Tag: Debt Ceiling (page 1 of 9)

How The Fed Destroyed The Functioning American Democracy And Bankrupted The Nation

Authored by Chris Hamilton via Econimica blog,

I hope this article brings forward important questions about the Federal Reserves role in the US and I openly admit this is by no means a comprehensive article…it simply attempts to begin a broader dialogue about the financial and economic impacts of allowing the Federal Reserve to direct America's economy.

Against the adamant wishes of the constitutions framers, in 1913 the Federal Reserve System was Congressionally created.  According to the Fed's website, "it was created to provide the nation with a safer, more flexible, and more stable monetary and financial system."  Although parts of the Federal Reserve System share some characteristics with private-sector entities, the Federal Reserve was supposedly established to serve the public interest.

A quick overview; monetary policy is the Federal Reserves actions, as a central bank, to achieve three goals specified by Congress: maximum employment, stable prices, and moderate long-term interest rates in the United States.  The Federal Reserve conducts the nation's monetary policy by managing the level of short-term interest rates and influencing the availability and cost of credit in the economy.  Monetary policy directly affects interest rates; it indirectly affects stock prices, wealth, and currency exchange rates.  Through these channels, monetary policy influences spending, investment, production, employment, and inflation in the United States.

I suggest what truly happened in 1913 was that Congress willingly abdicated a portion of its responsibilities, and through the Federal Reserve, began a process that would undermine the functioning American democracy.  How, you ask?  The Fed, believing the free-market to be "imperfect" (aka; wrong) believed it should control and set interest rates, determine full employment, determine asset prices; not the "free market".  And here's what happened:

  • From 1913 to 1971, an increase of  $400 billion in federal debt cost $35 billion in additional annual interest payments.
  • From 1971 to 1981, an increase of $600 billion in federal debt cost $108 billion in additional annual interest payments.
  • From 1981 to 1997, an increase of $4.4 trillion cost $224 billion in additional annual interest payments.
  • From 1997 to 2017, an increase of $15.2 trillion cost "just" $132 billion in additional annual interest payments.

Stop and read through those bullet points again… and one more time.  In case that hasn't sunk in, now check the chart below…

What was the impact of all that debt on economic growth?  The yellow line in the chart below shows the annual net impact of economic growth (in part, spurred by the spending of that new debt)…gauged by GDP (blue columns) minus the annual rise in federal government debt (red columns).  When viewing the chart, the problem should be fairly apparent.  GDP, subtracting the annual federal debt fueled spending, shows the US economy is collapsing except for counting the massive debt spending as "economic growth".

Same as above, but a close-up from 1981 to present.  Not pretty.

Consider since 1981, the Federal Reserve set FFR % (Federal Funds rate %) is down 94% and the associated impacts on the 10yr Treasury (down 82%) and the 30yr Mortgage rate (down 77%).  Four decades of cheapening the cost of servicing debt has incentivized and promoted ever greater use of debt.

Again, according to the Fed's website, "it was created to provide the nation with a safer, more flexible, and more stable monetary and financial system."  However, the chart below shows the Federal Reserve policies impact on the 10yr Treasury, stocks (Wilshire 5000 representing all publicly traded US stocks), and housing to be anything but "safer" or "stable".

Previously, I have made it clear the asset appreciation the Fed is providing is helping a select few at the expense of the many, HERE.

But a functioning democratic republic is premised on a simple agreement that We (the people) will freely choose our leaders who will (among other things) compromise on how taxation is to be levied, how much tax is to be collected, and how that taxation is to be spent.  The intervention of the Federal Reserve into that equation, controlling interest rates, outright purchasing assets, and plainly goosing asset prices has introduced a cancer into the nation which has now metastasized.

In time, Congress (& the electorate) would realize they no longer had to compromise between infinite wants and finite means.  The Federal Reserves nearly four decades of interest rate reductions and a decade of asset purchases motivated the election of candidates promising ever greater government absent the higher taxation to pay for it.  Surging asset prices created fast rising tax revenue.  Those espousing "fiscal conservatism" or living within our means (among R's and/or D's) were simply unelectable.

This Congressionally created mess has culminated in the accumulation of national debt beyond our means to ever repay.  As the chart below highlights, the Federal Reserve set interest rate (Fed. Funds Rate=blue line) peaked in 1981 and was continually reduced until it reached zero in 2009.  The impact of lower interest rates to promote ever greater national debt creation was stupendous, rising from under $1 trillion in 1981 to nearing $21 trillion presently.  However, thanks to the seemingly perpetually lower Federal Reserve provided rates, America's interest rate continually declined inversely to America's credit worthiness or ability to repay the debt.

