Jan 10. High Anxiety (weekly)
- High yield, energy markets, EM currencies have been flashing warnings for months. Now spillover into equity markets is creating high anxiety.
- The 2007/08 crisis was US driven but spilled over into the rest of the world. Why is it so hard for US pundits to grasp the importance of China similarly exporting financial instability? Is the US supposed to have a lock in that department? What do you need? A made-in-China frying pan to whack you in the forehead?
- Quick look at US Consumer Credit and Auto Loans.
Stocks tumble/ treasuries see modest bid
Here’s one of the early lessons I acquired the hard way. When you get bearish news and the market rallies, it’s a bull market. After strong non-farms of 292k Friday, treasuries closed on their highs and open interest went up in all contracts. Yes, the wage component was weak. Yes, seasonal adjustments may have been faulty. But in a bear market, NFP alone would have sent TYH hurtling lower. No reason to stand in the way of bullish price action, especially with weak stock markets.
Since lows at the end of last week, red and green Eurodollar contracts rallied over 25 bps; the evaporation of at least one prospective hike. EDH18 for example is up 31 bps from Dec 30 close. One year calendar spreads have collapsed. June’17/June’18, the peak one-year spread, is just 47.5 bps. Less than two hikes….take THAT Fed dots! Red to green Eurodollar pack spread (2nd to 3rd year) new low sub 36 bps!
In terms of US signals, high yield spreads had been blowing out for some time. Energy markets and commodities have been hammered. EM currencies have been pressured. In spite of all these red flags, some people want to place the blame for the stock sell off squarely on December’s Fed hike. “Michael Hartnett at Bank of America Merrill Lynch wrote that a tightening of financial conditions from the Fed often causes market ‘events’.” (Business Insider). Sure, it was another straw, but there were a lot of straws before the last FOMC. It’s my contention that the lagged effect of the end of QE is one of the biggest factors causing markets to adjust to new risk parameters, with China and regulatory changes as contributing agents. (SPX down 6% this week, but Dow Transports down 25% since last March!)
In any event, US manufacturing data have also been giving constant warnings; on display this week with ISM at just 48.2 and Prices Paid 33.5 (lowest since ’09). It’s all as clear as day in the Atlanta Fed GDP Now forecast for Q4, having been over 2.5% in early November and trending steadily lower to 0.8% currently. As Jim Bianco pointed out Friday (with Santelli on CNBC), in October 2009 the unemployment rate was 10% versus the current 5%. However, if the labor force participation rate had held steady, the unemployment rate would currently be 7.6%.
China
Clearly China is overshadowing all else at present. From Reuters: “Policy insiders are now calling for a quick and sharp yuan depreciation, backed by tighter capital controls to curb speculation and the flight of money out of the country.” That seems a likely course of action. The creativity to get money out of China is almost beyond belief. For example, Sovereign Man reported that Chinese are buying website domain names simply to circumvent capital controls.* It reminds me of the Cary Grant movie Charade. Make your wealth as small and transportable as possible; priceless stamps in Charade. Is that why gold is going bid? (By the way, I have a domain same for sale…)
So if all this money is trying to escape, but it’s now devalued and on lock-down, what happens to the assets that the previous flow was supporting? I think we’re seeing a hint of that now. Not pretty. And I think a good part of the decline to more negative levels in swap spreads this week is fear of more Chinese selling of reserves. The mere perception of Chinese authorities acting is enough to cause seismic adjustments.
Still, some people don’t think China is a big enough influence to derail US growth. It is. First, the US is not seeing great growth and second, China is huge. I had seen a million articles about China’s insatiable demand for commodities. Many articles on booming construction projects/ghost cities. This growth has stalled; doesn’t matter if we can’t exactly quantify it. From google, “China has 14 cities of over 5 million people (Shanghai, Beijing, Tianjin, Guangzhou, Shenzhen, Dongguan, Taipei, Chengdu, Hong Kong, Nanjing, Wuhan, Shenyang, Hangzhou, and Chongqing), whereas the USA has 8.”
So what happens going forward? If China clamps down further on capital flight, then global asset markets will likely suffer. What response from the Fed, ECB and BoJ? The Fed will abandon all pretense of trying to further remove accommodation. With the added instability of equity market weakness combined with refugee issues, tensions across borders in the EU will increase. Trade will suffer. Japan is toast. Earlier QE efforts there have run their course; anything new will be muted by the great wall of Chinese devaluation. Hopefully, the US administration will do what it can to ramp up fiscal stimulus. In an election year there is great incentive to do so, but also great obstacles.
Quick note on Auto Sales and Consumer Credit
As shown on the chart below, auto sales have been a bright spot in the US economy. My guess is that auto sales have peaked and are in for declines in terms of units sold. Outstanding auto loans are over $1T and the auto industry is about 3.5% of the US economy. The following data are from the Consumer Credit report: Avg amount financed in 2010, $25477. In 2014 $26288. Latest (Sept 2015) $27698, which is 5.3% higher than 2014. However, new car loan rates have come down from 6.28% in 2010 to 4.25% in 2014/15 for a 60 month loan. Consumers finance more for longer. Also, cash for clunkers was in 2009. So five years (60 months) later, we’ve probably seen the replacement spike. And auto financing isn’t likely to be quite as generous going forward.
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