Crowding Out

Sept 29, 2019 – Weekly
[Note: due to a change in hosting, charts are temporarily not being displayed]

WINSTON: Hey, Ray. Do you remember something in the Bible about the last days, when the dead would rise from the grave?

RAY: I remember Revelation 7:12. And I looked, as he opened the sixth seal, and behold, there was a great earthquake, and the sun became as black as sackcloth. And the moon became as blood.

WINSTON: And the seas boiled and the skies fell.

RAY: Judgment Day.

WINSTON: Judgment Day.

RAY: Every ancient religion has its own myth about the end of the world.

WINSTON: Myth? Ray, has it ever occurred to you that maybe the reason we’ve been so busy lately is because the dead have been rising from the grave? 

-Dialogue from Ghostbusters

When I was a kid, there was a lot of talk about “crowding out”.  No, I am not talking about manspreading.  Crowding out referred to the idea of government getting so large, especially at full employment, that it essentially crowded out the private sector in terms of new investment.  I googled it and there are no recent articles, just a few educational videos and a paper written in 2010.  The short educational video I watched (linked below) uses a cute graph plotting supply and demand for funds, and assumes that increased gov’t demand plus existing private demand shifts the curve upward and to the right, thereby raising rates which increases savings and decreases private consumption.  The Mercatus from 2010 paper cites Keynes in The General Theory:

Government borrowing can crowd out private spending and investment in a number of ways.  Consider first, the most extreme case in which gov’t borrowing has the exact same effect on the economy as gov’t taxation.

Borrowed money must eventually be paid back.  And because of this, some taxpayers may view gov’t borrowing as delayed taxation.  If so, these taxpayers will spend less today to save in anticipation of paying higher taxes in the future.  Accordingly, defcit-fianced spending is equivalent to tax-financed spending: it induces people to spend less and save more.

In many ways this is the Lacy Hunt (Hoisington) philosophy (and I am bastardizing it here), that gov’t spending’s marginal gain to the economy lessens to the point that ultimately, lower inflation and interest rates are the result.  Defunct economist indeed.

I read a couple of papers in the last couple of days, one by John Mauldin and the other by Ben Hunt.  The underlying theme in both is, ‘what if we’re approaching the cusp of a great change in debt dynamics?’  I loosely am referring to it as Judgment Day.  Mauldin calls it the Great Reset.  Strauss and Howe, the Fourth Turning.  Ben Hunt as the Fourth Horseman that can lay waste to financial markets and portfolios: inflation.

Ben Hunt employs a fascinating tool to quantify, or at least capture, the current narrative and its interconnectedness.  It’s AI that scans all Bloomberg articles and plots certain phrases and references in both time and connection.  I can’t do justice to the methodology here, but I will use a powerful example from his latest missive (linked below)

Okay, a bit of a comment. 25 articles talking about the federal budget deficit versus 2,200 talking about inflation over the same 12 month period from the same financial media source. I am not making this up. There is ZERO narrative creation around austerity in the United States. ZERO. And as long as that’s the case, the political dynamic for inflationary debt-be-damned policies is unstoppable.

And it’s here that I will paraphrase Winston Zeddemore from above: “…has it ever occurred to you that the reason we’re so busy is that the gov’t IS crowding out private investment and pressuring rates higher which then requires Fed intervention?” How would we know that if we saw it?  Well, we might see it with something like the recent repo spike.  There is an expanding edifice of government debt that needs to be financed, and sponsorship in the form of foreign central bank buying seems to be dwindling.  Any more clues?  Maybe we see it in the deceleration of Core Capital Goods orders since the 2018 tax bill (far right side of St Lois Fed graph below). Maybe it’s evident from the leading indicator Chemical Activity Barometer (second chart, see footnote** and thank you to Macro Chat member that posted). This, from BBG after Friday’s data:

The durable goods report for August is technically a beat relative to consensus, but the innards of the data suggest further softness in underlying private-sector capital spending intentions in the third quarter. Volatile categories, including defense orders, boosted the top line well above consensus expectations, while core capital goods orders were soft for a second month.

Chemical Activity Barometer

I know that there are a lot of technical and regulatory reasons that repo spiked.  I know that the NY Fed took aggressive action and got the Fed Effective EFFR and SOFR back down to 1.85% by the end of the week. October Fed Fund contract settled exactly at 1.85%, 98.15.  But another Ben Hunt observation is worth mention, and that is, the EFFR is where the Fed SETS a rate and repo is where it TRADES.  Is all financing limitless, as some proponents of MMT seem to imply? Corporate spreads remain tight, but episodes like the WeWork flame-out indicate that there are some limitations on the gullability of capital. Is that why some of the dealmakers took it on the chin Friday? (KKR down  7%, Blackstone down 4.6%).  

Here is where a dollop of the recent political drama seeps in.  Typically, I avoid the flashpoints of political discussion, and carefully avoid triggering so I will try to tread gently here.  The commie leftist sociopaths that want to strip assets from anyone who has worked for them are gaining ground on the religious right xenophobic wingnuts that fear all food besides apple pie. Said another way, what if Biden’s issues have shifted the entire political probability curve to the left?  Now you know, and I know, that debt never has to be re-paid, it simply has to be rolled.  However, what if the shift to the left and more taxation is working as Keynes suspected and is further accentuating the decline in capex?  What if some corporate debt can’t be rolled at favorable rates? 

To avoid the perception that they are losing credibility on funding, the Fed will likely lean much more aggressively towards easy policy.  Like everything else, it’s short term risk/reward vs long term possible distortions.  The strong dollar environment accentuates this bias; DXY is strongest it has been since May 2017.  According to an Inflation Outlook paper by Enduring Intellectual Properties ( ), yoy M2 growth is 5.6%, the highest since July 2017.  This is not the conclusion of Enduring, but I think there’s a risk the Fed may be more successful in manufacturing inflation than it hopes.  If so, and of course, timing is key, the curve should steepen. 

Important data this week includes Mfg ISM and prices which were both quite weak last time at 49.1 and 46.0.  The former is expected to rebound to 50, but no improvement is expected on prices.  Employment report is Friday with NFP also expected to bounce to 145k from 130k last.  YOY earnings +3.2%. 

Fed speakers include Clarida late Thursday on the outlook for the economy, and Powell on Friday afternoon, Perspectives on Maximum Employment and Price Stability.  Quarter end on Monday. 

9/20/2019 9/27/2019 chg
UST 2Y 169.2 162.2 -7.0
UST 5Y 163.0 155.1 -7.9
UST 10Y 174.4 167.5 -6.9
UST 30Y 218.7 212.5 -6.2
GERM 2Y -71.9 -77.0 -5.1
GERM 10Y -52.1 -57.3 -5.2
JPN 30Y 35.3 31.8 -3.5
EURO$ Z9/Z0 -46.0 -50.0 -4.0
EURO$ Z0/Z1 -8.0 -8.0 0.0
EUR 110.19 109.42 -0.77
CRUDE (1st cont) 58.09 55.91 -2.18
SPX 2992.07 2961.79 -30.28
VIX 15.32 17.22 1.90

**ACC’s Chemical Activity Barometer helps anticipate peaks and troughs in the US economy

Posted on September 29, 2019 at 1:50 pm by alexmanzara · Permalink
In: Eurodollar Options

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