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    In a trend observed every day this week, S&P futures are slightly in the red ahead of a post-open ramp with the VIX rising to 9.91, as Asian shares climb, European stocks are little changed. WTI crude pares recent gains, slipping below $51 after API showed an unexpected crude build. Earnings season launches with bank earnings reports from JPMorgan and Citigroup, while Economic data include PPI figures, jobless claims.

    As Reuters notes, broader investor risk sentiment has improved this week after Catalonia dialed back plans to break away from Spain, with MSCI’s 47-country world stocks index reaching a record high. Global equities now appear to be taking geopolitical developments such as the secessionist push in Spain and tensions on the Korean peninsula in their stride, to reach those record tops.

    Analysts will be keeping a close eye on banks Q3 reports: Trading probably dropped from the same period a year earlier. Executives from JPMorgan, Citigroup and Bank of America Corp. told investors last month to expect declines ranging from 15 percent to 20 percent. Goldman Sachs Group Inc., coming off its worst first half for the trading business in more than a decade, said the third quarter remained challenging. Subdued volatility, especially compared with the turmoil from Brexit and the U.S. election a year earlier -- made the period particularly tough.

    The Bloomberg Dollar Spot Index held a four-day decline as buying interest remained low after some Federal Reserve policy makers expressed concern in the account of the latest FOMC meeting that weak inflationary pressures are more than just transitory.  The minutes of the FOMC’s Sept. 19-20 meeting were interpreted as dovish, posing risks to the path of interest rate rises investors price in for 2018 onward should inflation be weaker than targeted. The importance of U.S. CPI growth data due Friday is highlighted by overnight volatility in euro-dollar, which hit a more than two-week high, surpassing the levels seen ahead of U.S. payrolls last week, although it was unable to hold on to gains and fizzled to session lows after the European open.

    Asian stocks advanced for a 5th day, sending the regional benchmark to a fresh 10-year high on Thursday, after minutes of the latest U.S. Federal Reserve meeting boosted optimism that rate increases in the world’s biggest economy will remain gradual, while the dollar sagged after the Federal Reserve showed a more guarded view towards inflation.  The MSCI Asia Pacific Index rose 0.5 percent to 165.80 as of 4:40 p.m. in Hong Kong, heading for the highest close since November 2007. As Bloomberg reports, SoftBank was the second-biggest contributor to the regional gauge’s advance as Japan’s Topix also added to decade-long highs.

    The Fed minutes released Wednesday showed officials debated hard last month over whether forces holding inflation down were persistent or temporary, with several policy makers looking for stronger evidence of price gains before supporting a third interest-rate increase this year.

    “We expect that only a further unanticipated decline in inflationary pressures would prevent the Fed from moving in December,” said David Sloan, senior economist at Roubini Global Economics. “Looking further ahead, however, inflation is likely to need to show some improvement if three more rate hikes are to be delivered in 2018.”

    “The Fed minutes signify the U.S. economy is on a recovery path and that succeeding rate increases will not be sharp," easing concerns of market shocks, said Lexter Azurin, analyst at Manila-based AB Capital Securities. “An improving U.S. economy is taken positively by market for its big role in the global economy."

    European equities kicked off the session on a relatively tame footing with very little seen in the way of direction. In terms of sector specific performance, things are also relatively contained with some very modest underperformance seen in financial names in the wake of yesterday’s slightly more dovish than anticipated FOMC minutes release. Individual movers include Deutsche Lufthansa (+2.6%) amid expectations the Co. will purchase 81 planes from Air Berlin and retain 3k of their staff, with easyJet (+2.2%) supported by a pre-market broker move. ECB's Praet said deflation risks have disappeared, but that Euro area inflation remains subdued and that sustained inflation adjustment will guide QE exit. Praet added that a substantial amount of stimulus is still required and that ECB should communicate more on reinvestment policy

    In the U.K., sterling rose for a fourth day even as the fifth round of Brexit negotiations draws to a close with seemingly little progress. The U.K.’s chief negotiator David Davis and his EU counterpart Michel Barnier are due to brief reporters before noon in Brussels. Brexit negotiations are at a virtual political standstill, with no notable advances made in the fifth round of negotiations, according to several diplomats briefed on the discussions, the FT reported.

    Overnight, President Trump stated we cannot allow North Korea situation go on. The President also commented on his tax plan, saying that he is looking at around 10% repatriation tax rate and vowing to lower corporate taxes to a maximum 20% from 35% and above, also pledges to cut small business tax marginal rate by 40%.

    Treasury yields dropped as the market looks to inflation data out of the U.S. due Friday.

    Gold continued its rally to climb above its 21-DMA, rising 0.2% to $1,294.66 an ounce, the highest in more than two weeks. West Texas Intermediate crude declined 0.7 percent to $50.93 a barrel.

    Bulletin Headline summary from RanSquawk

    • Greenback sees a marginal recovery as DXY finds support at 92.80
    • European equities trade subdued, failing to follow Asia and the US, likely hampered by the bullish EUR and lack of newsflow
    • Looking ahead, highlights include weekly jobs data, US PPI, DoEs and a slew of central bank speakers

    Market Snapshot

    • S&P 500 futures down 0.2% to 2,548.80
    • VIX Index up 0.6%, at 9.91
    • STOXX Europe 600 up 0.06% to 390.40
    • MSCI Asia up 0.5% to 165.79
    • MSCI Asia ex Japan up 0.6% to 548.24
    • Nikkei up 0.4% to 20,954.72
    • Topix up 0.2% to 1,700.13
    • Hang Seng Index up 0.2% to 28,459.03
    • Shanghai Composite down 0.06% to 3,386.10
    • Sensex up 0.5% to 31,991.46
    • Australia S&P/ASX 200 up 0.4% to 5,794.47
    • Kospi up 0.7% to 2,474.76
    • German 10Y yield fell 1.4 bps to 0.449%
    • Euro up 0.03% to $1.1862
    • Italian 10Y yield rose 5.9 bps to 1.892%
    • Spanish 10Y yield rose 0.7 bps to 1.645%
    • Brent Futures down 0.5% to $56.65/bbl
    • Gold spot up 0.4% to $1,296.56
    • U.S. Dollar Index down 0.09% to 92.93

    Top Overnight News from Bloomberg

    • Republican lawmakers from high-tax states are set to meet with House Majority Leader Kevin McCarthy and Ways and Means Chairman Kevin Brady Thursday to discuss GOP proposals to end the state and local tax deduction
    • U.S. and Turkish officials will meet in the coming days to try to defuse a diplomatic crisis over Turkey’s arrest of some U.S. citizens and local consular workers, Turkey’s Deputy Prime Minister Bekir Bozdag said
    • Fed’s Bostic said that with a relatively strong and improving labor market and stable inflation expectations, “I am looking for inflation to drift up to 2 percent over the next year or so”
    • Kevin Warsh has emerged as the leading candidate to run the Federal Reserve next year, jumping ahead of current Chair Janet Yellen, according to a Bloomberg survey of economists Oct. 6–11; Jerome Powell, until now seen as a long-shot, vaulted into a tie for second with Yellen in the poll
    • Germany wants the European Union to be prepared to grant U.K. financial companies transitional access to the EU if the Brexit process drags on, according to a government strategy document
    • Global oil supply and demand estimates for 2018 indicate that inventories may not fall further, potentially capping prices, following a projected drop in stocks this year, the International Energy Agency said in its monthly report
    • Trading Revenue in Focus at JPMorgan, Citi; Warsh Favored as Next Fed Chair; Trump on Iran, Tax and Health Care
    • President Donald Trump said his tax plan would simplify the tax code and save money for millions of U.S. businesses and families as he campaigns against criticism the proposal is a giveaway to the rich
    • U.S. central bankers are looking for clues that underlying strength in the economy will underwrite their plans to raise interest rates for a third time this year, a record of their meeting last month showed, as officials wrestled with why inflation remains so low
    • Comcast Corp., 3M Co. and Wal- Mart Stores Inc. are among the companies buying back bonds now in transactions that could save them millions of dollars if the latest proposed tax changes from the Trump administration and Congress end up becoming law
    • Prime Minister Mariano Rajoy gave his Catalan antagonist Carles Puigdemont five days to clarify whether he has declared independence from Spain or not as the country prepared for its national holiday on Thursday
    • Passive investments, already eating away at active managers’ assets, are getting another boost from MiFID and two other new rules
      Trump Is Said to Demand Tax-Break Change to Protect Middle Class
    • Brexit Talks Edge Backward as U.K. Prepares for the Worst
    • Proxy War Over Iran Nuclear Agreement Divides U.S., Europe at UN
    • BMW Said to Make Mini Brand Outside Europe in New China Tie-Up
    • China Sept. Auto Sales Rise 3.3% Y/y: CAAM
    • Bitcoin Strengthens Above $5,000 for the First Time

    Asian equity markets traded mostly positive after another set of fresh record levels for all major indices in US, where focus was on the FOMC minutes which suggested concerns over weak inflation. The positive momentum helped Nikkei 225 (+0.35%) extend on its highest levels in over 2 decades and test the 21,000 level, while ASX 200 (+0.40%) was somewhat muted as weakness in miners capped upside. Elsewhere, Hang Seng (+0.24%) and Shanghai Comp. (-0.06%) were mixed with underperformance in the mainland after another lacklustre PBoC liquidity operation which led to a net daily drain of  CNY 40bln. 10yr JGBs were relatively flat as demand lacked amid a mostly positive risk tone and reserved BoJ Rinban announcement for JPY 710bln of JGBs in the belly to the super-long end. PBoC injected CNY 20bln via 7-day reverse repos for a net daily drain of CNY 40bln.

    Top Asian News

    • Hong Kong Slaps Banker With Ban for Mobile Phone, WeChat Use
    • Sri Lanka Makes Arrests in $60 Million Taiwanese Bank Cyberheist
    • Japan Stocks Set Fresh Highs Amid Optimism of Abe Election Win

    European equities have kicked off the session on a relatively tame footing with very little seen in the way of direction. In terms of sector specific performance, things are also relatively contained with some very modest underperformance seen in financial names in the wake of yesterday’s slightly more dovish than anticipated FOMC minutes release. Individual movers include Deutsche Lufthansa (+2.6%) amid expectations the Co. will purchase 81 planes from Air Berlin and retain 3k of their staff, with easyJet (+2.2%) supported by a pre-market broker move. A firmer tone overall, with Bunds leading the way after an initial blip to set a fresh high for the week so far, but then running into selling above 161.50 (albeit with relatively tight stops). Some caution evident ahead of 30 year US long bond issuance, while  BTPs also pared best gains ahead of Italy’s multi-tranche offering. However, EZ peripheral debt still marginally outperforming on dovish ECB comments (Praet) and a brief period of calm on the Catalonia-Spain front. Contrasting fortunes for Italy’s BTP issuance, with the top end of the range raised, but yields mixed and covers not that liberal overall – hence, the 10 year benchmark yield showing little net change since the results, but still a tad softer on the day around 2.144%. If anything, the cost of borrowing reflects modest curve flattening, and note that this is the first tap of the long dated 30 year maturity that was launched via syndication.

    Top European News

    • Italy Bank Bulls Say Bad Loan Panic Overdone as Stocks Slide
    • European Refiners Hardest Hit If Kurdish Oil Disrupted, IEA Says
    • Serco Is Said to Be Among Bidders for Carillion Health Unit
    • Event-Driven Hedge Fund Melqart Plans to Stop Taking New Money
    • Tallinna Sadam Eyes Passenger Growth, Nordic Cargo Ahead of IPO

    In FX markets, the USD has regained some ground against its major counterparts that was seen in the wake of the aforementioned FOMC minutes with ranges overall relatively tight. This is likely as a by-product of a quiet European calendar and macro newsflow with a bulk of today’s releases and speakers not due until the latter half of the session. SEK has seen some weakness early doors with Swedish inflation metrics all falling short of expectations and subsequently providing the Riksbank with further ammo to stand pat on existing policy despite recent calls from the market to reconsider their  approach. In option activity, 2bln worth of expiries loom in EUR/USD between 1.1790 – 1.1805 with another 7.5bln worth of expiries between 112.00 and 113.05 in USD/JPY. AUD benefited from stronger than expected Home Loans data, printing 1.0% vs. Exp. 0.5%. EUR/AUD ran into key levels ahead of  the data, rejecting June’s high around the 1.5224 area.

    In commodities, WTI and Brent crude futures continue to remain in close proximity to their post-API lows with the latest report revealing a surprise 3.1mln bbl build and subsequently pushing WTI back below USD 51/bbl. This morning’s IEA release has done little to instigate price action with key findings including expectations that OPEC will maintain output steady around current levels and their measure of compliance standing at 88%. Gold prices have remained supported by the broadly softer USD while copper was flat overnight and held onto recent advances amid a mostly positive global risk tone during Asia-Pac trade.

    US Event Calendar

    • 8:30am: PPI Final Demand MoM, est. 0.4%, prior 0.2%; Ex Food and Energy MoM, est. 0.2%, prior 0.1%; Ex Food, Energy, Trade MoM, est. 0.2%, prior 0.2%
      • 8:30am: PPI Final Demand YoY, est. 2.6%, prior 2.4%; Ex Food and Energy YoY, est. 2.0%, prior 2.0%; Ex Food, Energy, Trade YoY, prior 1.9%
    • 8:30am: Initial Jobless Claims, est. 250,000, prior 260,000; Continuing Claims, est. 1.93m, prior 1.94m
    • 9:45am: Bloomberg Consumer Comfort, prior 49.9

    DB's Jim Reid concludes the overnight wrap

    Markets should be wide awake over the next 30 hours or so as we have US bank earnings kicking off Q3 reporting (JPM and Citi today), PPI today, US retail sales tomorrow and then possibly the data  highlight of the month at the moment,  namely US CPI. Before all that, the Fed kickstarted the second half of the week with their minutes last night where there was a clear debate on inflation but the tone - coupled with the two Fed speakers - was perhaps a bit more dovish than market expectations with UST 10y down 1.3bp. The odds of a December rate hike is c77% (per Bloomberg) though and not much changed.

    In the details, the minutes noted “many participants expressed concerns that the low inflation this year might reflect not only transitory factors…” and that several policy makers said their decision on whether to raise rates this year “would depend on whether the economic data in the coming months increased their confidence” that inflation is on track to reach the Fed’s target. Further, “it was noted that some patience in removing policy accommodation while assessing trends in inflation was warranted”. Elsewhere, some participants were more worried about upside risks to inflation arising from “a labour market that had already reached full employment and was projected to tighten further”. Notably, many participants continued to believe that labour market pressure would show through to higher inflation eventually.

    Onto the Fedspeak. The more dovish Fed Evans said “it’s too early” to make a call on a December rate hike and that “I really don’t see any harm in waiting longer just to take more stock of the inflation situation”. Further, he added that while price pressure should emerge from a stronger labour market, “it might take something like 3.5% unemployment rate before you really see inflation pick up”. Elsewhere, the Fed’s Williams said that with the unemployment rate now down to 4.2% in September, the Fed had “not only reached the full employment mark, we’ve exceeded it”. He expects the unemployment rate to fall below 4% and remains optimistic that core PCE inflation should rise to 2% “over the next couple of years”.

    Staying on the inflation debate, DB’s US economics yesterday published a note looking at demographics and inflation and find that aging has in fact been positive for US inflation in recent decades and that population aging should continue to act as a tailwind for inflation in the years ahead. Most people assume ageing is deflationary. I disagreed with that in last year’s long-term study and this report looks at the theme in much more detail. For more details, refer to Link. Also worth noting that Sweden’s September inflation reading (0.4% mom; 2.4% yoy expected) is due today and as George Saravelos reminded  us yesterday it's interesting as they the only G10 economy to see core inflation hit its target over the last few months. Although the Riksbank has previously said they are not fully convinced with the recent upside surprises and don't see the price pressures as sufficiently broad based enough to be too concerned.

    Over to Catalonia, Spain’s PM Rajoy has given the Catalan President Puigdemont until next Monday (10am local time) to formally clarify whether he has declared independence or not. The formal request for clarity is a necessary step if PM Rajoy decides to trigger legal procedures (Article 155 of  the constitution) which could lead to the suspension of the Catalan Government. PM Rajoy noted “if Mr Puigdemont makes clear his wish to respect the law and return institutions to normality, he would end a period of uncertainty and rupture” and that he “just needs to say he didn’t declare independence”. Spanish markets responded positively, with IBEX up 1.34% and 10y yields down 5.8bp. The spread between Bunds and Spain has now narrowed to 116bp (-15bp than 7 days ago).

    Staying with politics, the Italian government has won two of three confidence votes to pass a new electoral law, which could potentially penalise the 5-Star Movement party (5SM). A final confidence vote will be held today before the bill goes to the upper house senate later on where the government apparently has no clear majority. As a reminder, the new voting system allows 36% of lawmakers elected on a first-past-the-post basis and 64% via proportional representation. This development coupled with the latest over in Spain may have assisted the Italian markets too, with the FTSE MIB up 0.97% and 10y bond yields down 2.7bp yesterday.

    Turning to the US 3Q reporting season which has kicked off this week. DB’s Chief asset allocation strategist Binky Chadha noted that the bottom up consensus expects 2.9% EPS growth yoy in 3Q, but adjusting for a typical beat (+3.4%) this suggests growth more like 6.3%, although still down from the 12.2% in 2Q, partly driven by the hurricanes. Across sectors, median growth is expected to be stronger for the cyclical sectors, led by Energy (67%), Tech (12%) and the Industrials (11%), with Financials (+8%) in the middle and then lowest for several defensives sectors like Telecoms (-1%), Utilities (+1%) and  Staples (+4%). Link Elsewhere, JP Morgan (3Q adj. EPS $1.65ps consensus; +19% yoy, +4% qoq) and Citi’s (3Q adj. EP $1.32ps consensus; +14% yoy, +9% qoq) 3Q results will be out later today, with expected themes likely to be slowing loan growth, sound credit quality and weaker trading income. Notably, the latter has been well flagged by management, with Citigroup and JP Morgan previously suggesting trading income could decline c15% and c20% yoy respectively.

    This morning in Asia, markets are building on the positive US lead and are trading higher as we type. The Nikkei is up 0.42% back around 21-year highs. The Kospi (+0.46%), Hang Seng (+0.26%) and ASX 200 (+0.29%) are all slightly up. Quickly recapping other markets performance from yesterday. US equities nudged higher to another fresh record high, with the S&P and Dow both up 0.18% while the Nasdaq rose 0.25%. Within the S&P, modest gains in the real estate (+0.54%) and utilities sectors were partly offset by losses by telco and financial names. In Europe, excluding the Spanish (+1.34%) and Italian (+0.97%) markets, other indices were little changed (Stoxx 600 flat; DAX +0.17%; FTSE -0.06%).

    Over in government bonds, core European bond yields rose modestly while peripherals outperformed. Bunds (10y +2bp), Gilts (+1.7bp) and OATs (+1.4bp) rose modestly while peripherals such as Spain (-5.8bp), Portugal (-5.2bp) and Italy (-2.7bp) all outperformed. At the 2y part of the curve, core bond yields were little changed, with Bunds broadly flat but Gilts rose 2bp.