The impact of the declining rates meant America would not be burdened with significantly rising interest payments or the much feared bond "Armageddon" (chart below).  All the upside of spending now with none of the downside of ever paying it back or even simply paying more in interest.  Politicians were able to tell their constituencies they could have it all…and anyone suggesting otherwise was plainly not in contention.  Federal debt soared and soared but interest payable in dollars on that debt only gently nudged upward.

  • In 1971, the US paid $36 billion in interest on $400 billion in federal debt…a 9% APR.
  • In 1981, the US paid $142 billion on just under $1 trillion in debt…a 14% APR.
  • In 1997, the US paid $368 billion on $5.4 trillion in debt or 7% APR…and despite debt nearly doubling by 2007, annual interest payments in '07 were $30 billion less than a decade earlier.
  • By 2017, the US will pay out about $500 billion on nearly $21 trillion in debt…just a 2% APR.

The Federal Reserve began cutting its benchmark interest rates in 1981 from peak rates.  Few understood that the Fed would cut rates continually over the next three decades.  But by 2008, lower rates were not enough.  The Federal Reserve determined to conjure money into existence and purchase $4.5 trillion in mid and long duration assets.  Previous to this, the Fed has essentially held zero assets beyond short duration assets in it's role to effect monetary policy.  The change to hold longer duration assets was a new and different self appointed mandate to maintain and increase asset prices.

But why the declining interest rates and asset purchases in the first place?

The Federal Reserve interest rates have very simply primarily followed the population cycle and only secondarily the business cycle.  What the chart below highlights is annual 25-54yr/old population growth (blue columns) versus annual change in 25-54yr/old employees (black line), set against the Federal Funds Rate (yellow line).  The FFR has followed the core 25-54yr/old population growth…and the rising, then decelerating, now declining demand that represented means lower or negative rates are likely just on the horizon.

Below, a close-up of the above chart from 2000 to present.

Running out of employees???  Each time the 25-54yr/old population segment has exceeded 80% employment, economic dislocation has been dead ahead.  We have just exceeded 78% but given the declining 25-54yr/old population versus rising employment…and the US is likely to again exceed 80% in 2018.

Given the FFR follows population growth, consider that the even broader 20-65yr/old population will essentially see population growth grind to a halt over the next two decades.  This is no prediction or estimate, this population has already been born and the only variable is the level of immigration…which is falling fast due to declining illegal immigration meaning the lower Census estimate is more likely than the middle estimate.

So where will America's population growth take place?  The 65+yr/old population is set to surge.

But population growth will be shifting to the most elderly of the elderly…the 75+yr/old population.  I outlined the problems with this previously HERE.

Back to the Federal Reserve, consider the impact on debt creation prior and post the creation of the Federal Reserve:

  • 1790-1913: Debt to GDP Averaged 14%
  • 1913-2017: Debt to GDP Averaged 53%
    • 1913-1981: 46% Average
    • 1981-2000: 52% Average
    • 2000-2017: 79% Average

As the chart below highlights, since the creation of the Federal Reserve the growth of debt (relative to growth of economic activity) has gone to levels never dreamed of by the founding fathers.  In particular, the systemic surges in debt since 1981 are unlike anything ever seen prior in American history.  Although the peak of debt to GDP seen in WWII may have been higher (changes in GDP calculations mean current GDP levels are likely significantly overstating economic activity), the duration and reliance upon debt was entirely tied to the war.  Upon the end of the war, the economy did not rely on debt for further growth and total debt fell.

Any suggestion that the current situation is like any America has seen previously is simply ludicrous.  Consider that during WWII, debt was used to fight a war and initiate a global rebuild via the Marshall Plan…but by 1948, total federal debt had already been paid down by $19 billion or a seven percent reduction…and total debt would not exceed the 1946 high water mark again until 1957.  During that '46 to '57 stretch, the economy would boom with zero federal debt growth.

  • 1941…Fed debt = $58 b (Debt to GDP = 44%)
  • 1946…Fed debt = $271 b (Debt to GDP = 119%)
    • 1948…Fed debt = $252 b <$19b> (Debt to GDP = 92%)
    • 1957…Fed debt = $272 b (Debt to GDP = 57%)

If the current crisis ended in 2011 (recession ended by 2010, by July of  2011 stock markets had recovered their losses), then the use of debt as a temporary stimulus should have ended?!?  Instead, debt and debt to GDP are still rising.

