the “Magnificent Seven”

was –4.9% since last Friday. The “Magnificent Seven” account for

some of the heaviest-weighted constituents within the S&P 500 index,

and their earnings announcements this week have been mixed. Among

these seven constituents, Alphabet posted the largest drop in the S&P

500 (–9.7% week-to-date), as markets responded to its management’s

comments about unpredictable customer spending intentions. Concerns

over similar pressures flowing through to other companies weighed

on many S&P 500 stocks. Meanwhile, reaction to Microsoft’s earnings

release was strong, making it among the top 10 gainers on Wednesday

(+3.1%) following its quarterly report, which showed solid beats, led by

upside to revenues and margins, expense control, market share gains

in its cloud business, and strong bookings. Meta’s earnings were better

than analysts’ expectations, but the stock declined Thursday (–3.7%)

after management guided below analysts’ expectations for 2024. Post

Thursday’s close, Amazon reported an earnings beat, but questions

were raised about the outlook for corporate spending on cloud services,

as well as consumer spending within online stores (–0.5% in after-hours

trading).

On the yield discussion I thought this comment from Mark Haefele and team in the same note was bang on, note the bit I’m emphasizing:

In our view, the outlook for Treasury yields will ultimately depend on the

growth trajectory of the US economy. Much of the momentum behind

the rapid increase in Treasury yields has been due to technical factors that

should abate. Notably, the Federal Reserve’s shift from quantitative easing

to quantitative tightening has removed a significant source of buying,

while issuance is trending higher due to the increasing US budget deficit.

However, if this trend were to persist, we would expect action from the

Fed to preserve financial stability by ensuring the proper functioning of the

Treasury market. As a result, we expect economic fundamentals to reassert

themselves. Regardless of whether the landing is ultimately hard or soft, we

think US and global economic activity will slow and inflation will moderate

over the next year—boosting demand for high-quality bonds.

“Proper functioning of the Treasury market” – clock that?

Markets are still adjusting to higher yields. That’s a process and not an event. After fifteen years of financial repression, it’s no surprise the recalibration of mkts to the repricing of money is a lengthy and turbulent procedure

or chaos

The paper of note is this one:

https://www.kansascityfed.org/Jackson%20Hole/documents/9726/JH_Paper_Duffie.pdf

it gets a lot of traffic that piece

oh right our traffic. Lol

But back to the point. Yes, I’ve talked about this on the Blind Spot a number of times already, but it is in my opinion the first step towards normalising the idea of what will soon become U.S. yield curve control under the guise of a Fed “market-function purchase program”.

Got it?

Here’s the key passage:

After investigating these implications, I discuss improvements in Treasury market structure and other measures that could increase the market’s intermediation capacity under stress. These include broader central clearing, all-to-all trade, post-trade transaction reporting, substituting the Supplementary Leverage Ratio rule with higher risk-based capital requirements, and official-sector market-function purchase programs.

It’s worth noting that Sweden’s Riksbank this week announced its intention to provide greater overnight liquidity access to CCPs. (kind of related, as they are having a really tought time at the moment.)

chinese communist parties?

Central Counterparties

But going back to the “market-function purchase program” specifically, Duffie cites a lot of other relevant work to support the argument that sometimes you have to do de facto QE even when rates are supposed to be going up.

And there is a precedent from 2020 as the below Fed paper points out (while admitting this turned in QE):

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3992583

The most striking aspects of the market functioning purchases were their innovativeness

and their unprecedented speed and scale. In terms of speed and scale, the purchases quickly

reached over $100 billion per day and totaled over $2 trillion between March 13 and April 30 alone.

In terms of innovativeness, the Fed varied the pace and distribution of purchases based on

observable measures of market functioning, reflecting the particular motivation for the purchases.

It also adjusted the settlement timing of some MBS operations, allowing market participants to

quickly obtain cash for their MBS sales, reducing funding pressures in the market. The Fed also for

the first time purchased agency commercial mortgage-backed securities (CMBS) to support the

smooth functioning of this important market (Park, Gouny, and Liu, 2020).