    Turning to currencies, the US dollar index weakened 0.29%, while Sterling and the Euro gained 0.15% and 0.43% respectively, with the latter partly assisted by the Spanish developments. In commodities, WTI oil rose 0.75% following OPEC raising its demand forecasts for next year, but some of those gains are being reversed this morning following a surprise increase in US crude inventories. Elsewhere, precious metals were marginally higher (Gold +0.29%; Silver +0.31%) while other base metals were mixed, but little changed (Copper +1.82%; Zinc -0.96%; Aluminium -0.37%).

    Away from the markets, the ECB board member Peter Praet reiterated “a very substantial degree of monetary accommodation is still needed” and “in the next few weeks, the governing council will again  assess….its package of measures…and will recalibrate its instruments accordingly”. On the calibration of QE, the ECB’s Smet sounded a bit dovish, noting “given that we still need more confidence on inflation….” and “when there is more uncertainty, you would probably see more merits from a higher (pace of purchases)”. Earlier in the day, Bloomberg noted that according to Euro-area central bank  officials, policy makers are expected to preserve their pledge to not raise interest rates until “well past” the end of bond buying. We shall find out more in the next ECB meeting on 26th October.

    Over in the US, President Trump spoke in Pennsylvania to rally support for his tax reform. He provided more details on how the plans could benefit middle class families, claiming it will eventually translate   into a “$4,000 pay raise for an ordinary worker”, albeit over an eight year timeframe (as per Trump’s economic advisers). For Congress, Trump noted “all I can say is, you better get it (tax plans) passed”. Elsewhere, Trump will reportedly meet with one of the Fed Chair candidates (John Taylor – Stanford Uni. Economist) this week, while Politico reported that Treasury Secretary Mnuchin has privately recommended Fed Governor Powell to Trump. Either way, it sounds like we may have a winner pretty soon.

    Turning to Japan, a series of larger opinion polls suggest PM Abe could secure a two third majority in the election on the 22nd October. Kyodo news polled 90k people on 10-11 October and estimated Abe’s LDP party and his coalition partner could win a total 319 seats (out of 465). Elsewhere, the Asahi and Nikkei newspaper predicted the coalition could win c300 seats (c65%). The Kyodo polls estimates Governor Koike’s new Party of Hope could win 60 seats (c13%).

    Finally, turning back to Brexit. While the EU and UK are reportedly closer on issues such as citizens’ rights, the actual Brexit talks are still  likely in stalemate with a key issue being the potential financial obligations UK owes to the EU bloc. Chancellor Hammond said “we have to be prepared for a no deal scenario unless or until we have clear evidence that is not where we will end up”. When pressed further, he indicated that he would start investing money (for plan B contingency plans) as soon as January if progress hasn’t been made in the  talks.

    Before we take a look at today’s calendar, we wrap up with other data releases from yesterday. In the US, the August JOLTS job openings was lower than consensus at 6.08m (vs. 6.13m expected) as well as last month’s record level of 6.14m. The quits rate edged down 0.1pts to 2.1%. Elsewhere, the weekly MBA mortgage applications fell 2.1% (vs. -0.4% previous), but the 4-week average still rose 4.4% yoy. Over in Spain, the final reading for September inflation was broadly unchanged at 0.6% mom and 1.8% yoy (vs. 1.9% expected).

    Looking at the day ahead, in France we’ll receive the final September CPI revisions, while Eurozone’s August IP will be out (0.6% mom; 2.6% yoy expected). The BoE will also release the latest credit conditions and bank liabilities surveys mid-morning. In the US, the big focus will be on the September PPI report (0.2% mom; 2% yoy expected for core), while the latest weekly initial jobless claims will also be released. Onto other events, today is a busy day for speakers with the ECB’s Draghi and Fed’s Brainard due to take part in a monetary policy panel in the afternoon, while the Fed’s Powell will speak shortly after at a conference in Washington. President Trump is also tentatively scheduled to give a speech on US policy towards Iran. Earnings season also gains some early momentum with JP Morgan and Citi scheduled to report.


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    Hurricane Irma wiped out nearly 50% of Florida’s iconic orange crop when it buffeted the state with 160 mph winds and a massive storm surge last month, sending orange concentrate futures rocketing higher and stoking speculation that the state’s embattled orange growers – already struggling to fend off a worsening “greening” epidemic that’s constrained production over the past decade – might never recover.


    And in a development that confirmed traders fears that this year’s crop could be the smallest in decades, which in turn increases the likelihood that prices will remain elevated for the time being (no doubt conferring some small boost to headline CPI), Bloomberg is reporting that the state’s 2017 orange crop was its smallest since 1942, with 31 million boxes harvested.

    Oranges are also grown in California, but the drop in Florida orange stocks was largely responsible for the smallest national yield since 1964. In the season that ended Sept. 30, orange output was 68.7 million boxes, according to US Department of Agriculture data. The record low was 4 million boxes in 1918. The data go back to 1913.

    While it ultimately bypassed the state, Hurricane Katia terrified farmers and traders when it briefly appeared set to deliver the second devastating blow to the industry in two weeks.


     
    When it tore through the state in September, Irma caused an estimated $2.5 billion in damage to the state’s agriculture, the Florida Department of Agriculture and Consumer Services said on Oct. 4. Preliminary estimates showed $760.8 million in damage to the citrus industry.

    But more importantly, if CPI climbs in the coming months, will Janet Yellen (or maybe her successor) credit the oranges, like she once blamed falling prices for cellphone data plans for a "transitory" decline?


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    Many years ago, when it was still unclear who would replace then outgoing Fed chair Ben Bernanke, Zero Hedge endorsed John Taylor for the role of Fed chair: a futile endorsement as it had no chance of ever coming true due to Taylor's famous and long-running feud with the Fed over what the true Fed Funds rate should be, and the various pro forma adjustments the Fed imposed upon Taylor's own "Taylor Rule."

    Well, maybe not, because with the market convinced that the next Fed chair will be either hawk Kevin Warsh or dove Jay Powell, moments ago the WSJ reported that, out of the blue, President Trump also interviewed the iconic Stanford University economist, the namesake of the eponymous Taylor Rule, on Wednesday to discuss his potential nomination to become Federal Reserve chairman.  Citing a White House official, the WSJ reported that Treasury Secretary Steven Mnuchin and Vice President Mike Pence also attended the meeting.

    The news is surprising, and may have been the catalyst for the market's poor close, as Taylor has been a frequent critic of Fed policy in the years since the crisis, arguing that officials should have raised interest rates sooner and testifying on Capitol Hill on the benefits of following a mathematical formula to help guide interest-rate decisions.

    Mr. Taylor—the namesake for the most well-known monetary policy rule, the Taylor Rule—has said the Fed’s unconventional, discretionary policies were ineffective.

    “Economic growth came in consistently below what the Fed forecast and much weaker than in earlier recoveries from deep recessions,” he said in a Wall Street Journal op-ed in December 2016. “Such policies discourage lending by squeezing margins, widen disparities in income distribution, adversely affect savers and increase the volatility of the dollar.”

    The WSJ report means that - to the chagrin of all bubble lovers - John Taylor is now officially one of the handful of candidates under consideration for the job, together with Warsh, Powell all of whom Trump met with late last month. Fed Chairwoman Janet Yellen, whose term as Fed chief expires in early February, is also among a list of final contenders for the job, according to people familiar with the matter.

    “There is still ongoing interviews,” White House Chief of Staff John Kelly told reporters Thursday about the search for a Fed leader. “All of the people that have been in to interview have been really first-round draft choices, and we have more to come.” Trump said in late September he wanted to announce a decision on the Fed chairman job within three weeks.

    Still, we doubt that a president who is surrounded by ex-Goldmanites all day, every day, will be so brash as to promote the one candidate whose policies will have the most adverse impact on Goldman Sachs, and online betting odds confirm this: as of moments ago, after the WSJ news broke, Taylor is thrd in the rankings with a 19% chance, behind Warsh with 27% and Mnuchin's personal favorite, Powell, in top spot by a vast margin, at 46%.


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    Core CPI has now been below the Fed's 2% mandate for 6 straight months, printing a 1.7% YoY gain in September (weaker than the expected 1.8% rise).

     

    Headline CPI bounced back above 2% however, led by a 6.1% surge in Energy costs...

     

    The index for all items less food and energy increased 0.1 percent in September following a 0.2-percent rise in August.

    The shelter index rose 0.3 percent in September following a 0.5-percent increase in August. The indexes for rent and owners' equivalent rent both rose 0.2 percent, while the index for lodging away from home increased 1.5 percent.

    This is the lowest shelter inflation since April 2016...

    The motor vehicle insurance index rose 0.5 percent in September; it has declined only once in the last 23 months.

    The education index increased 0.3 percent, and the index for recreation rose 0.2 percent.

    The indexes for alcoholic beverages, personal care, and tobacco also increased in September.

    The index for new vehicles, which was unchanged in August, fell 0.4 percent in September.

    The index for household furnishings and operations declined 0.3 percent, and the index for used cars and trucks continued to fall, declining 0.2 percent. The medical care index fell slightly in September, declining 0.1 percent as declines in the indexes for prescription and nonprescription drugs outweighed increases in medical care service indexes. The apparel index declined 0.1 percent in September.

    Finally, Dear Janet Yellen - The index for wireless telephone services rose 0.4 percent in September, ending a streak of 14 consecutive declines.


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    While we will have much more to share from the latest weekend letter by One River's Eric Peters shortly, we found the following section on inflation vs asset bubbles - a topic which BofA's Michael Hartnett has been focusing extensively on in the past year and which serves as the basis for the "Icarus Rally" - particularly notable as it explains all of today's comments from Janet Yellen and other central bankers, discussing why it is only a matter of time before inflation returns, as the alternative, as Peters' explains, is a world in which yields simply refuse to go up, leading to a nightmare scenario for the next Fed chair, who will be forced to pop the world's biggest asset bubble.

    Excerpted from the latest weekend notes by One River CIO, Eric Peters:

    “Why are we not experiencing deflation?” he asked. “How can the top five stocks in the Nasdaq reduce US GDP but we feel better off?” he asked. “Why are Americans buying no more cars today than in 1978 when our population is 100mm higher?” he asked. “Why compare today to a world of combustion engines when we have so many more interesting things to do without moving an inch?” he asked.

     

    “And why do central banks create endless bubbles to restore an inflation rate from that ancient time?” he asked. “Why is that not the right question?” 

     

    “Global profits are rising, unemployment is falling, growth is up, wages too,” said the strategist.

     

    Yet bond yields seem unable to jump.” US 10yr bond yields are 2.27%, Germany 0.40%, Japan 0.05%. “The cyclical surprise is that the Phillips curve finally kicks in, just as everyone gives in.” US unemployment is 4.2%, a 17yr low. Germany 3.6%, a 37yr low. Japan 2.8%, a 23yr low. “And the biggest structural surprise is that technology has rendered wage inflation a phenomenon for the history books.” 

     

    “But if we don’t see a sustained cyclical jump in wages, then yields won’t go up. And if yields don’t go up, then the asset price ascent will accelerate,” continued the strategist. “Which will lead us into a 2018 that looks like what we had expected out of 2017; a war against inequality, a battle for Main Street at the expense of Wall Street, an Occupy Silicon Valley movement.”

     

    He paused, flipping through his calendar. "Then you’ll have this nightmare for the next Federal Reserve chief, because they’ll have to pop a bubble.”


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    On the heels of San Franciso Fed Governor John Williams' warning  that The Fed "doesn't want there to be excesses in financial markets... "Janet Yellen has reiterated her concerns that markets are a bit toppy...

    Market valuations “are at high level in historical terms” when assessed on metrics akin to price-earnings ratios,warned Fed Chair Janet Yellen in response to a question on an IMF panel in Washington, but was careful to add that "overall financial stability risks in the U.S. remain moderate."

     

    "Prospects for U.S. fiscal stimulus have buoyed sentiment but not yet had much impact on spending or investment," she said.

     

    Broader financial stability risks depend on more than just asset prices and it may also be important just why asset valuations are high. So one factor that clearly comes into play is an environment of low interest rates and central bankers like many market participants have been adjusting our notions of what” interest rates are likely to be in the longer term.

    So - to sum up - The Fed doesn't want excesses... Yellen thinks stock valuations are stretched... but don't worry coz rates are low (although we are dedicated to raising them) and financial stability (despite record high corporate leverage and record low spreads) is not a problem.

    Well... The market has almost never been this expensive...

    As Peter Boockvar warns: "Almost there. S&P 500 price to sales ratio is just 4% from March 2000 peak."

    Additionally, Draghi and Kuroda were also said they saw little evidence of frothiness in markets.

    Others in Washington were less sanguine...

    The market “feels as benign in 2017 as it felt in 2006,” said Jes Staley, the chief executive of Barclays Plc, referencing the eve of the crisis.

    Yellen also added in a subtle jab at Trump that while prospects for U.S. fiscal stimulus have buoyed sentiment but not yet had much impact on spending or investment...

    "It is a source of uncertainty," Yellen says of fiscal policy changes, "we've taken," as many households have, "a kind of wait-and-see attitude."

    Of course, The Fed head being worried about stock valuations is a nothing-burger for the mainstream.

    Since Janet Yellen's first warning in July 2014: "Equity market valuations appear stretched"

    • S&P +29%
    • Nasdaq +53%
    • DOW +33%

    So did Janet just give the market a reverse-psychology BTFD signal? If she did, not everyone's buying it...

    Swiss Finance Minister Ueli Maurer said in an interview with Swiss newspaper SonntagsBlick that:

    "the only question regarding next crisis is 'when and where', not 'if'..."

    And finally Mexico's central bank governor Agustin Carstens said Sunday on a panel in Washington, where he participated in IMF meetings that some emerging-market assets may be priced too richly and governments need to prepare for contingencies...

    A search for yield has dominated asset allocation for too long, and some severe problems could emerge when portfolios are re-balanced, Carstens says.

     

    A lack of liquidity can cause severe reactions in some emerging markets, he says.

    He's got a point!


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    World stocks and commodities rose on Monday, boosted by upbeat Chinese data, while U.S. oil futures jumped to a near six-month high as escalating tensions between the Iraqi government and Kurdish forces threatened supply.  Global markets digested the large amount of weekend newsflow, and clearly liked what they saw as S&P futures were modestly in the green, as both European and Asian stocks are higher.

    The USD is marginally stronger after Yellen’s comments suggest the Fed may look through weak inflation. Still, for those who missed this weekend financial elite extravaganza, Yellen stated that new normal will be lower interest rates than seen historically and that inflation has been largest surprise for the US economy this year. Yellen added that gradual hikes in fed funds rate are likely to be appropriate during next few years and that she will be paying attention to inflation data in the upcoming months, although she guesses that the soft reading will not persist. Meanwhile, Fed's non-voting soft-hawk Rosengren said 3 to 4 rate hikes next year will probably be appropriate and that the Fed may need to overshoot on rates if unemployment is below 4% while inflation reaches target.

    Looking at the big macro picture, via Bloomberg:

    • The dollar advanced against its major G10 peers and Treasury yields rose after Federal Reserve Chair Janet Yellen said on Sunday her “best guess” is consumer prices will soon accelerate after a period of surprising softness, a forecast echoed by European Central Bank President Mario Draghi and Bank of England Governor Mark Carney.
    • The Mexican peso hit a fresh five-month low as NAFTA talks revealed aggressive U.S. proposals;
    • Oil climbed as Iraqi troops moved to take over control of Kurdish fields.
    • The euro trades under pressure via crosses, EUR/JPY accelerates after breaking lower through 132.00,
    • JPY one-week calls also bid as they now capture domestic election date of Oct. 22;
    • EUR/GBP lower as GBP is supported by hawkish comments by Carney on Friday and on news U.K. PM making surprise visit to Brussels today for talks.
    • Gilts underperform from the open, gilt/bund spread wider by 3bps, short sterling strip bear steepens.
    • Bunds steadily grind higher; latest ECB sources report saying some ECB members see $3t QE is within market tapering expectations;
    • Little reaction seen in Spanish bonos to latest Catalonia rhetoric. However, Spanish IBEX underperforms other European equity markets as domestic banks sell off. Eurostoxx and Dax trade flat, miners rally strongly as copper forwards run upside stops through $7000/MT, new YTD high.
    • Crude futures higher after Iraq forces push into Kirkuk region.

    Meanwhile, tension over North Korea continues to simmer. The U.S. and South Korean navies began a joint drill involving around 40 warships, amid signs North Korea is preparing for another provocation such as a missile launch. North Korea’s state-run media agency KCNA on Saturday criticized the exercise, calling it a “reckless act of war maniacs.”

    Stocks in Europe nudged higher after their longest weekly rally since 2015, led by miners, as gains in oil and copper drove Bloomberg’s gauge of commodity prices to a six-month high.

    The Spanish IBEX index lags against its counterparts, down -0.7%  on Catalan fears with Spanish banks leading the losses. As reported previously, the Catalan Leader suspended independence mandate to pursue dialogue with PM Rajoy, however the letter sent by Puigdemont failed to clarify whether he has declared independence or not, prompting the head of the People’s Party in Catalonia Xavier Garcia Albiol says Puigdemont’s answer shows he is irresponsible. CaixaBank falls 2.4%, BBVA down 1.4%, Bankia down 1.5%; the IBEX is down 2% since independence vote on Oct. 1, vs 1% gain for Stoxx 600 over same period. Elsewhere, Convatec shares fall some 14% after announcing a profit warning, while strength in material names are helping European bourses make slight gains this morning.

    The MSIC Asia index was higher by 0.6%, its highest level since November 2007, led by Australia's ASX 200 (+0.3%) underpinned by strength in commodity related stocks after crude approached $52/bbl and iron ore gained over 4%, while Nikkei 225 (+0.5%) extended on its best levels in over 2 decades. Elsewhere, Hang Seng (+0.8%) outperformed and posted its highest close since December 2007 following stronger than expected Chinese Aggregate Financing, New Yuan Loans and PPI data, although the Shanghai Composite (-0.4%) lagged after the PBoC kept its liquidity operations at a minimal. Meanwhile, China's ChiNext Index of small-cap shares drops as much as 2.3%, the biggest intraday loss since July 17, amid expectations that liquidity could tighten and as investors turn more cautious ahead of the Communist Party congress this week. “Zhou Xiaochuan’s comments signal that China will move further to rein in financial leverage and is unlikely to maintain an easy liquidity environment,” says Shen Zhengyang, Shanghai-based analyst with Northeast Securities Co.

    Overnight, as reported previously, China CPI printed at 1.6% Y/Y, in line with expectations, and down from, 1.8% in August largely due to high year-over-year base effects, but it was PPI to come in smoking hot, jumping from 6.3% last month to 6.9% Y/Y, slamming expectations of a 6.4% print and just shy of the highest forecast, driven by the recent surge in commodity costs and strong PMI surveys.