  • 2007…Federal debt = $8.9 T (Debt to GDP = 62%)
  • 2011…Federal debt = $13.5 T (Debt to GDP = 95%)
  • 2017…Federal Debt = $20.5 T (Debt to GDP = 105%)

July of 2011 was the great debt ceiling debate when America determined once and for all, that the federal debt was not actually debt.  America had no intention to ever repay it.  It was simply monetization and since the Federal Reserve was maintaining ZIRP, and all oil importers were forced to buy their oil using US dollars thanks to the Petrodollar agreement…what could go wrong?

*  *  *

But who would continue to buy US debt if the US was addicted to monetization in order to pay its bills?  Apparently, not foreigners.  If we look at foreign Treasury buying, some very notable changes are apparent beginning in July of 2011:

  1. The BRICS (Brazil, Russia, India, China, S. Africa…represented in red in the chart below) ceased net accumulating US debt as of July 2011.
  2. Simultaneous to the BRICS cessation, the BLICS (Belgium, Luxembourg, Ireland, Cayman Island, Switzerland…represented in black in the chart below) stepped in to maintain the bid.
  3. Since QE ended in late 2014, foreigners have followed the Federal Reserve's example and nearly forgone buying US Treasury debt.

China was first to opt out and began net selling US Treasuries as of August, 2011 (China in red, chart below).  China has continued to run record trade driven dollar surplus but has net recycled none of that into US debt since July, 2011.  China had averaged 50% of its trade surplus into Treasury debt from 2000 to July of 2011, but from August 2011 onward China stopped cold.

As China (and more generally the BRICS) ceased buying US Treasury debt, a strange collection of financier nations (the BLICS) suddenly became very interested in US Treasury debt.  From the debt ceiling debate to the end of QE, these nations were suddenly very excited to add $700 billion in near record low yielding US debt while China net sold.

The chart below shows total debt issued during periods, from 1950 to present, and who accumulated the increase in outstanding Treasurys.

The Federal Reserve plus foreigners represented nearly 2/3rds of all demand from '08 through '14.  However, since the end of QE, and that 2/3rds of demand gone…rates continue near generational lows???  Who is buying Treasury debt?  According to the US Treasury, since QE ended, it is record domestic demand that is maintaining the Treasury bid.  The same domestic public buying stocks at record highs and buying housing at record highs.

Looking at who owns America's debt 2007 through 2016, the chart below highlights the four groups that hold nearly 90% of the debt: 

  1. The combined Federal Reserve/Government Accounting Series
  2. Foreigners
  3. Domestic Mutual Funds
  4. And the massive rise in Treasury holdings by domestic "Other Investors" who are not domestic insurance companies, not local or state governments, not depository institutions, not pensions, not mutual funds, nor US Saving bonds.

Treasury buying by foreigners and the Federal Reserve has collapsed since QE ended (chart below).  However, the odd surge of domestic "other investors", Intra-Governmental GAS, and domestic mutual funds have nearly been the sole buyer preventing the US from suffering a very painful surge in interest payments on the record quantity of US Treasury debt.

No, this is nothing like WWII or any previous "crisis". 

While America has appointed itself "global policeman" and militarily outspends the rest of the world combined, America is not at war.  Simply put, what we are looking at appears little different than the Madoff style Ponzi…but this time it is a state sponsored financial fraud magnitudes larger.

The Federal Reserve and its systematic declining interest rates to perpetuate unrealistically high rates of growth in the face of rapidly decelerating population growth have fouled the American political system, its democracy, and promoted the system that has now bankrupted the nation.  And it appears that the Federal Reserve is now directing a state level fraud and farce.  If it isn't time to reconsider the Fed's role and continued existence now, then when?



Stockman Exposes “The Black Swan In Plain Sight” – Debt Out The Wazoo

Authored by David Stockman via Contra Corner blog,

The black swan in plain sight does emit the Donald's orangish glow, but at the end of the day its true color is actually red.

That is, monumental towers of rapidly rising debt loom everywhere on the planet. For the moment, the artificial cash flow from this unsustainable borrowing spree is keeping a simulacrum of growth and prosperity alive. Yet this whole outbreak of debt madness—-represented by $225 trillion outstanding on a global basis—-is careening toward a financial and economic dead end that will soon crush today's fiscally profligate politicians and heedless financial punters, alike, in a devastating reset of bond yields.