There’s also Duffie’s original paper on it all here where he introduces the idea of fiscal buybacks:

https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr1054.pdf?sc_lang=en

Talk about quasi fiscal operating norms being established!

Anyway here he explains why “Market-function purchases” aren’t the same as QE. (Got it, DEFINITELY NOT QE)

nothing like it at all

And:

And here’s how it connects to YCC:

To implement open-market purchase operations, many central banks and fiscal

authorities conduct reverse auctions of a specified total quantity of a given security or

some specified sector of securities. In some jurisdictions, trades are negotiated

bilaterally with dealers. For example, with the ECB’s Pandemic Purchase Program, most

purchases were conducted bilaterally with dealers. In a reverse auction, purchases are

awarded to those bidders offering to sell at the highest yields (lowest prices). This

quantity-based auction approach has been used in the Fed’s Large-Scale Asset Purchase

(LSAP) programs and in its purchases of Treasuries in response to the situation in

March-April 2020. In an alternative price-based approach, a yield is announced and

designated market participants are given the right to sell at that yield. This can be done

on a full-allotment basis, as with “yield curve control,” which is the approach taken in

March 2020 by the Reserve Bank of Australia “to address market dislocations. The

Bank of Japan has conducted yield-curve control on a routine basis.

Which is another way of saying we will buy the securities from the dealers willing to accept the lowest bid first and fill the trade upwards from there. Or, we will announce our target yield  and give everyone the chance to be filled at that rate

Related to the approach of having market-function purchases conducted directly on the fiscal account, a central bank can be indemnified by the fiscal authorities for the associated gains and losses. For example, when the Bank of England purchased gilts to

address severe market disruptions in September 2022,42 it was explicitly indemnified in advance by the UK government for the associated gains and losses, with the stated intent of supporting the independence of the central bank.

Indemnification, however, implies a degree of coordination between the fiscal and monetary authorities that could,

in some jurisdictions, cut against independence of the central bank. In the end, it may be difficult to avoid some degree of coordination. Whether or not indemnification by a

fiscal authority of market-function purchases by the central bank is useful or reliable may vary across jurisdictions. Tucker (2018) writes that “a degree of explicit cooperation and coordination is unavoidable if overall policy is to be coherent,” and

“Suspicions are more readily assuaged if the need for coordination with government has been countenanced and telegraphed in advance.” In some jurisdictions, indemnification related to asset purchases is implicit because profits and losses from central bank operations are remunerated to the fiscal account.”

Sorry for all the block quotes but they’re important for the sake of historical archive!

@helmholtz – yeah i suspect so

Heavy stuff right? But it all comes down to potato potataho type logic. When is QE not QE, and when is a cbank really independent and when is it not? There’s way more i can say about this, but i will leave it for blind spot newsletter. Or maybe do some sort of voice note.

There are at least three other key connected themes that are worth signposting (but which we won’t have time to  go into today). The first is the question of LCLoR and have we reached it yet.

(am i with dario or Izzy here?)

Anyway there’s a good chance we’re approaching it now. And this, by the way, is why Im so obsessed with intraday liquidity and payments gridlocks and the return of Herstatt Risk. You can read about the Fed’s conclusions about what happened here:

https://rocks.wisburg.com/50320d7b-6a64-4758-8137-aa089a340342.pdf

As you can see here, intraday liquidity for managing payments is today a major driver of demand for a Lowest Comfortable Level of Reserves:

Which is a good point to bring in the ECB. Which has arguably been performing “Market-function purchase programs” since at least 2011.

ECB yesterday…  holding borrowing costs at this level for long enough will make a “substantial contribution” to bringing consumer-price gains back to the 2% target.

Christine Lagarde said any discussion of when to cut interest rates is “totally premature.” As we wrote earlier on this week, I don’t think central banks really ever plan to get inflation back down to 2, something around 4% makes more sense in terms of inflating away the debt

but prepping the mkt for this is fraught with peril and misinterpretation and will be the most gradual and painstaking of policy shifts imaginable

That said the argument to lift the target is now becoming very compelling. And it’s not just Jason Furman arguing this anymore.