     

    The stronger than expected PPI has pushed China's 10Y yield to the highest in 30 months, or since April of 2015.

     

    Japan's torried rally continued as technology firms and banks bolstered the Japanese stock market, sending the Topix index to its sixth day of gains, up 0.6%, and its longest winning streak for this year. All but four industry groups in the Topix advanced, while the Nikkei 225 Stock Average rose for the 10th day, the longest stretch since June 2015. Technology shares mirrored gains in U.S. peers as chipmakers and internet giants bolstered the S&P 500 Index at the end of last week. Automakers underperformed after the yen strengthened against the dollar for a second day on Friday as data showed the core U.S. consumer price index rose 0.1 percent in September from a month earlier, below the estimate of 0.2 percent. “Risks of not buying into Japanese equities are rising,” said Masahiko Sato, an analyst at Nomura Holdings Inc. in Tokyo. “In the midst of a global economic expansion, local corporate earnings are improving and equities are looking cheap. Foreign investors are buying into this.”

    The Bloomberg Dollar Spot Index rose 0.1 percent as the euro weakened and Spanish shares fell after Spain’s government gave Catalonia a new deadline to back down from its independence claim. The pound extended gains as British Prime Minister Theresa May headed for Brussels to intervene in deadlocked exit negotiations. The Japanese yen increased less than 0.05 percent to 111.81 per dollar.

    The Bloomberg Commodity Index gained 0.4% to the highest in six months. West Texas Intermediate crude rose 1.3% to $52.12 a barrel, the highest in two weeks, due to the conflict in Kurdish Iraq. Gold increased 0.1 percent to $1,304.53 an ounce.  Copper climbed 2.3 percent to $3.21 a pound, hitting the highest in more than three years. Palladium traded above $1,000 an ounce for the first time since 2001.

    Economic data include Empire Manufacturing Survey. Netflix, Schwab and CSX are among companies reporting earnings

    Bulletin Headline Summary from RanSquawk

    • Catalonian uncertainty continues to shadow over markets
    • EUR marginally underperforms, as CAD benefits from bullish oil markets
    • Looking ahead, investors will await US NY Fed Manufacturing data

    Top Overnight News

    • Kirkuk: Iraqi forces moved to take over oil fields from Kurdish forces
    • Fed’s Yellen: ongoing economic strength to warrant gradual rate hikes as soft inflation readings will not persist
    • ECB’s Draghi: no convincing signs of underlying inflation; would expect higher wage growth at this stage; sees V-shaped path of inflation due to oil prices
    • ECB QE: GC sees a limit of just over EU2.5t for the QE program based on current rules; enough bonds available to cut monthly purchases to EU30b in Jan. lasting until Sept, according to people familiar
    • Brexit: U.K. PM making surprise visit to Brussels today to meet EU’s Barnier and Juncker for talks; U.K. MPs holding cross-party talks in a bid to stop "No Deal" style Brexit
    • Catalonia: regional president does not give yes/no answer to Spanish govt. on independence declaration; defends claim to independence, asks for negotiations; Spanish Deputy PM says Thursday deadline is now activated
    • Italy: elections could be held March 4 after passage of 2018 budget law: Corriere
    • China Sept. CPI 1.6% vs 1.6% est; PPT 6.9% vs 6.4% est; M2 Money Supply: 9.2% vs 8.9% est; new Yuan Loans 1.27t vs 1.20t est; agg. Financing 1.82t vs 1.57t est.

    Market Snapshot

    • S&P 500 futures little changed at 2,553.50
    • STOXX Europe 600 up 0.2% to 392.30
    • MSCI Asia up 0.6% to 167.66
    • MSCI Asia ex Japan up 0.5% to 552.89
    • Nikkei up 0.5% to 21,255.56
    • Topix up 0.6% to 1,719.18
    • Hang Seng Index up 0.8% to 28,692.80
    • Shanghai Composite down 0.4% to 3,378.47
    • Sensex up 0.5% to 32,603.26
    • Australia S&P/ASX 200 up 0.6% to 5,846.76
    • Kospi up 0.3% to 2,480.05
    • German 10Y yield unchanged at 0.403%
    • Euro down 0.3% to $1.18
    • Italian 10Y yield fell 3.3 bps to 1.815%
    • Spanish 10Y yield fell 1.1 bps to 1.6%
    • Brent futures up 1.4% to $57.98/bbl
    • Gold spot up 0.04% to $1,304.39
    • U.S. Dollar Index up 0.1% to 93.22

    Asia equity markets began the week on the front-foot again after another record setting session last Friday on Wall Street, where softer than expected US CPI figures caused some to rethink the Fed’s hiking trajectory, while the region also digested encouraging Chinese lending and inflation data. ASX 200 (+0.3%) was underpinned by strength in commodity related stocks after crude approached USD 52/bbl and iron ore gained over 4%, while Nikkei 225 (+0.5%) extended on its best levels in over 2 decades. Elsewhere, Hang Seng (+0.8%) outperformed and posted its highest since December 2007 following stronger than expected Chinese Aggregate Financing, New Yuan Loans and PPI data, although the Shanghai Comp. (-0.4%) lagged after the PBoC kept its liquidity operations at a minimal. Finally, 10yr JGBs were initially mildly higher to track recent upside in T-notes and amid the BoJ’s presence in the market for an amount just shy of JPY 1tln in JGBs ranging from 1yr-10yr maturities, but then failed to sustain gains amid the positive risk tone.

    For those who missed the main Chinese economic data over the weekend, here are the highlights:

    • China Sept fiscal revenues CNY 2.27tln +9.2% y/y, spending at CNY 2.02tln, +1.7% y/y.
    • Chinese New Yuan Loans (CNY)(Sep) 1270.0B vs. Exp. 1100.0B (Prev. 1090.0B).
    • Chinese Aggregate Financing (CNY)(Sep) 1820.0B vs. Exp. 1572.7B (Prev. 1480.0B)
    • Chinese Money Supply M2 (Sep) Y/Y 9.2% vs. Exp. 8.9% (Prev. 8.9%)
    • Chinese CPI YY (Sep) 1.6% vs. Exp. 1.6% (Prev. 1.8%).
    • Chinese PPI YY (Sep) 6.9% vs. Exp. 6.4% (Prev. 6.3%)
    • PBoC injected CNY 20bln via 7-day reverse repos; PBoC set CNY mid-point at 6.5839 (Prev. 6.5866)

    PBoC Governor Zhou stated that total debt leverage in China is too high and that there is no clear fiscal discipline to restrict local governments; Zhou also stated that China's economic growth is to hit 7% in H2.

    Top Asian News

    • Japan Shares Rise, Topix Marks Longest Winning Streak This Year
    • Bad-Loan Recast Failures Portend More Pain for India Lenders
    • More Factories Go Dark as China’s Expansion Hangs in the Balance
    • Bitauto Car-Financing Arm Is Said to File for $800 Million IPO
    • H&M Supplier Crystal Sets Price Range for $574 Million IPO
    • Li’s H.K. Tower Sells for Record $5.15 Billion, Report Says
    • Wanda Golf Courses in Chinese Resort Shut Down by Authorities

    In Europe, the IBEX lags against its counterparts on Catalan fears with Spanish banks leading the losses. As reported previously, the Catalan Leader suspended independence mandate to pursue dialogue with PM Rajoy, however the letter sent by Puigdemont failed to clarify whether he has declared independence or not. Convatec shares fall some 14% after announcing a profit warning, while strength in material names are helping European bourses make slight gains this morning. UK debt appears to have weathered an early storm, but like Short Sterling remains on the relative backfoot on near term BoE tightening prospects. This follows more policy guidance from Governor Carney at the World Bank/IMF, and precedes Tuesday’s potentially policy-defining inflation report. Consensus is for headline CPI to climb to 3% y/y, but the bias suggests an above forecast print that would see the mandate breached and by inference strengthen the MPC’s resolve to act sooner rather than later (ie in November). Bunds are steady in comparison, and rangebound amidst contrasting drivers (ECB underscoring tapering intentions, but ongoing Spanish/Catalan uncertainty underpinning the EZ safe-haven). Perhaps surprisingly, Bonos not too adversely affected by the latest regional-national Government impasse, and RAGBs also holding in despite an unexpectedly strong showing by the far right in the weekend Austrian election. US Treasuries have eased off Friday’s post-CPI highs, with Fed chair Yellen still predicting higher inflation ahead and repeating that the wage components in the latest jobs data are encouraging – inference that this is more important than the negative (and obviously hurricane distorted) headline payrolls number.

    Top European News

    • Catalan Leader Defends Claim to Independence, Defying Spain
    • Spain’s OHL Studies Sale of Concessions Unit, EL Mundo Reports
    • Cyprus Rogue Borrowers Pose Threat to Sustained Growth
    • EDP Falls in Lisbon Following Regulator’s Proposal on Tariffs
    • European Miners Rise to 4-Yr High; Citi Still Bullish on Sector
    • U.K.’s Johnson Urges ‘Some Serious Negotiations’ in Brexit Talks
    • Serbia May Present Kosovo ‘Proposal’ in March, President Says

    In currencies, morning reports from the Spanish/Catalonian saga, stating that Catalan leader, Puigdemont has suspended the independence mandate to pursue dialogue with PM Rajoy, led to no reprieve in the EUR, which saw a slow, downward grind through the Asian session, as EUR/USD came back to break through Friday’s pre-US inflation data levels. EUR/GBP has come back to trade in the 0.8900 – 0.8750 range, alongside EUR/USD breaking firmly down through 1.18, with participants showing little optimism towards positive Spanish developments. Focus now slowly moves toward the end of October, as EUR/USD volatility sellers suggest more rangebound trade as we approach the ECB meeting. Options continue to play a part in FX markets as the large expiries theme remains, with hedges evident - EUR/USD sees 2.5bln between 1.1760 and 1.1910, and EUR/GBP has 1.7bln rolling off between 0.8885 and 0.8900. The probability of a Fed move in December has declined (as low as 73.2%, according to some measures) , following Friday’s tame inflation report. Some concerns over the US economy continued over the weekend, with comments from Fed Chair Yellen, stating that the new normal will be lower interest rates, further saying that inflation has been the largest surprise for the US economy this year, yet did add that gradual hikes in the Fed Funds rate are likely to be appropriate during the next few years and will pay close attention to inflation in the coming months. DXY remains rangebound, struggling to break into the range seen prior to Friday’s Inflation report. A marginal inflow into the JPY has been seen in early European trade, however, USD/JPY continues to struggle to trade below 111.70, with rangebound price action clear. The day sees no standout economic data on the docket, with trade potentially likely to remain subdued, as investors focus on global concerns given that various geopolitical and political uncertainties remain.

    In commodities, oil prices notably firmer with WTI and Brent making a breach above USD 52 and USD 58 respectively, largely as a result of the conflict between Iraqi and Iraqi-Kurdish forces, whereby Iraqi forces have moved into Kirkuk, consequently raising concerns over exports (Kirkuk exports account for roughly 600k). OPEC Secretary General Barkindo stated that OPEC and shale companies share responsibility to rebalance market, while there were also comments from Kuwait that producers need another month before deciding on deal extension and decision may be made in November. Iraqi forces capture Kirkuk's K1 airbase from Kurdish forces, according to a military statement. Kurdish leaders have agreed to avoid fighting in Kirkuk's Oil and Gas facilities, according to the Iraqi oil ministry.

    US Event Calendar

    • Oct. 16-Oct. 20: Monthly Budget Statement, est. $6.0b, prior $33.4b
    • 8:30am: Empire Manufacturing, est. 20.5, prior 24.4

    DB's Jim Reid concludes the overnight wrap

    There were few inflationary gusts on Friday after the much anticipated US CPI report. After nudging against 2.40% last Friday after a strong US average hourly earnings number, 7 days later the miss on CPI saw 10yr USTs close the week at 2.274% having traded just below 2.33% most of the session before hand. September core inflation rose only 0.13% mom (vs. 0.2% expected) and 1.7% yoy (vs. 1.8% expected). In the details, core services inflation was inline, but the main miss was on the core goods side, which fell 0.2% mom (-1% over past 12 months - the lowest reading since August 2004). Our US team believes some of this weakness should prove transitory (eg: medical care commodities), but there were also more broad based signs of weakness. The team still expects core CPI inflation to remain near recent levels in yoy terms through 2017, albeit with risks that it now rounds down to 1.6%.

    This now makes it 6 out of 7 months of misses relative to expectations but a) remember that we’ve previously shown US inflation tends to lag growth by around 18 months and growth was weak at the end of ‘15/ early 16, b) that many at the Fed have recently suggested a bias to look through the ‘temporary’ weakness, and c) the Fed have also made it clear they’re looking more and more at (the very loose) financial conditions in their rate discussions.

    So overall, Friday’s number should reduce the risk of a December Fed hike but not perhaps by much. Bloomberg’s calculator has it at 73.3% now, down 3.4ppt versus Thursday’s close. If the usual lag between growth and CPI holds, we still may have weak YoY CPI into Q1 but just as the market gives up on inflation ever rising again, we may get some higher than expected shocks as we move into Q2 2018. Staying with inflation, China’s September CPI was in line at 1.6% yoy, but lower than the prior month, driven by lower food prices. Elsewhere, PPI was notably higher than consensus at 6.9% yoy (vs. 6.4% expected).

    Over the weekend, the main movers and shakers of global central banks spoke on inflation, tapering and risks at the annual IMF meeting. Firstly, Mrs Yellen said “my best guess is that these soft readings (inflation) will not persist” and that “with the ongoing strengthening of labour markets, I expect inflation to move higher next year”. On rates, she noted “we expect the neutral level of the federal fund rates to rise somewhat over time” and that “additional gradual rate hikes are likely to be appropriate over the next few years to sustain the economic expansion”. On fiscal policy changes, she said “it’s a source of uncertainty”, we have taken “a kind of wait and see attitude”.

    ECB’s Draghi also reiterated that he is “confident” inflation will “gradually converge in a self-sustained manner”, but we should be patient, because “it’s going to take time”. On tapering, ECB’s Praet had noted the idea of a bigger reduction in monthly bond buying in exchange for longer duration of the program earlier. When asked by reporters, Draghi said that Praet “had said it very well”. Back on Friday, Bloomberg reported that ECB policy makers are considering reducing the pace of bond buying to €30bn/mth (from €60bn/mth), but for nine more months to September 2018. Elsewhere, Bundesbank President Weidmann noted he does not see the need to further expand monetary stimulus, while the ECB’s Italian governor Visco noted he would prefer not to have specific dates on the unwinding of QE as ECB needs “the flexibility that is in the program”. Given the difference in opinions, we shall find out more at the next ECB meeting next week on 26 October.

    Elsewhere, BOE’s Carney reiterated he may need to raise rates in the “coming months” as the UK’s economy is running out of spare capacity. Japan’s BOJ Kuroda noted “achieving the 2% target is still a long way off and the BOJ  will persistently [maintain] aggressive monetary easing” and he does not “see risks mounting in the financial markets in the US, Europe and Japan”. This was also backed up by Draghi who saw little signs that “stocks and bonds are having valuations that are stretched when compared to historical averages”.

    Finally, China’s PBC Governor Zhou noted that “6.9% economic growth may continue in the second half”. He also said “the main problem (in China) is that the corporate debt is too high” and that while debt servicing costs remain low, “we need to pay further efforts to deleveraging and strengthen the policy for financial stability”. Zhou flagged that some of China’s corporate debt includes borrowing from financing vehicles owned by the local  governments, so if redefined, corporate debt / GDP is closer to c125% than the official figure of 160%, while government debt would be 70% of GDP (vs. 36%). Elsewhere, he said the asset management business is “a relatively chaotic situation”, partly due to three different regulators with different sets of rules. For those who have missed it, our note “The next financial crisis” takes a closer look at this and other developing risks.

    Overnight, South Korean military officials warned North Korea may be preparing for another round of missile launches, while US and SK navies have begun a joint drill involving 40 warships. Elsewhere, US Secretary of State  Tillerson said he will continue with diplomacy measures with NK “until the first bomb drops”. This morning in Asia, markets havefollowed the positive lead from the US and are trading higher. The Kospi (+0.12%), Nikkei (+0.68%), ASX 200 (+0.63%) and Hang Seng (+0.81%) are slightly higher as we type.

    In Austria, the centre-right People’s Party (OVP) leader Sebastian Kurz is expected to become the world’s youngest government leader (aged 31). Of the votes counted (c85%), the Interior Minister Sobotka said the OVP received 31.4% (vs. c33% in late polls per The Independent), while the Social Democrats party has 26.7% (vs. 24.4%) and the Freedom Party (FPO) has 27.4% (vs. c26%). A renewed coalition between OVP and SPO is seen as less likely, which makes the far right, anti-immigrant and euro-sceptic FPO party in a strong bargaining position when forming the next coalition government. This would mark the FPO’s first return to government since 2005. So it will be interesting to see what a potential OVP & FPO tie up would mean for Europe on issues such as immigration and deeper EU integration.

    Over in Germany, Merkel’s CDU party has likely suffered the worst election result since 1959 in the northern state of Lower Saxony (home state of Volkswagen with 7.8m people). The Social Democrats Party (SPD) was the big winner, with official preliminary results putting the SPD as winning 36.9% (+4.1ppt from 2013) of the votes, while Merkel’s party came second, wining 33.6% (-2.6ppt). The loss is unlikely to shift the power mix at the state level as the Social democrats and the Green already govern the state, but the softer  sentiment for her party could have follow on implications ahead of Merkel’s talks with potential coalition partners (likely the Greens & FDP) this week, in order to form the next federal government.

    Indeed UK PM May is expected to travel to Brussels and meet with EC Commission President Junker and Chief Brexit negotiator Barnier for Brexit talks today. According to her office, the trip has been in her diary for some time, but has only now been publicly announced. We wait and see whether her efforts will improve the chance of some resolution ahead of the EU Summit meeting later this week. Elsewhere tomorrow’s Euro and UK CPI will be a focal point as will the 57 S&P 500 companies reporting. Today, Spain and Catalonia will be back in the spotlight with Catalan President Puigdemont due to face a deadline to clarify to the Spanish Government Catalonia’s position on independence. For the full week ahead we’ve copied the text from “Next week, this week” at the end.

    On the US fiscal front, optimism and pricing of a deal has again faded but the next key step is the adoption of a budget by the Senate (expected to be later this month), which should be followed by a House-Senate conference to agree on a common FY18 budget. As DB’s fixed income weekly explains, the base case is that the House will converge towards a plan consistent with the Senate’s USD1.5 trillion deficit target (relative to the CBO baseline) and assuage deficit hawks with the prospects of higher growth reducing the deficit relative to this target. The final tax reform is more likely to amount to a more modest tax cut with a relatively limited impact on GDP. However, the increase in deficits will still be relevant to bond markets from a flow perspective.

    Quickly recapping the markets performance on Friday. Equities (S&P +0.09%, Stoxx 600 +0.29%) edged higher back towards their record highs. Within the S&P, HP rose 6.42% post results, while bank results were mixed with WFC down 2.75% following an unexpected $1bn legacy legal charge and softer revenue trends, while BofA gained 1.49%, partly due to improved cost discipline.

