Enemy of the State

August 25, 2019 – Weekly Comment

Enemy of the State is an action thriller from 20 years ago (1998) starring Will Smith and Gene Hackman.  Highly entertaining though somewhat formulaic, Robert Clayton Dean (Smith) is a labor attorney who unwittingly receives a disc with evidence that could rock, of course, the highest echelons of power.  At the heart of the film is the issue of government surveillance and the unbridled power of the National Security Agency. Through a connection of Dean’s ex-girlfriend (Lisa Bonet), Brill (Hackman) comes into the picture, a reclusive communications and intelligence expert who exposes the extent of technological surveillance and helps Dean restore his life and bring the film to its contrived (though amusing) conclusion.  It’s one of those movies where you just have to suspend belief and hop on for the joy ride. 

As they say, truth is stranger than fiction, and the end of this week was no exception, encapsulated by this Trump zinger: “…My only question is, who is our bigger enemy, Jay Powell or Chairman Xi?” 

Even the Mooch has been getting in on the action, saying a couple of weeks ago about Trump, “Eventually he turns on everyone and soon it will be you and then the entire country.” 

In today’s world, Enemy of the State and pervasive surveillance could refer to almost anything.  Hong Kong protests.  China/US trade wars.  Credit scores.  Social scores.  Alexa.  Facebook.  Jeffrey Epstein. However, I personally have a hard time throwing Powell into the mix.

In any case, Powell’s Jackson Hole speech on Friday was supposed to be the big economic event of the week.  However, it too, was formulaic, holding to the parameters of the Fed’s dual mandate, full employment and low inflation.  The speech was so bland that markets barely reacted.  The key theme, however, is that the Fed can’t ignore the effects of trade policy on the economy, as referenced in this excerpt:   

…fitting trade policy uncertainty into this framework is a new challenge. Setting trade policy is the business of Congress and the Administration, not that of the Fed. Our assignment is to use monetary policy to foster our statutory goals. In principle, anything that affects the outlook for employment and inflation could also affect the appropriate stance of monetary policy, and that could include uncertainty about trade policy. 

Another core line in the speech is below:

At the end of the day, we cannot prevent people from finding ways to take excessive tweeting financial risks. But we can work to make sure that they bear the costs of their decisions, and that the financial system as a whole continues to function effectively. 

Perhaps trade policies fit into the category of excessive risks.  Obviously, it’s all tied together, because Friday’s incendiary tweets and ratcheting up of tariffs on both sides sent stocks into a tailspin, and last year’s fourth quarter made it patently clear that stocks are all that really matters for Fed policy. Trump’s order to US businesses to move away from China was icing on the cake. [For a good summary of Friday’s tweet and trade action, see Doug Noland’s Credit Bubble Bulletin, linked at bottom].  

Last week I wrote that August 2019 may be looked back upon as a critical month.  Friday August 23, may end up being viewed as a critical day in terms of a shift away from the US a globalist force.  It’s not just Trump’s policies and tweets (“We don’t need China…”) that are turning the US inward.  In a way, the ‘buy Greenland’ ploy is symbolic in terms of making sure raw resources are closer to our shores.  The isolationist theme was reinforced from the outside as well, namely BOE’s Carney speech suggesting that the dollar’s reserve status should be supplanted.  Carney’s argument is that the US is becoming a somewhat smaller percentage of global GDP, and that a relatively strong currency and tighter monetary policy is spilling over into the rest of the world.  He suggested a Synthetic Hegemonic Currency like Facebook’s Libra might be a part of a new international monetary and financial system. 

A key quote is from an interview after the speech with CNBC’s Steve Liesman.  Carney said that the Fed was right to adjust policy tighter as the US economy was improving.  However, he added, “That means the rest of the world policy is tighter than it needs to be, and that feeds back on the US economy in a way that ultimately slows this economy.  And it leads to a substandard outcome.  In a world where you only have limited policy space, it is a dangerous place to be.  So the trade issues we’re talking about are reinforced by the structure of the monetary system.”  Wow.

The combination of the US turn inward, the deterioration of prospects for a US/China deal, and the suggestion that the US dollar should have a lesser role in a new global financial order is not a good sign for the US equity market. Even If Trump tries to walk back Friday’s comments (which he ambiguously did at the G7) the prospects for US financial assets, apart from treasuries, have dimmed. 

It doesn’t help that there is dissension within the Fed itself.  The Dallas Fed’s Kaplan noted that the Fed Funds target is higher than all other rates on the curve (and it certainly didn’t get any better on Friday) and allowed that perhaps the Fed is tighter than thought.  The KC Fed’s Ester George however, said on a Bloomberg interview, “I would judge policy to be at neutral or even accommodative with this last rate cut. If you think about where real rates are relative to the rate of inflation and where the FF rate is, we’re operating close to zero with real rates.  I can’t believe that that is tight in any sense for the economy right now.”  I would note that the Inflation Indexed ten year yield is very close to zero, having gone negative this past week ending at -2.2 bps.

The market is, of course, indicating that the Fed is tight with an inverted curve.  2/10 ended the week just under zero.  On the eurodollar curve, near one-year calendars became more inverted, closing at new lows.  EDU9/EDU0 settled -72.5, down 1 on the week, EDZ9/EDZ0 at -50.5, down 3 on the week and EDH0/EDH1 at -31.0, down 3.5.  Zerohedge ran a piece citing BofA research that the three-month rate one year forward versus the current 3 month rate is the best predictor of forward economic growth.  In other words, the front one-year eurodollar calendar. (And it’s going south).

One year ago on August 20, Atlanta Fed’s Raphael Bostic said, “I pledge to you I will not vote for anything that will knowingly invert the curve and I am hopeful that as we move forward I won’t be faced with that.”  Haven’t heard much from him lately…

Net changes on treasury yields weren’t all that large week over week.  The two year rose 4.9 bps to 1.525%, tens fell 1.6 bps to 1.523% and 30’s rose 1.9 to 2.018%.  However, back eurodollar contracts from EDM21 through the golds posted new contract high settles.  The peak point on the euro$ curve is EDM21 which settled 9881.0 or 1.19% vs last week’s high settle (also on Friday) of 9879.5.  The blue pack (4th year forward) closed the week at 98.72, just 9 bps away from the peak.  Apart from the geopolitical arena, economic data also provided support for the bond rally, as Markit’s US Mfg PMI fell below 50 (49.9) with a Composite of 50.9.

The upcoming week isn’t particularly heavy with respect to economic data, though the second estimate of Q2 GDP is on Thursday and Core PCE prices (expected 1.7% from 1.6% last) is on Friday.  Treasury auctions 2, 5 and 7 year notes. 

8/16/2019 8/23/2019 chg
UST 2Y 147.6 152.5 4.9
UST 5Y 141.2 140.6 -0.6
UST 10Y 153.9 152.3 -1.6
UST 30Y 199.9 201.8 1.9
GERM 2Y -91.1 -89.2 1.9
GERM 10Y -68.5 -67.5 1.0
JPN 30Y 18.4 20.4 2.0
EURO$ Z9/Z0 -47.5 -50.5 -3.0
EURO$ Z0/Z1 -2.5 -5.5 -3.0
EUR 110.95 111.45 0.50
CRUDE (1st cont) 54.81 54.17 -0.64
SPX 2888.68 2847.11 -41.57
VIX 18.47 19.87 1.40



Posted on August 25, 2019 at 3:33 pm by alexmanzara · Permalink
In: Eurodollar Options

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