Mohammed El Erian made a similar point at his book launch a couple of weeks ago, but he also stressed cbankers would be very unkeen to go ahead with it out of fear it looked like a desperate move.

Though what Lagarde also said, which made me raise my eyebrows a lot, when responding to the FT’s Martin Arnold question about central bank losses at the Riksbank:

“As a Eurosystem and as ECB we have one mission which is price stability. We do not have as a purpose to show profits or to cover losses. It will be actually wrong if our decisions were guided by our P&L accounts rather than MP purposes.”

Which i found quite extraordinary. And goes towards all teh jedi mindtricks about how “cbanks are different”

No time for details on that, but check out the latest Blind Spot newsletter as to why i think she’s wrong. And why we are in the domain of quasi fiscal operations and that means greater not lesser coordination with the fiscal authority. As per above.

which explians why the yen is where it is – ie through 150

one outcome of the blowout US GDP number was further dollar strength… with delightful consequences for the top third of Japan’s 30 biggest companies who now reap an extra $10bn in aggregate revs from yen weakness.

 A lot of Japan’s biggest companies are exporters and making hay from yield curve control

or ycc

if i can mix my metaphors

The biggest beneficiary is Toyota, deriving Y45 billion of operating profit for every yen decrement against the dollar

Is Toyota btw still the preferred vehicle for initiating militant insurgencies?

would work on Kabul cable tv

something we’ve been discussing of late…

mead…

only jokingh

has been the relatively phlegmatic approach of global mkts to the execrescence of violence in the ME

i saw this superb piece by Clocktower group

they explain very cogently why

While the Hamas terrorist attack is unprecedented in scale, it pales in comparison to the existential risk that Israel faced from the 1948 Arab-Israel War, the Six-Day War in 1967, and the 1973 Yom Kippur War. As such, the two macro legends running for the hills – Jones and Dalio – have fallen into the trap of trading off of headlines. We would remind both that Israelis and Palestinians have been fighting the same fight for centuries.’

(they’re not right about everything because israel hasn’t existed for centuries)

one thing Clocktower are very good at articulating is how financial markets are totally amoral

they remind investors that they are operating – now – in a multipolar geopolitical environment.

and here is the salient line

geopolitical risk premium is the derivative of actual geopolitical risk.

What that means is that the stabilization of conflict, even if at a high rate of casualties and military conflict, causes geopolitical risk premium embedded in related assets to collapse. The market becomes desensitized to the conflict and moves on.

my emphasis

advertisers will be flocking like swans to associate with that headline

The reality here is that neither Iran nor Hezbollah really care about the fate of Palestinians. If they cared, they would have done something about the plight of Palestinians over the past seventy years

Hamas is hoping that Israeli brutality will lead to widespread protest against governments in the region that have largely ignored the situation in Palestine. While Hamas would love to see such protest in Gulf states and Saudi Arabia, that is highly unlikely to happen given strong government satisfaction in these countries.

Hezbollah and Iran are likely to retaliate directly in one way or another, although Clocktower expect their retaliations to be largely designed for popular consumption at home, not for effect (sort of like Tehran’s reaction to Soleimani’s assassination).

The question for investors, however, is whether any of these would change the balance of power in the Middle East. We suspect the answer is no, for the time being. As such, most geopolitical risk premium is to be faded.

boom in*

I think we are nearly out of time.

Just to say, more on the importance of cbank losses in my newsletter this week. But also, don’t forget to come back on Monday at 1030 am. And do spread the word. these sessions are always best when they’re interactive. And don’t be frightened to push back with comments.

Next monday I’m at a weird conference all day in Greenwich called the ARC forum.

I might send some sneaky pics your way

Tho we live next door to some nuns, so i worry about upsetting them.

so to speak

on that diabolistic note, bon weekend