    Bond markets were broadly firmer following the US CPI miss and stronger than expected retail sales. Core bond yields fell 4-5bp at the 10y part of the curve (UST: -4.5bp; Bunds -4.1bp; OATs -4.6bp), but Gilts underperformed (-1bp). The US dollar index was broadly flat (+0.04%) while Sterling gained 0.17% but the Euro dipped 0.08% versus the Greenback. In commodities, WTI oil rose 1.68% following reports of lower US crude stockpiles, and continues to edge higher this morning as fighting broke out between Iraqi and Kurdish forces near Kirkuk. Iron Ore rallied 4.06% to $62.53/ton following China trade figures that showed a three year high for monthly ore imports.

    Before we take a look at today’s calendar, we wrap up with other data releases from Friday. Excluding the CPI miss, other US macro data were broadly stronger than expected. The September retail sales (ex-auto & gas) beat expectations at 0.5% mom (vs. 0.4% expected), while the University of Michigan’s October consumer confidence also beat at 101.1 (vs. 95 expected). Elsewhere, the August business inventories print was in line at 0.7% mom. In  Europe, the final readings of September CPI for Germany and Italy was unrevised, at 1.8% yoy (flat mom) and 1.3% yoy respectively.

    Looking at the day ahead, in Europe the August trade balance reading for the Euro area is the sole release due while in the US the October empire manufacturing print is due. Away from the data Spain and Catalonia will be back in the spotlight with Catalan President Puigdemont due to face a deadline to clarify to the Spanish Government Catalonia’s position on independence. Earnings wise, Netflix results are likely to be the most significant.


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    Richard Sylla: 70% to 80% Chance of Another Global Financial Crisis

    Written by Peter Diekmeyer, Sprott Money News

     

    Richard Sylla: 70% to 80% Chance of Another Global Financial Crisis - Peter Diekmeyer

    When Janet Yellen, Chairman of the US Federal Reserve, said in June that she does not expect another financial crisis in our lifetime, eyebrows were raised.

     

    None more so than Richard Sylla’s.

     

    Sylla, a professor emeritus at the Stern School of Business and co-author with Sydney Homer of the magisterial A History of Interest Rates, has studied past business cycles. He is thus able to put today’s events in a broader context.

     

     

    “A lot of the same things are going on right now as before the 2008 crisis,” said Sylla, who puts the probability of a repeat in our lifetimes at between 70% and 80%.

     

    “People figure that central banks avoided a Great Depression last time and can do it again,” said Sylla. “So, they are not worried.”

     

    The most important price in the economy


    Sylla’s work is particularly important because interest rates, which have a direct influence on all economic activity, are simply the most important prices in the economy.

     

    For example, the average American who bought a $250,000 home and financed it for 30 years at 3.83%, would pay just over $175,000 interest during that time. That’s almost as much as the cost of the house itself.

     

    Interest rate levels also affect the real prices of cars, as well as all other consumer, business and government purchases - hence the ever-present temptation among policy-makers to keep rates low.

     

    US Treasuries: yields at least 8% in a free market?


    History provides a hint of the scale of the Fed’s current interventions, which could be depressing interest rates by at least 5.0 percentage points across the yield curve. The result is the transfer of trillions of dollars a year from American savers to borrowers.

     

    As Sylla and Homer note in A History of Interest Rates, British Consuls' perpetual bonds yielded between 2.5% and 3% during much of the 100+ years that the British Empire was at its peak.

     

    Their long duration, during a time when currency was backed by gold, provide a suggestion of where natural interests rates would be in a free market environment.

     

    In fact, those British Consuls traded not too far from where US 30-year treasuries are currently trading (just under 2.9%).

     

    However, there are huge differences. For one, Treasuries today trade during a time of high inflation, particularly in asset prices.

     

    Furthermore, bond investors today are at unprecedented risk of government default, and, in a free market, would almost certainly demand a premium.

     

    Finally, Treasury holders (unlike investors in British Consuls, when they were first issued) are taxed on their profits, often at the highest marginal rates. In a free market, investors would surely demand a significant premium as compensation.

     

    To give an idea of what US Treasuries would trade for in a free market, you’d take their current yields (approximately 3%), add an inflation compensation (say 2%+), a risk premium (of at least 1%) and compensation because interest payments are currently taxable (a rough guess of say 2%).

     

    So, a theoretical minimum US Treasury yield in a free market environment would be 3% + 2% + 1% + 2% = 8%.

     

    This suggests that Fed manipulations are currently depressing yields on US 30-year Treasuries by 5 percentage points, an effect which extends, to various degrees throughout the yield curve.

     

    If we apply that rate to all $47.9 trillion in US non-financial debt, as per the Fed’s Q2 Z.1 Flow of Funds report, that suggests that government manipulations are transferring $2.4 trillion each year from savers to borrowers.*

     

    Historians given scant attention


    Sylla’s warnings are particularly important as America’s public schools and universities teach students almost nothing about history. That applies to economics professors, who focus almost exclusively on econometrics models.

     

    Few economics programs teach detailed courses about the German and French hyperinflation episodes (which led to the rise of Hitler and Napoleon), let alone about Greek and Roman financial history.

     

    Economics academics thus head confidently into government often without a clue as to the damages that fiat money and low interest rates can cause.

     

    The upshot is that the US and other global governments and central banks have been systematically following the same high taxation, spending and money printing policies that in the past have led to disaster.

     

    The prevailing assumption remains that “this time is different.”

     

    CAPE, derivatives and a global debt bubble



    Sylla worries that current central bank financial repression policies, which have kept interest rates artificially low for decades, have created massive mal-investment and an unstable situation in which threats abound.

     

    These include cyclically-adjusted price-earnings ratios on US stocks, which are at highs not seen since the tech bubble and the 1929 stock market crash. This comes during a time in which record personal, business and government debts, put limits on possible flexible responses.

     

    As if that weren’t enough, massive derivative books, which by some estimates contain more than $1 quadrillion of mostly-hidden contingent liabilities, leave investors and policymakers uncertain as to who they can trust to honor payments during times of uncertainty.

     

    Hopes for a long life


    Sylla attributes much of the challenges in the current system to the US government’s 1971 decision to stop backing its currency with gold, a decision replicated by governments around the world which enabled them to borrow and print almost without limit.

     

    The result was the current huge imbalances, a situation made worse by the fact that the general public, blinded by indecipherable central bank communications, has literally no idea of the stakes and risks.

     

    However as Sylla coyly admits, while another global financial crisis will almost certainly come within “our lifetimes”, the key question is “how long that will be?”

     

    The venerable historian did not volunteer his age. However a “back of the envelope” calculation suggests that Sylla, who completed his undergraduate degree in 1962, is approaching 80.

     

    Americans who worry about a repeat of the 2008 events during the ageing academic’s lifetime had better hope he has many more good years left.

     

    * These are rough calculations. Comments from readers who can fault/refine those estimates would be much appreciated.

     

     

    Questions or comments about this article? Leave your thoughts HERE.

     

     

     

     

     

    Richard Sylla: 70% to 80% Chance of Another Global Financial Crisis


    Written by Peter Diekmeyer, Sprott Money News

     

     


    0 0

    Gold and USDJPY have had a busy last 60 minutes as they swung wildly on North Korea headlines but Gold tumbled back below $1300 when Bloomberg reports that Stanford's John Taylor is said to impress President Trump, as Warsh's star fades.

    • *WARSH AND TAYLOR BOTH REMAIN ON SHORTLIST, PEOPLE FAMILIAR SAY
    • *TRUMP INTERVIEWED TAYLOR LAST WEEK WITH CHIEF OF STAFF KELLY
    • *KEVIN WARSH IS SAID TO SEE STAR FADE IN WHITE HOUSE FED SEARCH
    • *STANFORD'S TAYLOR IS SAID TO IMPRESS TRUMP FOR FED CHAIR

    Which jumped Taylor up to 3rd place with the bookies...

    And the reaction was a clear dollar positive, gold negative...

     

    The dollar strength is likely related to the fact that according to John Taylor's "Rule", the current Fed Funds rate - based on inflation and unemployment - should be around 5.74%!!

     

    Additionally, Politico reports that Trump is said to plan an interview with Janet Yellen later this week.


    0 0

    Something unexpected happened on the market's relentless trek to all time highs: the market died.

    At least that is the impression one gets from walking around Wall Street's formerly busy trading desks (certainly the formerly biggest trading floor in the world, that of UBS, now hauntingly empty) where these days one can hear a pin drop. Take the Credit Suisse Prime Brokerage desk in Manhattan for example: here, as BusinessWeek reports in its 1987 anniversary issue, "the phones hardly seem to ring anymore." In fact, if one didn't know better, one could assume that instead of all time highs, the market has just experienced another spectacular crash resulting in a universal trading revulsion.

    Credit Suisse's hedge fund clients don’t call about Donald Trump’s tweetstorms and the stock market or ask what to do when terrorists attack. And there was barely a whiff of panic when North Korea erupted in August. “Two rockets flew over the land mass of Japan and nothing happened,” says Mark Connors, Credit Suisse’s global head of risk advisory.

    Connor's assessment, in not so many words, the market has died: “There were no calls. That’s absolutely crazy.”

    Why crazy? Because traders who don't belong to the millennial generation, will recall that in addition to buyers, stocks also have sellers. But not now, unfortunately, because what goes on in Credit Suisse' prime brokerage desk does not stay in Credit Suisse' prime brokerage desk. Instead, it’s become the norm on Wall Street. "Whether it’s the threat of nuclear war, hurricanes, or Russian meddling, it seems nothing can unnerve investors bent on pushing the U.S. stock market higher and higher. Even Richard Thaler, who won a Nobel Prize last week for explaining how irrationality drives financial markets, said on Bloomberg Television he couldn’t understand why stocks keep going up now."

    What is causing this unprecedented meltup? The same thing we first presented in 2010: the "Buy The [Fucking] Dip" (which subsequently became "Buy the Fucking All Time High") mentality, originally popularized by a couple of cartoon characters, which has since become the one and only "trading strategy" on Wall Street - and everywhere else - and which is also known as "don't sell anything." Because why sell in a world in which central banks have everyone's back?

    "So what’s going on?" Bloomberg asks and ponders:

    During most of the first 8½ years of the bull market, the mood was paradoxical. Although stocks rose, many investors scarred by the financial crisis acted as though they hated owning shares again, and every obstacle was framed as the next big meltdown (even as the underlying fundamentals remained strong). Now, everywhere you look—swelling stock valuations, hot sales of new cryptocurrencies, IPO shares with no voting rights—investors are embracing their speculative side. In the language of Wall Street, every day it’s “risk-on.”

    Actually, dear Bloomberg authors - while we do realize the question is rhetorical - the answer is simple. Bubbles. Bubbles everywhere.

    Back in June Citigroup's hans Lorenzen pointed out precisely what was going on in financial markets that scramble to maximize every last ounce of what central bank impulse remains, in which we get such bubbles as London real estate, bitcoin and vintage cars amid the Fed's attempts to "facilitate recovery", or as Citi puts it: "the wealth effect is stretching farther and farther afield."

    And while on the upside the surge in sweet for everyone involved, it's what happens when bubbles burst - as they always inevitably do - that is the problem, a problem which the Fed clearly is not concerned about (and for Janet Yellen, in just three months it will be someone else's problem).

    Unfortunately, the realization that it is a bubble provides little relief for those who careers depend on being fully invested, i.e. all of Wall Street. Which is also why goalseeked justifications and rationalizations - "the market is a bubble, but a much smaller bubble than bonds, etc." - emerge. This is also known as FOMO, or Fear of Missing Out. As a result, as Bloomberg notes, while it is an uncertain world out there, "fear invariably turns into greed, and the fear of missing out overshadows any anxiety about the next crash." That tends to quickly draw money back into the market every time it wobbles, despite legitimate worries about high valuations.

    “We certainly all joke about it: Buy the dip, that’s what we’ve been conditioned to do,” says Benjamin Dunn, president of the portfolio consulting practice at Alpha Theory, which works with money management firms. “Now you kind of have to do it. It’d almost be irresponsible not to.

    A joke for some, perhaps, but in the end all that will be left are tears, of course. Until then, however, the market not only refuses to crash, it hasn't had a mere 2% drop in months.

    Another way of seeing the market's unprecedented complacency: the number of days with a 1% up or down move in the S&P is below 10 so far in 2017, among the lowest on record. By comparison, the post WWII average is over 50.

    In light of the above, it is not surprisng that This year, the S&P 500 index has hit records on almost four dozen different occasions, with the single biggest drop from the latest record amounting to less than 3 percent. At the same time, more than $3.2 trillion of market value has been added to U.S. equities (and $5 trillion since Trump's election as he will gladly remind his twitter followers each day) while volatility is at record lows.

    And speaking of goalseeked justifications for this epic, artifical, central-bank inspired rally, that's what Bloomberg does next: 

    It’s easy to say it’s all about Trump and his promise of big tax cuts. His election has fueled some impressive gains (though perhaps not quite as impressive as he has often claimed and still far short of the best year for U.S. stocks during this current cycle). But for Credit Suisse’s Connors, the shift in market psychology can be traced back to a different signal event: Brexit.

     

    After the U.K. voted to leave the European Union in June 2016, $2.6 trillion was wiped off the value of equities worldwide in just three days. Many were calling it one of the most dramatic and shocking turns of events in modern British history. Among investors, the panic was palpable, and some were paralyzed with fear. But almost as quickly, the markets roared back and jolted investors out of their crisis-era fatalism.

     

    Since then, naysayers selling into any weakness have looked like suckers. In the aftermath of other post-crisis upheavals, “we got a lot of incoming client calls,” Connors said. “But that all ended with Brexit. Now, even though the events seem dire, volume is low and and reversals are sharp. People are looking through to things that keep them long. Buy-the-dip is in place.”

    None other than JPMorgan's Marco Kolanovic quantified this effect, showing that starting with the August 2015 ETFlash crash, and passing through the Brexit, Trump and ultimately Italian vote, the BTFD rebound has been shorter and shorter, shrinking from 65 days to just a few hours. This is what Kolanovic wrote last December:

    It appears that the time horizon of macro traders has shortened, likely as a result of increased participation of machines and algorithms that are quicker to adjust to significant events and can eliminate trading activity of slower investors. Consider for example the US elections - traders in Japan registered a 5.4% Nikkei drop on the 9th, followed by a 6.7% rally on the 10th, while S&P 500 investors did not register a significant close-to-close move over the election (due to market hours difference). These two days were enough to shift the volatility regime (usually calculated from closing returns) for the whole of 2016 for the Japanese equity market, and leave it unchanged for S&P 500 (e.g. think of rebalancing needs of a hypothetical risk parity fund, or a short volatility strategy based on Nikkei vs. one based on S&P 500). We also noticed that for a number of significant catalysts this year (Brexit, US Election, Italy Referendum) broad expectations were wrong both on the outcome and the directionally forecasted impact. It is possible that the lack of market reaction (or a reaction that went against the accepted narrative) was in part driven by investors’ reluctance to transact (“two negatives equal a positive”).

    Whether central banks are involved in some capacity in these dramatic rebounds remains to be seen: so far all that has been publicly documented is that both the BOJ and SNB, as well as various sovereign wealth funds, have been aggressive in purchasing and accumulating stocks come rain or shine, with zero regard for price. Why would retail investors and algos not piggyback?

    And piggybacking is precisely what retail investors are doing, hopeful to profit during the upcoming melt up phase, as Ed Yardeni found out just a few days ago.

     

    The former chief economist for Deutsche Bank was in Texas recently, visiting clients. In hurricane-ravaged Houston, locals were still dealing with the aftermath of Harvey, and two clients couldn’t meet because of damaged buildings.

    Yet there was one thing on everyone’s mind. “They wanted to talk about the potential for a stock market melt-up,” he says. A melt-up is a last-gasp surge like the one in 1999, when the Nasdaq doubled—just before it crashed. Nothing like it has happened in this bull market. To the extent 2017 has a precedent, the current backdrop is closer to 1995 or 2013, when the S&P 500 gained 30 percent or more with barely a peep of turbulence.

    So there's the self-fulfilling prophecy of a "melt up", there is also the sense that investors have become invincibly, riding on the coattails of $14 trillion in central bank liquidity and not realizing it:

    According to Wedbush Securities Inc.’s Ian Winer, all the things underpinning the gains, from robust earnings and the Federal Reserve’s low interest rate policy to the falling dollar and the retreat of sellers, has created a sense of invincibility. “Is the risk priced into the market appropriate to what the real risk is?” says Winer, the firm’s director of equities. “To me, it isn’t. People have grown more complacent and certainly more speculative, and it’s a little bit frightening.”

    Of course, knowing it's a bubble is meaningless, unless one also knows when it will burst. And it is this that is the problem, as Bloomberg points out:

    it’s far from obvious what will trigger the next downturn or when investors should get out. The hazards of market timing were illustrated by a Bank of America Corp. study last year, which showed that missing the very end of a bull market often means missing a quarter of its gains. What’s more, anyone who owned stocks just before they crashed in the worst bear market since the Great Depression would still have doubled their money as long as they had the fortitude—and enough of a financial cushion—not to bail.

    Meanwhile, and most ironically, the biggest losers even as the zombie market, in which nobody bothers to sell any more hits all time highs, are professional, active investors, who have become a dying breed, among the biggest active to ETF, or passive, asset allocation shift in history. 

    Among the very few who are happy with the current "dead" market, is the Vanguard Group, whose trillions of dollars in low-cost and index-tracking funds have been credited and blamed for the current market mood, as so many retail investors have decided just to buy a diversified fund and forget about it—the new mindset is a sign of a job well done.

    “To see people not trading wildly on political news is optimistic,” says Fran Kinniry, a principal in Vanguard’s investment strategy group. “Investors are acting in a very positive way, how a professional investor should be investing. Have an asset allocation and rebalance it, and do your best to differentiate between the noise vs. reality.”

    Still, one can't help but wonder just how professionally these investors will be acting during the next, perhaps last, ETFlash crash, one which will make the August 24, 2015 market break, ETF and VIX freeze seem like a walk in the park. One thing that is certain: the market will simply shut down that day. The question is for how long, and will it ever reopen.


    0 0

    Global markets traded near all-time highs on Tuesday, with S&P futures, Asian shares and European stocks all flat this morning, while oil continued to gain on Kurdish geopolitical concerns while most industrial metals fell.  The euro extended its recent slide and stocks drifted as Spain’s escalating hard-line response to the Catalonian secession threat fueled concern the crisis may intensify.

    Markets initially followed the US reaction to reports of a positive John Taylor (Rule) - Donald Trump meeting, which sent 2Y Treasury yields to their highest since 2008 and pushed up the dollar higher amid speculation the next Federal Reserve chairman will be more hawkish, while TSYs briefly traded through Monday’s session lows because as we showed yesterday, the Taylor Rule would suggest a Fed Funds rate that is far higher than the current.

    However, the pop in short-yields was not matched at the long end and the 2-to-10 year U.S. yield curve hit its shallowest in more than a year.

    “Fed chairs have often influenced U.S. monetary policy quite considerably in the past. And I would certainly see Taylor as a candidate who would fit in this pattern,” Commerzbank analyst Thu Lan Nguyen said. “That makes one thing clear: should Trump nominate Taylor as Yellen’s successor the U.S. dollar would initially appreciate notably.”

    Cable remained volatile through U.K. inflation data and dovish commentary from BOE’s Ramsden but eventually traded flat. In addition to Spain, the EUR/USD continued its recent trend lower, pricing a nine-month QE extension within ECB taper, while bunds and other EGBs continue to grind higher. The South African rand weakened following a Zuma cabinet reshuffle

    The common currency declined for a fourth day, the longest streak since May. The Stoxx Europe 600 Index was little changed following mixed trading in Asian stocks earlier, after North Korea warned that a nuclear war could “break out any moment.” Core European equity markets dipped from the open before trading back to unchanged with the tech sector supported by Infineon (2.5%) after positive comments from BofA, leisure sector underperforms after Merlin Entertainments (-19.5%) posts poor earnings forecast. Spain’s IBEX Index fell 0.3 percent to the lowest in a week as Spain cut its economic growth forecast for 2018, acknowledging the impact of an escalating political crisis that led the National Court in Madrid to jail two leading Catalan separatists. As reported on Monday, the Spanish state is turning up the pressure on the separatist leaders as Prime Minister Mariano Rajoy tries to persuade Catalan President Carles Puigdemont to drop his push for independence or see Madrid take direct control of the regionl two Catalan independence leaders were ordered jailed without bail during a sedition trial.

    Asia’s regional stock benchmark was little changed, holding near its highest level in 10 years, while a gauge of mining stocks advanced after Rio Tinto Group signaled it’s on track for record annual iron ore shipments. The MSCI Asia Pacific Index added less than 0.1 percent to 167.82 as of 11:40 a.m. in Hong Kong, after extending gains from its highest level since November 2007 on Monday. Materials stocks led gains Tuesday, rising 0.5 percent. Japan’s Topix fluctuated, erasing early gains, after a six-day rally pushed it further into technically overbought levels. It eventually closed 0.2% higher in Tokyo after gaining as much as 0.6%. Australia’s S&P/ASX 200 Index rose 0.7 percent and South Korea’s Kospi index was up 0.2 percent.

    “Investors are pausing just a bit while waiting for more directional data points on the global state of affairs before they assess whether current high valuations have firm footing,” said Attila Vajda, managing director of Project Asia Research & Consulting Pte. China’s GDP report due on October 19 will help determine investment decisions.

    Elsewhere, the pound dropped amid speculation the Bank of England will deliver the U.K.’s first rate increase in more than a decade next month after data showed inflation in U.K. accelerated in September, although testimony by Governor Mark Carney befire lawmakers in London appears to have taken away the fizzle. British Prime Minister Theresa May and European Commission chief Jean-Claude Juncker agreed over dinner in Brussels on Monday that the pace of negotiations over Britain’s departure from the European Union should be stepped up. Some market watchers such as JP Morgan are sceptical on sterling’s outlook, recommending investors to buy euros against the British pound as “the overhang of the Brexit issue itself would constrain how much accommodation the BoE would be able to remove.”

    One of Monday’s big movers, oil, consolidated a near month-high having spiked after Iraqi forces seized the oil-rich city of Kirkuk from fighters loyal to the country’s semi-autonomous Kurdish Regional Government. After months of rangebound trading during which OPEC-led supply cuts supported crude values but rising U.S. output capped markets, prices have moved up significantly this month. Brent crude oil was 5 cents higher at $57.87 a barrel by 0800 GMT, up almost a third from its mid-year levels. U.S. West Texas Intermediate (WTI) crude CLc1 was nudging up again too at $51.99. There were unconfirmed reports that Kurdish forces had shut around 350,000 barrels per day (bpd) of oil production from major fields. “The 500,000 bpd Kirkuk oilfield cluster is at risk,” Goldman Sachs said in a note to clients.

    Tension between the United States and Iran is also rising, after U.S. President Donald Trump on Friday refused to certify Iran’s compliance over a nuclear deal which removed long-running sanctions. “If there (were new sanctions), we expect that several hundred thousand barrels of Iranian exports would be immediately at risk,” Goldman said. During the previous round of sanctions around 1 million bpd of oil was cut from global markets.

    In currencies, the Bloomberg Dollar Spot Index gained 0.1 percent to the highest in more than a week.  The euro dipped 0.3 percent to $1.1764. The British pound dropped to session lows near $1.3226. The Japanese yen climbed less than 0.05 percent to 112.15 per dollar.

    Yields were little changed, with the US 10-year up one basis point to 2.31%; Germany’s 10-year yield decreased less than one basis point to 0.37 percent; Britain’s 10-year yield climbed two basis points to 1.336 percent, the biggest increase in almost two weeks.

    Gold declined and most emerging-market currencies weakened alongside developing-nation stocks. WTI crude resumed its push above $52 a barrel as tensions in Iraq lingered. Treasuries edged higher as odds rose that John Taylor will replace Janet Yellen at the Fed.

    Johnson & Johnson, Goldman Sachs, Harley-Davidson, Morgan Stanley, Omnicom are among companies reporting earnings

    Market Snapshot

    • S&P 500 futures little changed at 2,556.10
    • STOXX Europe 600 down 0.07% to 391.13
    • VIX Index down 0.6% at 9.85
    • MSCI Asia down 0.04% to 167.74
    • MSCI Asia ex Japan unchanged at 553.36
    • Nikkei up 0.4% to 21,336.12
    • Topix up 0.2% to 1,723.37
    • Hang Seng Index up 0.02% to 28,697.49
    • Shanghai Composite down 0.2% to 3,372.04
    • Sensex down 0.09% to 32,605.86
    • Australia S&P/ASX 200 up 0.7% to 5,889.61
    • Kospi up 0.2% to 2,484.37
    • German 10Y yield unchanged at 0.372%
    • Euro down 0.2% to $1.1769
    • Brent Futures up 0.5% to $58.10/bbl
    • Italian 10Y yield fell 4.9 bps to 1.766%
    • Spanish 10Y yield fell 1.6 bps to 1.566%
    • Brent Futures up 0.5% to $58.10/bbl
    • WTI crude up +0.5% at $52.15/bbl
    • Gold spot down 0.5% to $1,289.85
    • U.S. Dollar Index up 0.1% to 93.41

    Top Overnight News from Bloomberg

    • John Taylor, a Stanford University economist and a candidate for
      Federal Reserve Chairman, made a favorable impression on President
      Donald Trump after the interview at the White House last week, according
      to several people familiar with the matter
    • North Korea
      warned that a nuclear war may “break out any moment” as the U.S. and
      South Korea launched one of the largest joint naval dri
    • Spanish Interior Ministry is preparing first steps it would take if govt opts to trigger clause in constitution allowing for suspension of Catalonia’s self-government, El Pais reported
    • Spain cut growth forecast for 2018 to 2.3% from 2.6% earlier, acknowledging the impact of an escalating political crisis
    • BOE is seen keeping rates on hold through 2018 after making first hike in over a decade in November, according to a Bloomberg survey; 76% of the economists see a rise next month, up from 22 percent of respondents in September but they don’t see another increase until 1Q 2019
    • BOE’s David Ramsden said he wasn’t in MPC majority pushing for a hike in coming months
    • Last-minute efforts by U.K. PM Theresa May to unblock stalled Brexit talks came up short with EU officials now looking to December to move negotiations on to discussions about the future EU-Britain relationship
    • Some Qatari banks are becoming less willing to sell dollars to foreign lenders amid a lingering regional standoff with a Saudi- led alliance, according to people familiar with the matter
    • European car sales fell in September for only the second monthly drop this year as concerns about Brexit among U.K. consumers more than offset gains in France, Italy and Spain
    • Reserve Bank of Australia said economic conditions at home and abroad “had been more positive since 2016,” according to minutes of this month’s policy meeting where interest rates were left unchanged
    • U.K. Prime Minister Theresa May and European Commission President Jean-Claude Juncker’s dinner attempt to smooth out Brexit differences yielded little, revealing entrenched previous stances before the summit on Thursday
    • Industrial production in September and Home Builders Market Index for October will be announced today in the U.S.
    • Goldman Sachs, Morgan Stanley, IBM, Johnson & Johnson, Harley Davidson

    Asia equity markets eventually traded mostly higher following the momentum from their US peers, where all major indices edged to fresh record levels once again. The positive lead provided an early bid tone in ASX 200 (+0.8%) which was also led by materials names as Rio Tinto rose to its highest in around 6 years on strong Q3 iron ore shipments, while Nikkei 225 (+0.4%) was also higher but saw some intraday pressure in which participants took heed of a strengthening JPY and booked profits. Elsewhere, Hang Seng (+0.1%) and Shanghai Comp. (+0.1%) were choppy despite a substantial liquidity operation by the PBoC, with participants tentative in the midst of earnings season and ahead of China’s 19th National Congress. Finally, 10yr JGBs were subdued amid a somewhat positive risk tone in Japan and after softer 20yr bond auction results in which the amount sold, b/c and accepted prices all declined from prior. PBoC injected CNY 100bln via 7-day reverse repos and CNY 90bln via 14-day reverse repos. PBoC set CNY mid-point at 6.5883 (Prev. 6.5839) China researcher states that China should tighten its monetary policy and toughen property curbs.

    Top Asian news

    • The Money-Losing Volatility Trade That Hedge Funds Can’t Resist
    • China Bonds Slump as Zhou’s Optimism on Economy Seen Taking Toll
    • HNA to Spend $7.6 Billion on Technology in Tourism Industry
    • Hedge Fund Oasis Joins Asatsu Shareholders Opposing Bain Bid
    • China’s Stocks, Bonds, Currency Drop in Unison Before Congress
    • Gym of Choice for Hong Kong Financial Elite Is Said to Seek Sale
    • Don’t Panic: China’s Deleveraging May Actually Be Good for Bonds

    European equity markets trade marginally in the red, the FTSE found a marginal bid following the UK CPI data, recovering from best levels, however, still
    behaving as one of the noticeable underperformers across Europe. The CAC continues to trade near session lows,
    despite strong earrings from the likes of Danone. An opening markdown for the 10-year German debt future, largely due to reports that the more hawkish-leaning John Taylor put in
    an impressive performance when interviewed by President Trump for the role as next Fed chair. The news unsettled US
    Treasuries, and especially the short end of the curve where 2 year yields rallied to multi-year peaks alongside a jump in implied
    rates per Eurodollar contracts from the turn of next year through to 2019. A strong German ZEW report could add more
    pressure, while supply is also due via a Eur4 bn Schatz offering (though dovish ECB forward guidance on rates should
    underpin sentiment here, and reiterated by speakers to come). Back to Eurex, the range so far for Bunds has been 162.59-
    37.
    With a 3% headline print all priced in to the UK CPI data, (and in fact a bit more for many), Gilts have rebounded to a fresh intraday
    high of 124.34 (from 124.23 at best pre-data), while Short Stg futures have pared losses to just a tick. Note, comments from BoE’s
    Ramsden may also be lending some support to the 10 year bond and 3 month strip as he highlights slack in the economy, no
    second round inflation in wages and investment risks from Brexit. Note, however, y/y CPI has hit a 5 year-plus peak and November
    tightening remains a better than 50% prospect so any further bounce in debt/STIRs may be contained.
    Germany sells EUR 3.22bln vs. Exp. EUR 4bln 0% 2y Schatz Auction b/c 1.3 prev. 1.8 and average yield -0.75 prev. -0.72%,
    retention 19.5%.

    Top European news 

    • Bunds Unruffled by ECB Taper Prospects Paint a Picture of Calm
    • Italy Exercises Power Over Strategic Telecom Italia Assets
    • Lloyds Can’t Shake Troubled Past in Suit Over HBOS Takeover
    • U.K. Inflation Climbs to 5 1/2-Year High on Food, Transport
    • Brexit Timeline Pushed Back as May’s Late Push Comes Up Short
    • Credit Suisse Investor Herro Opposes Push to Break Up Bank

    In currencies, Sterling saw choppy trade following the 9.30 data, as the bid coming into the figures saw a marginal retracement. GBP/USD still trades near session highs, likely to look toward 1.33. USD: The greenback firmer by 0.2% following the move higher in US rates amid source reports stating that John Taylor (very hawkish) made a favourable impression on President Trump in regards to the Fed Chair position. The break above 93.32 (38.2% Fib retrace of the October fall) and the subsequent push through 93.40 indicates a bullish trend forming, however 93.50 is capping further gains for now. Meanwhile, the downward trend continues for EUR which ended yesterday’s session on the back foot amid the stronger greenback. Although with little key risk events until the Oct 26th ECB monetary policy decision it is possible that the pair will stay within close proximity to 1.18.

    In commodities, US Total shale regions oil production for November is seen upwards of 82,000 bpd at 6.12mln bpd WTI and Brent Crude futures have ground higher through early European trade as WTI trades through   52.00/bbl, with latest news from an IEA head stating that OPEC compliance is currently at 86%.

    Looking at the day ahead, the September industrial production print is the most notable release, while September manufacturing production and the import price index readings are also due, along with the October NAHB housing market index print. Onto other events, keep an eye on BoE Governor Carney testifying before the UK Parliament. Away from this, the ECB’s Constancio and Costa is also slated to make comments. Meanwhile EU foreign ministers hold preparatory talks ahead of the summit at the end of the week. Morgan Stanley, Goldman Sachs and IBM results are also due.

    US Event Calendar

    • 8:30am: Import Price Index YoY, est. 2.6%, prior 2.1%; Export Price Index MoM, est. 0.45%, prior 0.6%
    • 9:15am: Industrial Production MoM, est. 0.3%, prior -0.9%; Capacity Utilization, est. 76.2%, prior 76.1%; Manufacturing (SIC) Production, est. 0.2%, prior -0.3%
    • 10am: NAHB Housing Market Index, est. 64, prior 64
    • 1pm: Fed’s Harker Speaks on Equitable Transit
    • 4pm: Total Net TIC Flows, prior $7.3b deficit; Net Long-term TIC Flows, prior $1.3b

    DB's Jim Reid concludes the overnight wrap

    Last week I mentioned that the previous weekend's papers were discussing how a supposed soothsayer was predicting that the start of the end of the world would happen this past weekend. This guy predicted that from  October 15th the world will be hit with a tempest of tsunamis, earthquakes, hurricanes and then nuclear war. I dismissed this cheery forecast but if anyone took a walk around London yesterday afternoon then you'd be forgiven for thinking that the apocalypse had arrived as the overcast skies had turned an ominous dark orange. The only thing I've seen like it before was an eclipse on a cloudy day! It wasn't until I got home that I read that this was due to the bypass from Hurricane Ophelia bringing Saharan dust with it. Just to be safe I’m off to Frankfurt this morning to escape the day of reckoning.

    Maybe bonds thought the end of the world was nigh as yesterday was most notable for a strong rally in Euro Govt bonds. Core European 10y bond yields fell c3bp (Bunds -3.2bp; Gilts -3.3bp; OATs -3bp) while most peripherals outperformed, down c5bp (Italy: -5.1bp; Spain: -4.7bp; Portugal: -0.6bp). It’s not obvious to me why the dam broke yesterday, especially as US Treasuries actually climbed c1.8bp from intraday low into the European close.  Some talked about Yellen being more resolute about low inflation being transitory over the weekend than Draghi who asked for patience with regard to inflation returning to normal. It didn’t feel to me that either deviated too much from recent remarks though. It could have also been a delayed reaction to the recent inflation misses in France and Sweden and then the US last week. So not easy to pinpoint the reason. Notably, the odds of a December rate hike in US has increased back to 80% (+7ppt from Friday, per Bloomberg).

    After Europe went home we saw a flurry of activity over the next Fed Chair as Bloomberg first reported that John Taylor had impressed Trump, but that Warsh had slipped down the pecking order. A short while later it was reported that Mr Trump will meet Mrs Yellen on Thursday. Net net, yields climbed to 2.31% on the Taylor news but quickly dipped back towards 2.29% and closed 2.304% (+3bp from Friday) as the Yellen headlines came through. Mr Taylor is a renowned economist, known for his Taylor rule on rates as well as serving on the Council of Economic advisers under three presidents. Interestingly, last week he noted that “rules should (not) be used as a way to tie central bankers’ hands” as “there are reasons to run policy with a strategy”. It seems that we should have an announcement on the new Fed Chair within a few weeks so this will remain an important topic.

    This morning, bond market will see the latest round of inflation numbers with the UK the more interesting. Headline UK CPI is expected at +0.3% mom and +3.0% yoy, with core unchanged mom and +2.7% yoy. This will be the highest annual rate since April 2012 for headline and joint highest since December 2011 for core if comes in as expected (Aug. 17 was 2.7% too). The final Euro area CPI is also due but this is the final reading. The flash reading was +0.4% mom and +1.5% yoy (headline) and little change is expected. Core is expected to be +1.1% yoy and also same as the flash reading.

    Over in Catalonia, in his letter to Spanish PM Rajoy, Catalan President Puigdemont has called for more negotiations rather than clarifying whether independence was formally declared or not. He has reasserted that he has a mandate from Catalan voters to declare independence, but noted “for the next two months, our main objective is to bring you dialogue…I’m sure we can  find the path to a solution”. In response, Spain has ruled out  negotiations until Puigdemont withdrew his demands for independence, noting that he has until Thursday (10am local time) to formally respond again. Spain’s deputy PM said “the question we have asked is…not hard to answer…It’s not hard in these three days for common sense to return” and that the decision “it’s in his hands”. Should Thursday’s response be unsatisfactory, PM Rajoy could ask the Senate to hold an emergency session to invoke Article 155 and seek a suspension of the self-rule by Catalans. The Spanish markets were a bit mixed with equities down 0.75% (Caixabank -1.73%, Sabadell -2.80%), but bonds were firmer with 10y yields down 4.7bp.

    In the latest 2018 budget plan to Brussels, Spain’s Economy ministry has revised down its economic growth forecasts to 3.1% for 2017 (-0.1ppt) and 2.3% for 2018 (-0.3ppt). Elsewhere, as per Bloomberg, Spain’s National Court  as ordered the Catalan Police Chief to surrender his passport and report to the court in Madrid every two weeks.

    Turning to Brexit, there were quite a few headlines ahead of the official EU Summit meeting later this week which could make or break the current talks. Firstly, UK PM May flew into Brussels yesterday and had a “broad and constructive” working dinner with European Commission President Juncker,where they reviewed the progress made so far and “agreed that these efforts should accelerate over the months to come”, but fell short of delivering a tangible break through. Elsewhere, the FT has reported that PM May will not budge on her offer of €20bn divorce bill. Earlier yesterday, the UK Chancellor Hammond noted that a Brexit (transitional) agreement was in the interest of both sides, while PM May’s office (per Bloomberg) feared that talks are heading for a ‘catastrophic breakdown” unless EU signals a willingness to allow talks to move onto trade and transition at this week’s summit.

    On the other side, the messaging has been firmed but somewhat mixed. The latest draft of the EU summit conclusion has apparently tougher language where the UK have to make “sufficient progress” on all three key areas (the divorce bill, the Irish border and the status of EU citizens) before talks progress to trade. Elsewhere, according to EU officials (per Bloomberg), both Germany and France wants to toughen the tone on the summit declaration. This follows phone calls between PM May with Merkel on Sunday and France’s Macron on Monday. However, there is some optimism, as according to a draft paper prepared by Germany’s Foreign Ministry, it is working on proposals that include calls for the “comprehensive free trade accord” with the UK. So with all this bubbling along, we await for the EU summit later and see who blinks first.

    Staying in the UK, there were a couple of interesting headlines on house prices yesterday. Acadata & LSL suggested that London home values are now down 2.7% in the year through to September, which is the most since 2009. Elsewhere, the stockpile of unsold London homes under construction also rose to a post GFC high, with the number of properties being built or completed but yet to find buyer now at 12,952 units (+2.8% from end of last year). Notably, outside of London and Southeast England, house prices are more resilient, with average prices up c3% on the year through to September.

    Turning to Italy, the Corriere della Sera reported that the President may dissolve parliament early and potentially call for an early election on 4th March, which is c2 months earlier than the original schedule for a May election.

    Overnight, North Korea’s deputy ambassador to the UN warned that a nuclear war “may break out any moment” but “as long as one does not take…military actions against NK, we have no intentions to use…..our nuclear weapons against” others. This morning in Asia, markets are trading slightly higher. The Nikkei (+0.27%), Kospi (+0.10%) and Hang Seng (+0.18%) are up slightly while the Chinese bourses are also up marginally as we type.

    Onto yesterday’s market performance, US bourses edged higher onto another  fresh record high, with the S&P (+0.18% to 2,557.6), Dow (+0.37%) and Nasdaq (+0.28%) all up slightly. Within the S&P, modest losses were driven by the real estate and health care sectors (-0.38%), with the latter likely impacted by President Trump’s latest comments that prescription drug prices are “out of control” and that healthcare companies are “getting away with murder”.

    Elsewhere, the weakness was more than offset by solid gains from Telcos (+0.77%), financials and tech stocks. Notably, the VIX was slightly higher at 9.91 (+0.3 pts) yesterday, but has seen 15 sessions out of the last 19 below 10 now.

    Elsewhere, European markets were mixed, but little changed with Stoxx 600 flat, while the DAX (+0.09%) and CAC (+0.21%) rose marginally. Elsewhere, FTSE 100 (-0.11%) and Spain’s IBEX (-0.75%) fell modestly.

    Turning to currencies, the US dollar index strengthened 0.24% while Euro and Sterling weakened 0.20% and 0.26% respectively. In commodities, WTI oil rose 0.82% following reports of increased tensions between Iraqi and Kurdish forces which could disrupt oil supplies. Precious metals softened on the risk on bias (Gold -0.62%; Silver -1.1%), while LME copper rose 2.55% to a new 3 year high, but other base metals were slightly softer (Zinc -1.17%; Aluminium -0.88%). Elsewhere, palladium retreated 1.66% after reaching an intraday high of $1,010, which if held would have been the highest close since February 2001. Away from the markets and onto the timing of US tax reforms. Both President Trump and Senate Majority Leader McConnell have reaffirmed their aim of delivering a tax bill by December. However, Trump pointed out the last major tax reform in 1986 was achieved “mid-way” through President Regan’s second term, but “I’ve been here for a little more than nine months”. Elsewhere, Senator McConnell noted that some of the major changes under President Obama were also signed in the second year of his first term (Affordable Care Act and Dodd- Frank Act).

    Yesterday’s data releases were fairly quiet aheadof a more busy day and week ahead. In the US, the empire manufacturing survey was materially higher than consensu s at 30.2 (vs. 20.4 expected) - the strongest since  September 2014. Elsewhere, the Eurozone’s August trade surplus was slightly higher than expected at €21.6bn (vs. €20.2bn expected).

    Looking at the day ahead, a bit of a bumper day for data and particularly inflation readings with September CPI/PPI/RPI due in the UK and the final September CPI report also due for the Euro area. The October ZEW survey will also be worth keeping an eye on in Germany. In the US the September industrial production print is the most notable release, while September manufacturing production and the import price index readings are also due, along with the October NAHB housing market index print. Onto other events, keep an eye on BoE Governor Carney testifying before the UK Parliament. Away from this, the ECB’s Constancio and Costa is also slated to make comments. Meanwhile EU foreign ministers hold preparatory talks ahead of the summit at the end of the week. Morgan Stanley, Goldman Sachs and IBM results are also due.


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    Authord by Chris Whalen via The Institutional Risk Analyst,

    Almost as soon as it started, the excitement surrounding earnings for financials in Q3 2017 dissipated like air leaving a balloon.

    Source: HedgeEye

    Results for the largest banks – including JPMorgan (NYSE:JPM), Citigroup (NYSE:C) and Wells Fargo (NYSE:WFC) – all universally disappointed, even based upon the admittedly modest expectations of the Sell Side analyst cohort.

    Bank of America (NYSE:BAC), the best performing stock in the large cap group (up 60% in the past year), disappointed with a $100 million charge for legacy mortgage issues.  Despite strong loan growth, year-over-year BAC's net revenue is up about 5% but actually fell in the most recent period compared with Q2 '17.

    As with many other sectors, in large-cap financials there was little excitement, no alpha -- just slightly higher loss rates on loan portfolios that are growing high single-digits YOY.  Yet equity valuations are up mid-double digits over the same period.

    The explanation for this remarkable divergence between stock prices and the underlying performance of public companies lies with the Federal Open Market Committee.  Low interest rates and the extraordinary expansion of the Fed's balance sheet have driven asset prices up by several orders of magnitude above the level of economic growth, as shown in Chart 1 below.

    Meanwhile across the largely vacant floor of the New York Stock Exchange, traders puzzled over the latest management changes at General Electric Co (NYSE:GE), the once iconic symbol of American industrial prowess.  Over the past year, GE's stock price has slumped by more than 20% even with the Fed's aggressive asset purchases and low rate policies.  Just imagine where GE would be trading without Janet Yellen. 

    To be fair, though, much of GE’s reputation in the second half of the 20th Century came about because of financial machinations more than the rewards of industry.  A well-placed reader of The IRA summarizes the rise and fall of the company built by Thomas Edison:

    “For years under Welch, GE made its money from GE Capital and kept the industrial business looking good by moving costs outside the US via all kinds of financial engineering.  Immelt kept on keeping on. That didn't change until it had to with the financial crisis.  No matter what, untangling that kind of financial engineering spaghetti is for sure and has been a decade long process.  No manager survives presiding over that.  Jeffrey Immelt is gone.”

    Those transactions intended to move costs overseas also sought to move tax liability as well, one reason that claims in Washington about “overtaxed” US corporations are so absurd.  Readers will recall our earlier discussion of the decision by the US Supreme Court in January not to hear an appeal by Dow Chemical over a fraudulent offshore tax transaction.

    The IRS also caught GE playing the same game.  Indeed, US corporations have avoided literally tens of trillions of dollars in taxes over the past few decades using deceptive offshore financial transactions.  Of note, the Supreme Court’s decision not to hear the appeal by Dow Chemical leaves offending US corporations no defense against future IRS tax claims.

    Like other examples of American industrial might such as IBM (NYSE:IBM), GE under its new leader John Flannery seems intent upon turning the company into a provider of software.  Another reader posits that “they’re going to spend a decade selling the family silver to maintain a dividend and never make the conversion they would like and never get the multiple they want.  GE is dead money at a 4% yield, which given some investors objectives – retirees and the like -- might not be such a bad thing.”

    The question raised by several observers is whether the departure of Immelt signals an even more aggressive “value creation” effort at GE that could lead to the eventual break-up of the company.  Like General Motors (NYSE:GM), GE has been undergoing a decades long process of rationalizing its operations to fit into a post-war (that is, WWII) economy where global competition is the standard and the US government cannot guarantee profits or market share or employment for US workers.

    GE's decision this past June to sell the Edison-era lighting segment illustrates the gradual process of liquidation of the old industrial business.  Henry Ford observed that Edison was America’s greatest inventor and worst businessman, an observation confirmed by the fact that Edison’s personal business fortunes declined after selling GE.  In fact, the great inventor died a pauper.  And of the dozen or so firms that were first included in the Dow Jones Industrial Average over a century ago, GE is the only name from that group that remains today.

    But the pressure on corporate executives to repurchase shares or sell business lines to satisfy the inflated return expectations of institutional investors is not just about good business management.  The expectations of investors also reflect relative returns and asset prices, which are a function of the decisions made in Washington by the FOMC.  Fed Chair Janet Yellen may think that the US economy is doing just fine, but in fact the financial sector has never been so grotesquely distorted as it is today.

    Let’s wind the clock back two decades to December 1996.  The Labor Department had just reported a “blowout” jobs report. Then-Federal Reserve chairman Alan Greenspan had just completed a decade in office. He made a now famous speech at American Enterprise Institute wherein Greenspan asked if "irrational exuberance" had begun to play a role in the increase of certain asset prices.  He said:

    “Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy? We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.”

    In the wake of the 2008 financial crisis, the FOMC abandoned its focus on the productive sector and essentially substituted exuberant monetary policy for the irrational behavior of investors in the roaring 2000s.  In place of banks and other intermediaries pushing up assets prices, we instead have seen almost a decade of “quantitative easing” by the FOMC doing much the same thing.  And all of this in the name of boosting the real economy?

    The Federal Reserve System, joined by the Bank of Japan and the European Central Bank, artificially increased assets prices in a coordinated effort not to promote growth, but avoid debt deflation.  Unfortunately, without an increase in income to match the artificial rise in assets prices, the logical and unavoidable result of the end of QE is that asset prices must fall and excessive debt must be reduced.

    Stocks, commercial real estate and many other asset classes have been vastly inflated by the actions of global central banks.  Assuming that these central bankers actually understand the implications of their actions, which are nicely summarized by Greenspan’s remarks some 20 years ago, then the obvious conclusion is that there is no way to “normalize” monetary policy without seeing a significant, secular decline in asset prices.   The image below illustrates the most recent meeting of the FOMC.

    The lesson for investors is that much of the picture presented today in prices for various assets classes is an illusion foisted upon us all by reckless central bankers.  Yellen and her colleagues seem to think that they can spin straw into gold by manipulating markets and asset prices.  As Chairman Greenspan noted, however, “evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.”

    While you may think less of Chairman Greenspan for his role in causing the 2008 financial crisis, the fact remains that he understands markets far better than the current cast of characters on the FOMC.  Yellen and her colleagues pray to different gods in the pantheon of monetary mechanics.  As investors ponder the future given the actions of the FOMC under Yellen, the expectation should be that normalization, if and when it occurs, implies lower returns and higher volatility in equal proportion to the extraordinary returns and record low volatility of the recent past. 


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    Authored by Raul Ilargi Meijer via The Automatic Earth blog,

    Central bankers have never done more damage to the world economy than in the past 10 years. One may argue this is because they never had the power to do that. If their predecessors had had that power, who knows? Still, the global economy has never been more interconnected than it is today, due mostly to the advance of globalism, neoliberalism and perhaps even more, technology.

    Ironically, all three of these factors are unremittingly praised as forces for good.

    But living standards for many millions of people in the west have come down and/or are laden with uncertainty, while millions of Chinese now have higher living standards. People in the west have been told to see this as a positive development; after all, it allows them to buy products cheaper than if they had been made in domestic industries.

    But along with their manufacturing jobs, their entire way of life has mostly disappeared as well. Or, rather, it is being hidden behind a veil of debt. Still, we can no longer credibly deny that some three-quarters of Americans have a hard time paying their bills, and that is very different from the 1950s and 60s. In western Europe, this is somewhat less pronounced, or perhaps it’s just lagging, but with globalism and neoliberalism still the ruling economic religions, there’s no going back.

    What happened? Well, we don’t make stuff anymore. That’s what. We have to buy our stuff from others. Increasingly, we lack the skills to make stuff too. We have become dependent on nations half a planet away just to survive. Nations that are only interested in selling their stuff to us if we can pay for it. And who see their domestic wage demands go up, and will -have to- charge ever higher prices for their products.

    And we have no choice but to pay. But we can only pay with what we can borrow. As nations, as companies, and as individuals. We need to borrow because as nations, as companies, and as individuals we don’t make stuff anymore. It’s a vicious circle that globalization has blessed us with. And from which, we are told, we can escape only if we achieve growth. Which we can’t, because we don’t make anything.

    So we rely on central bankers to manage the crisis. Because we’re told they know how to manage it. They don’t. But they do pretend to know. Still, if you read between the lines, they do admit to their ignorance. Janet Yellen a few weeks ago fessed up to the fact that she has no idea why inflation is weak. Mario Draghi has said more or less the same. Why don’t they know? Because the models don’t fit. And the models are all they have.

    Economic models are more important in central banking than common sense. The Fed has some 1000 PhDs under contract. But Yellen, their boss, still claims that ‘perhaps’ the models are wrong, with it comes to inflation, and to wage growth. They have no idea why wages don’t grow. Because the models say they should. Because everybody has a job. 1000 very well paid PhDs. And that’s all they have. They say the lack of wage growth is a mystery.

    I say that those for whom this is a mystery are not fit for their jobs. If you export millions of jobs to Asia, take workers’ negotiating powers away and push them into crappy jobs with no benefits, only one outcome is possible. And that doesn’t include inflation or wage growth. Instead, the only possible outcome is continuing erosion of economies.

    The globalist mantra says we will fill up the lost space in our economies with ‘better’ jobs, service sector, knowledge sector. But reality does not follow the mantra. Most new jobs are definitely not ‘better’. And as we wait tables or greet customers at Wal-Mart, we see robots take over what production capacity is left, and delivery services erase what’s left of our brick and mortar stores. Yes, that means even less ‘quality’ jobs.

    Meanwhile, the Chinese who now have taken over our jobs, have only been able to do that amidst insane amounts of pollution. And as if that’s not bad enough, they have recently, just to keep their magical new production paradise running, been forced to borrow as much as we have been -and are-, at state level, at local government level, and now as individuals as well.

    In China, credit functions like opioids do in America. Millions of people who had never been in touch with the stuff would have been fine if they never had, but now they are hooked. The local governments were already, which has created a shadow banking system that will threaten Beijing soon, but for the citizens it’s a relatively new phenomenon.

    And if you see them saying things like: “if you don’t buy a flat today, you will never be able to afford it” and “..a person without a flat has no future in Shenzhen.”, you know they have it bad. These are people who’ve only ever seen property prices go up, and who’ve never thought of any place as a ghost city, and who have few other ways to park what money they make working the jobs imported from the US and Europe.

    They undoubtedly think their wages will keep growing too, just like the ‘value’ of their flats. They’ve never seen either go down. But if we need to borrow in order to afford the products they make in order to pay off what they borrowed in order to buy their flats, everyone’s in trouble.

    And then globalization itself is in trouble. The very beneficiaries, the owners of globalization will be. Though not before they have taken away most of the fruits of our labor. What are you going to do with your billions when the societies you knew when you grew up are eradicated by the very process that allowed you to make those billions? It stops somewhere. If those 1000 PhDs want to study a model, they should try that one.

    Globalization causes many problems. Jobs disappearing from societies just so their citizens can buy the same products a few pennies cheaper when they come from China is a big one. But the main problem with globalization is financial: money continually vanishes from societies, who have to get ever deeper in debt just to stand still. Globalization, like any type of centralization, does that: it takes money away from the ‘periphery’.

    The Wal-Mart, McDonald’s, Starbucks model has already taken away untold jobs, stores and money from our societies, but we ain’t seen nothing yet. The advent of the internet will put that model on steroids. But why would you let a bunch of Silicon Valley venture capitalists run things like Uber or Airbnb in your location, when you can do it yourself just as well, and use the profits to enhance your community instead of letting them make you poorer?

    I see UK’s Jeremy Corbyn had that same thought, and good on him. Britain may become the first major victim of the dark side of centralization, by leaving the organization that enables it -the EU-, and Corbyn’s idea of a local cooperative to replace Uber is the kind of thinking it will need. Because how can you make up for all that money, and all that production capacity, leaving where you live? You can’t run fast enough, and you don’t have to.

    This is the Roman Empire’s centralization conundrum all over. Though the Romans never pushed their peripheries to stop producing essentials; they instead demanded a share of them. Their problem was, towards the end of the empire, the share they demanded -forcefully- became ever larger. Until the periphery turned on them -also forcefully-.

    The world’s central bankers’ club is set to get new leadership soon. Yellen may well be gone, so will Japan’s Kuroda and China’s Zhou; the ECB’s -and Goldman’s- Mario Draghi will go a bit later. But there is no sign that the economic religions they adhere to will be replaced, it’ll be centralization all the way, and if that fails, more centralization.

    The endgame of that process is painfully obvious way in advance. Centralization feeds central forces, be they governmental, military or commercial, with the fruits of labor of local populations. That is a process that will always, inevitably, run into a wall, because too much of those fruits are taken out. Too much of it will flow to the center, be it Silicon Valley or Wall Street or Rome. Same difference.

    There are things that you can safely centralize (peace negotiations), but they don’t include essentials like food, housing, transport, water, clothing. They are too costly at the local level to allow them to be centralized. Or everybody everywhere will end up paying through the nose just to survive.

    It’s very easy. Maybe that’s why nobody notices.


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    The Fed is no longer even trying to hide the fact that it WANTS inflation.

    In the last month, the Fed has attempted to feign ignorance about the true nature of inflation. Fed Chair Janet Yellen even went so far as to claim the Fed doesn’t “fully understand” inflation during a Q&A session in September.

    The Fed “understands” inflation just fine, it just chooses to feign ignorance so it can maintain a “gosh, we didn’t know!” attitude about the coming inflationary storm.

    Enter Chicago Fed President Charles Evans.

    Evans, along with NY Fed President William Dudley, is the real “power behind the throne” for the Federal Reserve. Like Dudley, Evans is in charge of a branch of the Fed that is associated with one of the major financial centers of the US. In other words, he is a Fed President with close ties to the financial firms that call the shots for the US financial system.

    This allows Evans to speak more bluntly than most Fed President. And when he talks, you know he is doing so with the full backing of the Chicago financial elite.

    With that in mind, consider Evans’ recent statement on inflation.

    Fed's Evans: An increase in U.S. inflation is a priority

    Chicago Federal Reserve Bank President Charles Evans said on Friday that the U.S. central bank’s priority must be to get inflation back to its 2 percent target…

    The first order thing for policy right now is to get inflation up to our objective,” Evans said at a financial literacy event in Green Bay, Wisconsin.

                Source: Reuters

    As we’ve already noted, the Fed is well aware that inflation is already well above its 2% target. But with the US financial system sporting some $60 trillion in debt total (including all sectors of the economy) the Fed has no choice but to keep "papering over" these debts. Small wonder then that even the Fed's own "sticky inflation" measure has been rising steadily since 2010 and is already clocking in well over 2%.

    Put simply, BIG INFLATION is the THE BIG MONEY trend today. And smart investors will use it to generate literal fortunes.

    We just published a Special Investment Report concerning FIVE secret investments you can use to make inflation pay you as it rips through the financial system in the months ahead.

    The report is titled Survive the Inflationary Storm. And it explains in very simply terms how to make inflation PAY YOU.

    We are making just 100 copies available to the public.

    To pick up yours, swing by:

    https://www.phoenixcapitalmarketing.com/inflationstorm.html

    Best Regards

    Graham Summers

    Chief Market Strategist

    Phoenix Capital Research

     

     


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    In the latest update on Trump's search for the next Fed Chair, Reuters reported that the search has narrowed down to 5 finalists - Yellen, Warsh, Taylor, Powell and Cohn (condolences to Jeff Gundlach: his dark horse candidate, Neel Kashkari did not make the cut) - and that after meeting Yellen on Thursday, Trump will have discussed the Fed job with all five candidates. More importantly was the news that Trump is expected to announce his decision for next Fed Chair in the next 2 weeks, before he leaves for his Asian trip on November 3.

    • YELLEN, WARSH, TAYLOR, POWELL AND COHN ALL CANDIDATES FOR FED CHAIR -WHITE HOUSE OFFICIAL
    • FED CHAIR SEARCH NOW NARROWED TO FIVE FINAL CANDIDATES, WHITE HOUSE OFFICIAL SAYS
    • AFTER YELLEN MEETING, TRUMP WILL HAVE DISCUSSED FED JOB WITH ALL FIVE FED CANDIDATES -WHITE HOUSE OFFICIAL
    • TRUMP EXPECTED TO ANNOUNCE FED DECISION BEFORE HE LEAVES FOR ASIA TRIP NOV. 3 -WHITE HOUSE OFFICIAL

    Yesterday, the USD and bond yields turmoiled briefly following news that Trump had warmed to the candidacy of San Fran professor John Taylor, father of the Taylor Rule and advocate of rules-based monetary policy, and who is widely perceived as a mega hawk. The news sent the USD surging and hit bonds.

    That said, Taylor's hawkishness appears to have worked against him, and after surging to 2nd spot on Predictit yesterday, Taylor was tumbled to 4th spot this morning.

    That said, Taylor's hawkish reputation may be unwarranted. As SocGen's Kit Juckes wrote this morning, what rate the Taylor Rule indicates is dependent on a variety of assumptions. To wit:

    President Trump is reported to have taken away a favourable impression of John Taylor after he met the Stanford University economist and inventor of the ‘Taylor Rule'. As the President ponders who to appoint as the next Fed Chair, he now only has Janet Yellen to meet with, and Professor Taylor is the new market favourite. That, in turn, has given the dollar a bit of support and sent yields a bit higher as everyone contemplates what the Taylor Rule would imply for monetary policy. It's generally concluded that a rules-based approach would deliver higher rates faster than we would see under the current policy framework.

     

    Anyone armed with a Bloomberg terminal can type in TAYL GO and see where a Taylor rule estimate of appropriate rates is, and if they want, they can play with the critical elements of the rue - the estate of ‘neutral' real rates, NAIRU, and the inflation target. On the basis of a 2% neutral real rate, and a 4% NAIRU, the Fed is a long way behind the curve, which may be reason enough to think that a Taylor Fed would be more hawkish. On the other hand, lower the NAIRU (which may be reasonable given what we've seen from the labour market data in recent years) and you can get that estimate down. A 3% NAIRU throws out a 1.5% Funds rate, for example. And if Professor Taylor really wants to fine-tune his rule, he can head down the road from Stanford to the San Francisco Fed, 36 miles away, and have a chat with Stanford alumni and head of the San Francisco Fed, John Williams. He developed an estimate of neutral rates with Thomas Laubach, which moves over time and is currently at -0.2%. See Professor's comments on a debate about that here . Plug Williams-Laubach's R* into Bloomberg's TAYL function with a 4% NAIRU and rates ‘should' be 0.5%. Now cut NAIRU to 3% and we're at -0.75%. By way of indication, I've plotted some variants of this below, though I haven't adjusted the Wiliams-Laubach R* all the way through the time series so they are only relevant in the recent past. The lesson is clear however - the rule's just a rule, it's how it's used that matters.

     

    Choose your rule - but neither R* or NAIRU are necessarily constant through time

    For now, however, Taylor's hawkish reputation precedes him, and - for a president who realizes he needs rates as low as possible for as long as possible - that will hardly boost Taylor's application. In fact, as we noted yesterday, the most likely outcome at this point is that Trump simply asks Yellen to continue for one more term.


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    As the end of Federal Reserve Chairwoman Janet Yellen’s first term approaches, financial markets are beginning to digest the increased likelihood that US President Donald Trump will opt to appoint a more hawkish individual to the position.  Even though the Federal Reserve is largely expected to continue tightening monetary policy over the coming months as it pares down the balance sheet and contemplates a dovish hike, Trump’s appointment could send shockwaves through the housing market. 

    One of the nastier side effects of operating at or near the zero-bound for interest rates has been the rapid expansion of asset valuations.  Lower interest rates encourage individuals and companies to finance their purchases and then reinvest for more aggressive returns. However, this rapid valuation expansion has not been limited strictly to financialized assets, but also physical assets like real estate.  When seen in the context of the more hawkish leanings of Trump’s recent Fed Chair interviewees, the Administration’s next Fed appointment could pose the risk of a serious correction across asset classes.

    Fed Frontrunners Exhibit More Hawkish Bent

    Financial news outlets have been rife with reports covering the potential picks for Fed Chairman, with two of the leading candidates including Economist John Taylor and former Federal Reserve Governor Kevin Warsh.  Taylor, who currently serves as an economics professor at Stanford University, received high marks from Trump according to a Bloomberg report on the matter.  Trump was purportedly very impressed with his credentials, though unlike other candidates, Taylor is among the fiercest advocates of having policy measures closely reflect economic conditions.  

    The “Taylor Rule”, titled after the economist, stipulates rates should rise when inflation is running at an elevated pace or unemployment is below the “full employment” threshold and should fall in the opposite scenario.  Applying this set of rules to current economic conditions indicates that the key Fed Funds rate should be 3.74% to reflect high levels of employment and rising prices.  At nearly 3 times the present rate, a selection of John Taylor to chair the Fed could rapidly dampen overextended valuations in equities and the housing market.  Already his interview with Donald Trump caused a palpable dip in gold prices considering his overtly hawkish stance.

    By comparison, Kevin Warsh has also advocated for a tighter monetary policy regime, greater deregulation, and a general makeover of the Central Bank.  His attitude towards reform has won him positive mentions as well.  However, his overall degree of hawkishness and stated desire to overhaul the inflation target could put him at the epicenter of a dramatic policy shift that departs from the more cautious approach of current Chair Janet Yellen.

    Factors Outside the Fed’s Control

    While easy to label the rebuilding efforts in Texas and Florida as positive for the overall housing market, this deals more with the supply angle than demand.  On the buy side, a Fed determined to raise interest rates will assuredly presage rising mortgage costs which could in turn subject buyer interest to some downside as financing costs climb.  Though it is tempting to cite the foreclosure rate at an 11-year low as a sign of strength, it does not necessarily imply that the housing market is on stable footing, especially as prices reach past the realm of affordability.

    Considering income growth has kept nowhere near the same pace as price growth for homes according to the monthly Case-Shiller home price index, the lack of affordable solutions may be another factor that hurts demand and concurrently weighs on pricing.  For the year through July, average hourly earnings climbed by 2.50% while housing prices of 20 major US metropolitan areas increased by 5.80% over the same period. With price growth outpacing wages by such a significant margin, the surge in values should be a worrying sign for prospective buyers thinking about diving in while mortgage rates remain not far from record lows.

    However, a more concerning indication apart from unaffordability is the degree to which flipping has reemerged.  The move is eerily reminiscent of the years leading up to the last financial crisis as lending standards are relaxed.  House flipping reached the highest point since 2007 during the second quarter of 2017 and nearly 35% of the transactions were accompanied by mortgages.  Even Goldman Sachs is getting into the flipping game with its recent acquisition of Genesis Capital LLC, a move designed to help the institution build a bigger presence in the lending sphere.  Should mortgage rates rise in tandem with interest rates, it could spell doom for this substantial portion of residential real estate activity.

    The Fed as the Deciding Factor

    With the shortlist for the next Federal Reserve Chair realistically narrowed down to 5 candidates, those under consideration for the job have significantly more hawkish leanings than current Chair Janet Yellen and her predecessor Ben Bernanke.  While ultimately housing prices are a function of the interaction of supply and demand, demand largely behaves inverse to interest rates.  As rates climb, mortgage costs will echo the gains, potentially reducing interest.  Should demand fall, housing prices are likely to experience a correction as well after a near 8-year unabated rise in values.  Considering the unaffordability aspect and the degree of house flipping, the approaching Fed appointment has a higher propensity to cause a downturn compared to another leg of the ongoing housing market rally.

     

     


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    World stocks stayed near peaks and currencies moved in tight ranges on Wednesday as China’s 19th Communist Party Congress opened while focus in Europe turned to speeches from top euro zone central bankers before next week’s key policy meeting, as well as Catalonia's ultimatum due on Thursday. S&P futures are solidly in the green as usual, with Dow futures jumping above 23,000, driven higher by IBM as investors looked for new reasons to extend gains after hitting new all-time highs Tuesday. The dollar continues to strengthen, buoyed by speculation that the next Federal Reserve chair will be more hawkish, as volatility in major currencies fell to a three-month low, while Treasury yields rose. 

    Among the factors contributing to today's burst of risk on buying is the continued bid in USD, which has forced markets into hybrid risk-on mode according to Bloomberg. EUR/USD and GBP/USD push through yesterday’s session lows, which consequently supports domestic equity markets via exporters and multinationals. Rally in USD/JPY pressures USTs, dragging down core fixed-income markets; UST/bund spread wider by 1.6bps. U.S. equity futures also supported, Dow futures test 23,000; crude futures hold small gains after bullish API data.

    European stocks are on fire, with the Stoxx 600 heading for its biggest rise in 2 weeks as the euro weakened for a fifth day on speculation the ECB will remain accommodative even as it tapers asset purchases, while volatility slid; the Stoxx 600 gained 0.4% while euro falls back to $1.1750 and VStoxx hits intraday record low. Technology, food and beverage best performers among industry groups, all 19 sectors in green; DAX hit another record high. The European vol index, the VStoxx dropped as much as 8% to 10.7, the lowest level on record. bond yields fell ahead of a series of speeches from top European Central Bank officials before next key policy meeting on Oct. 26.

    Looking at European stocks, BNP Paribas Wealth Management CIO Florent Brones said that “there are many positive elements supporting the euro-area stock market at this point, and while the market has been rallying, we’re not yet seeing double-digit gains.”

    European Central Bank chief Mario Draghi, Chief Economist Peter Praet and Executive Board Member Benoit Coeure are among those officials scheduled to speak. First remarks from Draghi at a conference in Frankfurt had limited initial market impact. “Today, bond market investors will probably concentrate exclusively on the various ECB speakers, who could influence market expectations for the last time ahead of next week’s meeting,” said ‎BayernLB rate strategist Alexander Aldinger.

    The MSCI’s Asia-Pacific index ex Japan was flat, near its late 2007 peak after China President Xi Jinping kicked off the twice-a-decade party congress with a wide-ranging speech, in which he warned of “severe” challenges while laying out a road map to turn the country into a leading global power by 2050. Investors are watching to see whether Xi will push through tough reforms as the world’s second-largest economy faces structural challenges over the next five years. Jinping said the market would be allowed to play a decisive role in allocating resources but also said the role of the state in the economy had to be strengthened.

    “His speech offered nothing to move the markets in Asia,” ‎Bayern LB’s Aldinger also said. Investors are looking for clear direction on economic and financial market reform over the next five years, but as has been the case in history, the actual speech was light on detail.

    China's CSI300 index added 0.8 percent in reaction, while Shanghai stocks rose 0.3 percent. “Market participants are paying much more attention to the party congress this time, as they are watching if any surprise reforms will emerge amid concerns over economic growth,” said Yan Kaiwen, analyst with China Fortune Securities.

    Still in Asia, Japan's Nikkei rose for a 12th consecutive day, getting a lift from hopes that this weekend's election will produce political stability and continuation of loose monetary policy even as technical indicators suggest the gauge is overheating. An opinion poll by Kyodo showed Japanese Prime Minister Shinzo Abe’s coalition was on track for a roughly two-thirds majority in Sunday’s general election there. The 14-day relative strength index stood above 70 - a level frequently seen as overbought - for an eighth day, while the Toraku Index, a barometer of momentum, climbed to 128, far higher than the 120 level that signals the Topix is poised to fall.

    “The Japanese stock market may be on alert for high prices and stay in a narrow range,” said Mitsushige Akino, an executive officer with Ichiyoshi Asset Management Co. in Tokyo. “Yet business sentiment is on a firm footing not only in the U.S. but also globally.” Pharmaceutical stocks and automakers were among the biggest boosts to the benchmark gauge, while banks and services companies weighed the most. About two stocks fell for every one that rose. The Nikkei 225 Stock Average extended its winning streak, the longest since June 2015, boosted by Fast Retailing Co. and Astellas Pharma Inc. The Topix has gained 2.5 percent in an 8-day rally, boosting its advance this year to almost 14 percent. It trades at 15.3 times estimated profits for the next year, well below the high of 20.5 reached in March 2013 and compared with the S&P 500 Index’s 19.4 times. “Valuations are low, both compared to other global markets and particularly so when taking account of the 0% yield on 10yr government bonds,” said Nicholas Smith, a strategist at CLSA Ltd. in Tokyo. “Sure, over the short-term it might have a pullback, but I think the fundamentals are excellent and the market is pricing in the decreased uncertainties that go with Abe stronger for longer.”

    In currencies, the dollar edged up amid speculation President Trump could chose a more hawkish leader to replace Federal Reserve Chair Janet Yellen, while investors awaited for any news on progress on U.S. tax reforms.The dollar index rose 0.07 percent to 93.54, extending a rebound from Friday’s 2 1/2-week low of 92.749. It rose as high as 93.729 on Tuesday. The onshore yuan predictably strengthened against the dollar as the 19th Party Congress began in Beijing while the U.S. Treasury’s twice-yearly report softens China FX criticism. The PBOC injected a net 270 billion yuan of liquidity helping the Shanghai Composite 0.3% higher. Australian 10-year yield drops to a one-month low of 2.72% as the curve extends bull-flattening; Treasuries steady. Canadian dollar outperforms G-10 peers after Nafta negotiators agree to extend talks into next year; kiwi slips following weaker Fonterra milk price auction. WTI crude holds above $52; Dalian iron ore futures gain 2.2 percent

    In Europe, the euro was holding at $1.17, still some way above the recent low and major chart support at $1.1667, as dealers awaited speeches by several policymakers from the European Central Bank due later on Wednesday, which includes President Mario Draghi. Some risks linger: Catalonia has until Thursday to back down from its secession push. Investors were reminded of the economic cost of the crisis when Spain, the euro-region’s fourth-biggest economy, cut its growth forecasts for next year. The Catalan standoff is one of several political risks facing investors in Europe, including high-stakes coalition talks that began Wednesday in Germany between Angela Merkel’s Christian Democrats and potential partners to lead Europe’s biggest economy.

    Overnight, the biggest mover was the Mexican peso which boasted its biggest rise in over four months after trade ministers from the United States, Canada and Mexico extended the deadline on a contentious round of talks.

    In commodity markets, talk the next U.S. Federal Reserve chief may be a policy hawk kept gold pinned down $1,283.01 an ounce. Oil prices were lifted by a fall in U.S. crude inventories and concerns that tensions in the Middle East could disrupt supplies. Brent crude futures were at $58.31, up 0.4 percent from their last close - and almost a third above mid-year levels.

    Rates markets remain paralyzed with barely any moves across the bond complex: the yield on 10-year TSYs rose 3 bps to 2.33% , the highest in a week; Germany’s 10-year yield gained two basis points to 0.39 percent, while Britain’s 10-year yield advanced two basis points to 1.276 percent.

    The Fed’s Beige Book and earnings from American Express, EBay and Alcoa will be in focus today.

    Bulletin headline summary from RanSquawk

    • European equities higher, with IT outperforming
    • CAD and MXN notably firmer after NAFTA ministers agreed to extend negotiations into 2018.
    • Looking ahead, highlights include US Housing Starts and comments from Praet and Coeure.

    Market Snapshot

    • S&P 500 futures up 0.1% to 2,559.50
    • VIX Index trading 0.3% lower at 10.28
    • STOXX Europe 600 up 0.4% to 391.35
    • MSCI Asia down 0.01% to 167.44
    • MSCI Asia ex Japan up 0.01% to 552.36
    • Nikkei up 0.1% to 21,363.05
    • Topix up 0.07% to 1,724.64
    • Hang Seng Index up 0.05% to 28,711.76
    • Shanghai Composite up 0.3% to 3,381.79
    • Sensex up 0.1% to 32,656.28
    • Australia S&P/ASX 200 up 0.01% to 5,890.48
    • Kospi down 0.06% to 2,482.91
    • WTI Crude up 0.3% to $52.05
    • Brent futures up 0.68 to $58.35/bbl
    • Gold spot down 0.2% to $1,282.88
    • U.S. Dollar Index up 0.1% to 93.60
    • German 10Y yield rose 0.6 bps to 0.371%
    • Euro down 0.06% to $1.1759
    • Italian 10Y yield fell 3.4 bps to 1.732%
    • Spanish 10Y yield rose 2.8 bps to 1.575%

    Top Overnight News

    • Xi Jinping warned of “severe” challenges while laying out a road map to turn China into a leading global power by 2050. The nation will continue opening its doors to foreign businesses and strengthen financial sector regulation
    • The U.S. softened FX criticism for China, lauded it for acting to avoid a “disorderly” depreciation and then allowing the yuan to rise against the dollar this year. The Treasury Department said no major trading partner is manipulating its currency to gain an advantage in trade
    • Senators from both political parties said a bipartisan deal was reached to stabilize Obamacare, just two weeks before Americans start signing up for 2018 coverage
    • Nikki Haley, the U.S. ambassador to the United Nations, will use a Wednesday Security Council meeting to seek world attention on Iran’s actions in the Middle East in an early test of whether President Donald Trump’s toughening position on the Islamic Republic is alienating allies and leaving the U.S. isolated internationally
    • The SEC is preparing to provide formal assurances to Wall Street by telling financial firms they won’t have to overhaul their operations to comply with sweeping new European rules on investment research, three people familiar with the matter said
    • With monetary policy being accommodative, there is a window of opportunity for economic reforms, European Central Bank President Mario Draghi said as he spoke on Wednesday
    • Dollar continued to strengthen helped by speculation that the next Federal Reserve chair will be more hawkish; Trump’s choice will be unveiled before he leaves Nov. 3 for an 11-day trip to Asia and Hawaii, a person familiar with the process said Tuesday
    • Spanish Deputy PM: Spanish government will take control of Catalonia unless the regional leader withdraws his claim to independence by 10 a.m. on Thursday
    • Housing starts and building permits for Sept. will be announced and the U.S. Federal Reserve releases its Beige Book

    Asia equity markets traded marginally positive following a similar picture in the US where all indices extended on record levels, in which the DJIA briefly surmounted the 23,000 milestone for the 1st time ever. The mild momentum from the historical feat in US carried over to Asia which saw ASX 200 (+0.1%) briefly above 5,900 and at its highest in almost 6 months, while Nikkei 225 (+0.1%) also eked minor gains. Hang Seng (Unch) and  Shanghai Comp. (+0.3%) were kept afloat after a continued substantial liquidity operation by the PBoC, although upside was capped as focus remained on the 19th CPC National Congress which opened today. Finally, 10yr JGBs were flat amid a lack of drivers and with demand restricted by a mildly positive tone in Japan and a tepid BoJ Rinban announcement for JPY 400bln of JGBs. Chinese President Xi delivered address at the opening of the 19th CPC National Congress in which he said China will continue to reduce overcapacity and that China will deepen interest rate and FX reform. President Xi also commented that China will lower barriers of entry for foreign businesses and that GDP is to increase to CNY 80tln from CNY 54tln over the next half-decade.

    Top Asian News

    • Topix Holds Near 10-Year High as Indicators Signal Overheating
    • Japan Equity Movers: Ichiyoshi Securities, Matsuya, Toho Zinc
    • Espenilla Vows Philippines Won’t Overheat, Peso Is Under Control
    • Xi Imagines China in 2050: Highlights From His Three-Hour Speech
    • Europe Aviation Agency Warns on Kobe Steel as Scandal Deepens
    • China Sells Bonds at Cost Lower Than Forecast as PBOC Adds Cash

    European bourses were relatively directionless early in the session, although they have since picked up some upward momentum, with the Stoxx 600 up 0.4%. Focus this morning has been on the latest batch of earnings releases, particularly from the some of the Dutch large caps, with Akzo Nobel announcing a second profit warning this year, while ASML Holding also announced a weak earnings update. EGBs softer across the board, the belly of the German curve noticeably underperforming with the yield up 2bps. Focus will be on the German auction in the long-end.

    Top European News

    • U.K. Jobless Rate Stays at 42-Year Low Amid Strong Labor Demand
    • ECB Bond Program Survives Another Challenge at German Court
    • ECB’s Draghi Sees ‘Window of Opportunity’ for Economic Reforms
    • ECB Set-Up in Euro Bonds Underway as Market Sees QE for Longer
    • Bond Calls Clash at JPMorgan, Morgan Stanley Before ECB Tapering
    • Saenz Says Spain Will Apply Art. 155 if Catalans Don’t Comply

    In FX, the dollar index caught a bid overnight and throughout the morning session, trading back above 93.50. This comes off the back of yesterday’s reports that the US President could be swaying towards, noticeable hawk, John Taylor as Janet Yellen’s successor, with the announcement expected before Trump’s department for Asia on November 3rd. NAFTA reports were a theme of yesterday’s US session, as early source reports indicated that Canada and Mexico were said to reject US NAFTA proposals. However, as the story developed, later comments took focus, stating that ministers had agreed to extend negotiations into 2018. Following the initial reports, USD/CAD hit 1.2590, however, over the following hours, the move was reversed, as the pair broke through 1.25, hitting lows through 1.2490. USD/MXN saw similar price action, after firstly moving to highs of 19.1500, the pair came back to trade at lows of 18.7300. Sterling trades subdued, following the bearish BoE commentary seen yesterday. GBP/USD took a slight move higher following the release of the UK jobs reports, however this was quickly pared given that wages had slowed from the prior month. GBP/USD has consolidated through 1.32, with EUR/GBP running into a slowdown at 0.8930, now behaving as the weekly high.

    In commodities, West Texas Intermediate crude increased 0.3 percent to $52.04 a barrel, the highest in three weeks.  Gold dipped 0.4 percent to $1,280.13 an ounce.

    Looking at the day ahead, data will likely play second fiddle with the most notable releases being August/September employment data in the UK and September housing starts and building permits data in the US. The Fed’s Beige Book is also due out in the evening. Corporate earnings results on Wednesday include eBay and American Express

    US Event Calendar:

    • 7am: MBA Mortgage Applications, prior -2.1%
    • 8am: Fed’s Dudley and Kaplan Discuss Economic Development
    • 8:30am: Housing Starts, est. 1.18m, prior 1.18m;  Building Permits, est. 1.25m, prior 1.3m
    • 2pm: U.S. Federal Reserve Releases Beige Book

    DB's Jim Reid concludes the overnight wrap

    China’s 19th Party Congress is front and centre today with headlines developing as we type. In his opening speech, President Xi Jinping started with the opening remark that “the prospects are bright while the challenges are also grave”, before reminding his audience of his achievements over the past five years, which included: poverty reduction, strengthening the one party rule, national security, cutting down pollution and the Belt and Road infrastructure initiatives. Further, his anti-graft drive has achieved an “important and irreversible’ momentum and he insisted that China has ‘zero tolerance” on corruption. On the long term, he wants to set the agenda for the country to be “a modern, socialist power” by 2050. On the economy, he says the liberalisation of both interest rate exchanges will continue as "the door China opened will not close but will open wider and wider". Elsewhere, he wants China to make the "quality and efficiency" of growth a priority and deepen supply side reforms as well as insisting on the need to reduce excessive capacity and debt ratios. On housing, he said "houses are for people to live in, not for speculation" and he promised to provide more homes through a variety of different channels. Before his formal address, Deputy central bank chief Pan also noted that he expects that the Yuan will have a more secure foundation after the congress allowing the central bank to push exchange rate market reforms.

    This morning in Asia, markets are trading marginally higher. The Nikkei (+0.12%), Hang Seng (+0.01%) and Chinese bourses (+0.2% to 0.5%) are up slightly, while the Kospi is down -0.12% as we type. For those who have missed it, our China Chief Economist Zhiwei Zhang published a prior note previewing the 19th National Congress meeting. Zhiwei notes that this week-long event actually kicks off a six-month process that continues with the Central Economic Working Conference (CEWC) in December and the National People’s Congress (NPC) in March next year. He notes that the current event is more about politics than setting economic policies, as the representatives will elect a group of leaders. Based on the age rule, five of seven incumbent members of the Politburo should retire as they are older than 67. Other important things to look out for include the CEWC setting GDP growth targets, while finally, the NPC will see a reshuffle of cabinet ministers and government posts.

    Over to the US, and the search for the next Fed Chair is apparently very close, with an announcement potentially as soon as 3 November according to sources familiar with the selection process (per Bloomberg). Earlier, Trump told reporters that “within those five (candidates) you’ll get the answer” and that “honestly I like them all”. The five candidates he is referring to are Mrs Yellen, Kevin Warsh, John Taylor, Jerome Powell and Gary Cohn. Elsewhere, Trump continued to rally support for his tax reforms, this time speaking at the Heritage Foundation and reiterating the need for lower corporate tax rates and that “let’s give our country the best Christmas present of all – massive tax relief”.

    Turning to the UK, Gilts outperformed yesterday with 10y yields down 6.1bp (Bunds -0.8bp, OATs -1bp; UST -0.3bp) but GBPUSD fell 0.46% following the combination of Brexit headlines and a slightly less hawkish tone from  central bankers. Firstly, in BOE Governor Carney’s testimony to UK lawmakers, he has reiterated that the “majority of the committee (believe) some raise in rates over the coming months may be appropriate”, in part as the UK economy is running out of spare capacity. However, other new MPC members seem a bit less hawkish, with Deputy Governor Ramsden saying “I still think there is some slack in the economy” and noted he was not part of the majority of MPC members pushing for a rate increase. Elsewhere, Tenreyro noted that “we’re approaching a tipping point at which it would be necessary to remove some of that stimulus” but her decision on rates in the coming months will depend on how the economy evolves. Finally, Carney noted the “very limited amount of time” between now and March 2019 and that the Bank was preparing for the possibility of a “hard Brexit” without a transition period, although he conceded that an “agreement is in everyone’s interests”. The next BOE meeting is on 2 November and the odds of a rate hike fell 1.5ppt to 80.6% (per Bloomberg).

    Over to Brexit talks, where the stalemate has continued with rhetoric suggesting a reduced chance of a breakthrough at the EU Summit later this week. The EU negotiator Barnier noted Monday’s dinner with UK PM May has  yielded little and that “we are ready to accelerate the rhythm, but to accelerate you need two”. On the other side, UK negotiator Davis has signalled his side is unlikely to make more offers until after the EU Summit, noting “let’s wait and see what they are before we make the next move” and that “we’re reaching the limits of what we can achieve without considerations of the future relationship”. That said, there is still hope, with the Council of the EU reportedly working on preparatory work on the future relationship with UK and aim to have a roadmap ready by December, although this is contingent on the EU deciding that UK has made sufficient progress on the divorce bill issue. Elsewhere, perhaps the Irish PM summed it up well, saying “it’s quite a difficult negotiation when people who want to leave EU in the UK don’t really seem to agree among themselves with what that actually means”. So for now, we continue to wait and see which side blinks first.

    Onto yesterday’s market performance, the Dow edged (+0.18% to 22,997) higher and touched an intraday high of 23,002, which was the sixth time the index passed a 1,000 increment in the last 12 months. Elsewhere, Nasdaq was broadly flat while S&P 500 rose +0.07%. Within the S&P, the healthcare sector rebounded (+1.31%) following a bipartisan deal to allow insurance subsidies for Obamacare to resume, while modest losses were led by the consumer staples and financials sector (-0.55%). Both Goldmans and Morgan Stanley’s results beat consensus with weaker trading income mainly offset by stronger revenue from investing and lending units (GS) and wealth management (MS) respectively. However, the share price performance diverged slightly with MS +0.37% and GS -2.61% on the day. Notably, the VIX rose above 10 yesterday (+0.4pts to 10.31).

    European bourses were broadly softer, with the Stoxx 600 (-0.25%), DAX (-0.07%) and FTSE (-0.14%) down slightly, while Spain’s IBEX was the one of the few higher (+0.35%). Turning to currencies, the US dollar index  strengthened 0.20% while the Euro and Sterling fell 0.25% and 0.46% respectively. In commodities, WTI oil was broadly flat (+0.02%) yesterday but is trading slightly higher this morning, as tensions between Iraqi and Kurdish forces have reduced. Precious metals softened for the second consecutive day (Gold -0.82%; Silver -1.11%), while Copper retreated (-1.14%) from its 3 year high and other base metals (Zinc -3.07%; Aluminium -0.82%) also fell.

    Turning to other central bankers commentaries. In the US, the Fed’s Harker told the WSJ that he thinks one more rate hike is appropriate this year, but warned “we just have to be prudent and take our time” with his view dependent on the inflation readings. The Fed’s Kaplan reiterated his views, noting that softer inflation readings recently “may well be transitory” and that “it’s likely we’ll see greater evidence of this progress (rising inflation), so “as a consequence, it will be appropriate to continue the process of gradually removing monetary accommodation”. Elsewhere, he pointed out that the change in fiscal policy and structure reforms “could provide upside” for US economic growth.

    In Europe, ECB VP Constancio noted that the euro area is "more resilient" than last year", but that "in the present configuration of risks….(we) will have to take macro prudential policy much more seriously or they will face the risk of other financial crises that monetary policy cannot prevent.” Elsewhere, he noted that monetary policy, even when recalibrated, “will continue to keep a very accommodative stance”.

    Finally, back onto a topic that has gone quiet for a while. As per the Politico, special counsel Mueller’s team has interviewed President Trump’s former press secretary (who left in August) Sean Spicer back on Monday. He has been previously tasked with investigating potential Russian interference in the 2016 US Presidential election. For now, we await what eventually comes out from these investigations.

    Before we take a look at today’s calendar, we wrap up with other data releases from yesterday. In the US, the September IP was in line with market expectations at 0.3% mom (up for the first time since June), but the prior month reading was revised upwards by c0.2ppt. Elsewhere, the capacity utilization was slightly softer at 76% (vs. 76.2% expected). The September import price index came in higher at 0.7% mom (vs. 0.6% expected) but was partly offset with the export price index at 0.8% mom (vs. 0.5% expected). Finally, the NAHB housing market index was stronger than expectations at 68 (vs. 64).

    In the UK, the macro data was broadly in line with consensus. The September CPI was in line at 0.3% mom and 2.7% yoy (for core CPI) – steady on August and the joint highest since December 2011. The PPI was also in line at 0.2% mom and 3.3% yoy. Elsewhere, the RPI was slightly lower than expected at 0.1% mom (vs. 0.3%) and 3.9% yoy (vs. 4.0% expected), along with the house price index at 5% yoy growth (vs. 5.4% expected). Across Europe, the final reading of the Eurozone September CPI was unchanged at 0.4% mom and 1.5% yoy. Germany’s ZEW survey of the current situation was slightly lower than expected at 87 (vs. 88.5) along with expectations at 17.6 (vs. 20 expected). Finally, the October Eurozone ZEW survey on expectations continued to weaken from the recent peak back in June (37.7) to a still reasonable level of 26.7.

    Looking at the day ahead, the ECB’s Draghi, Coeure and Praet are all taking part at a Conference in Frankfurt. The Fed’s Dudley and Kaplan are also due to speak in the afternoon. Data will likely play second fiddle with the most notable releases being August/September employment data in the UK and September housing starts and building permits data in the US. The Fed’s Beige Book is also due out in the evening. Corporate earnings results on  Wednesday include eBay and American Express.


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  • 10/18/17--08:50: Happy Black Friday
  • Amsterdam | As the financial world happily fixates on who will be the next Fed Chairman, I am in Europe celebrating the 30th anniversary of Black Friday, October 19, 1987. Three decades ago, I was on a trading desk at Bear, Stearns & Co in London along with David, Joey, Gregory, Peter and Paul, among others. We had just finished a remarkable four year run, but the party was over.

    That fateful day, our Treasury/MBS trader Matt got his eyes ripped out early in the day. His big mistake was answering the phone. Investors lifted every offer for US Treasury paper to be found. We were short a couple of bucks before 10 AM with no offers to be found. We stopped answering the phone way before lunch. Fortunately, we had large sell orders from several Japanese insurance companies so by the close Matt was flat and went home to have a couple of well-deserved pints.

    This story is relevant today because the markets seem to have forgotten how it feels to be physically molested without the protection of Mother Fed. As I told Frank W. from Handelsblatt earlier today, the crash in 1987 was the last financial crisis where the private markets were allowed to function without government support. We had manipulated markets when I worked at the Fed of New York, but only on the margins.

    Since 1987, however, the US government (i.e. the Federal Reserve) has turned market stability into an entitlement. The degree of government intervention in the markets has grown enormously since Black Friday 1987, with no authority or even acknowledgement from Congress, begging the question as to whether the United States can any longer be described as a free-market democracy.

    Whether we admit it or not, the global markets are in the hands of a cadre of “experts” at the various central banks, who make decisions based upon private deliberations and questionable reasoning. The markets depend upon these experts to provide the expected stability, making the entire financial system more fragile today than ever before. Neither capital nor even market intervention by central banks is the issue here. The currency of financial stability is, more than ever before, confidence. And the people who are piloting the starship have not a clue what they are doing.

    Case in point, the FRBNY is conducting “stress tests” on how the sale of mortgage backed securities will impact the markets. The tests are tiny, double digits millions of dollars. The fact that the Fed is even doing this illustrates not only the fragility of the financial markets, but the lack of understanding and familiarity that the FRBNY has with the markets it is supposed to surveil. With Treasury 2s to 10s at the narrowest spread ever, one has to wonder just what the Fed is waiting for in terms of portfolio sales. See chart below c/o Ed Harrison. 2s to 10s Fact is, the Fed is in a special trap of its own design. By continuing the process of QE (that’s “quantitative easing” in FedSpeak) beyond the first round in 2010, the central bank skewed the credit markets to an enormous degree and, in the process, boosted asset prices for everything from stocks to bonds to commercial real estate. The rally in stocks is all about cheap credit.

    Naturally, the Fed cannot “normalize” interest rates (and credit spreads) unless it first sells a large chuck of the $3.8 trillion in securities on its book. But Janet Yellen & Co on the FOMC, know now that they have screwed up large by continuing with QE after 2010. Naturally they are reluctant to admit this error. Like the Church of Rome, the Fed is never wrong. And Yellen is afraid to put the proverbial magic bus into reverse for fear that both stock and bonds, which are now 100% correlated, will tank simultaneously. And they are right to be concerned.

    Chair Yellen is wedded to a neo-Keynesian/socialist world view. Thus the FOMC has moved benchmark rates before selling any of the mortgage paper or Treasury bonds in the System Open Market portfolio. Anybody who understands the bond markets and duration will tell you that there is more that sufficient demand to soak up $50 to $100 billion in MBS per month in current market conditions, especially when you consider that agency MBS issuance will probably be down $400-500 billion in 2017 at $1.6 trillion vs $2 trillion in issuance last year.

    Yet somehow our friends at the Fed can look at narrowing bond spreads and a completely manic stock market, and do nothing. Raising benchmark rates is pretty much an exercise in futility because there is no “cascade” from Fed Funds to longer maturities. Indeed, absent some pesky externalities, bond prices are likely to rise and yields will fall because of the intense demand for duration from end investors and other central banks, who continue to buy public and private debt.

    Remember that with short-term "risk free" Treasury rates at current levels, the net-present value of equities is far higher than current market valuations. Yet by the time that President Donald Trump gets around to picking the next Fed Chair, the markets will be ready for a truly cathartic collapse, a “reset” if you will. The only thing that will delay the great repricing will be, naturally, a tax cut from Washington. Once that final act of idiocy has been achieved, however, there will be no more shiny objects to fascinate Wall Street.

    Banks and interest rate investors will be starring at a flat yield curve – the traditional signal for an approaching recession – and there will be no real reason to keep playing at the big table. Indeed, the smarter players will be taking the money off the table before Congress actually votes on a tax cut. Fact is, most large cap stocks that are bobbing around at multi-year highs will tumble once the proverbial deed is done in Washington. Tesla anyone?

    Once the stock market begins to crack, Yellen & Co will not only need to delay asset sales, but they will probably be bullied into mimicking the European Central Bank and the Bank of Japan, and start buying both bonds and stocks in the name of financial stability. For as we mentioned earlier, financial stability is now an entitlement, like defaulting on your home mortgage. So start practicing your Italian, make sure that you have plenty of ammo and food at home, and sit back to watch the spectacle unfold.

    Happy Black Friday


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