For our first case in point, the always excellent Wolf Richter published a great chart over the weekend on the exploding US public debt. To say the least, it constitutes a clanging wake-up call amidst the absolute fantasy world that prevails on both ends of the Acela Corridor. That's because during the mere 8 weeks since the public debt ceiling was suspended by the Donald's end-run with Nancy and Chuckles in September, the national debt has spiked by $640 billion.

That's about $16 billion per Federal business day, and they are not done yet. The US Treasury will continue to borrow heavily until the current debt ceiling "suspension" expires on December 8—-at which time it will repair to the old game of divesting trusting funds and employing other gimmicks which circumvent the ceiling, while waiting for Congress to blink and raise the ceiling or authorize a new "temporary" suspension.

As Wolf pointed out, this pattern played out during the debt showdowns of 2013 and 2015, as well, when the resulting "temporary" suspension resulted in borrowing spikes of $464 billion and $650 billion, respectively.

Accordingly, Washington has suspended it way into a $5.7 trillion increase in the public debt in just six years since October 2011. That is, during a period which supposedly constitutes the third longest business expansion in US history.

Indeed, when viewed in cyclical context the latest spike screams out a severe warning. To wit, in the 12 months since the election shock of November 8, 2016, the net public debt— after giving effect to the fluctuations in the cash balance—-has risen by $870 billion to the current total of nearly $20.28 trillion.

That's right. Way late in the business cycle—–between month #89 and month #101 of the expansion—-the debt is increasing at a rate just under $1 trillion annually. Yet there is virtually no one in the Imperial City or in the Wall Street casino who has even noticed.

Nor have they noticed that revenue collections continue to weaken—-even as a massive surge of spending for the four disasters since August—Texas, Florida, California (fires) and Puerto Rico—– crank up, along with the Donald's sharply increased temp0 of defense operations.

During the last four months (July through October), in fact, revenue collections came in at $918 billion. That represented just a 2.9% gain over the $892 billion collected in the same prior year period, and barely 1% in real terms after factoring in CPI inflation during the interim.

Needless to say, adding a $1.5 trillion deficit-financed tax cut on top of that over the next decade—–when a public debt of $31 trillion is already guaranteed by the cumulative baseline deficits through 2027— would be the height of folly even under ordinary circumstances. But there are currently two aggravating circumstances that make it even more dubious.

First, as we demonstrated in our post on Friday, the Brady mark is neither a middle class tax cut nor a supply side growth and jobs stimulant; it's actually a giant windfall to the top 1% and 10%, who own most of the financial assets and especially equities.

That's because the bill cuts Federal income taxes for the very wealthy by $2.2 trillion over the next decade owing to repeal of the minimum tax, phase-out of the estate tax and the sharp reduction in tax rates on business profits to 20% and 25% for corporate and pass-thru entities, respectively.

Yet the net tax cut for the entire Brady bill over ten years—according to the Joint Committee on Taxation—is just $1.49 trillion. That means, obviously, everyone else is getting a $700 billion increase.

Needless to say, we don't see much incremental growth from the $2.2 trillion windfall to the top of the economic ladder. We are quite sure, for example, that the 5500 dead people who will benefit from the estate tax repeal each year will not work harder or invest more as a result.

Likewise, we don't see the 3.2 million minimum tax filers shortening their vacations or cutting back on luxury purchases in order to generate more output and investment from the repeal of that levy.

If anything, it will cause taxable incomes for lawyers, accounts and consultants to fall, thereby reducing Federal revenues. Indeed, like much else in the IRS code, the alternative minimum tax is not so much anti-work, as it is pro-complexity and waste.

Moreover, it is certain beyond much doubt that upwards of 90% of the increased after-tax cash flows from the business rate cuts will go to shareholders in the form of higher dividends and stock buybacks, not increased investments in productive assets or high payments for existing or added workers.

In fact, in a globally mobile and competitive labor market where the US is at the top of the cost curve, wage rates on the margin are set by the India Price for back office services and the China Price for goods. That's why IBM raised its job count in India from zero in 1993 to 130,000 at present, while cutting its domestic employment count from 150,000 to less than 90,000.

What this means is that the great off-shoring of the US economy has occurred owing to economic causes and the technological enablement of the global internet. These include dramatically lower labor rates abroad and proximity to materials, supply chains and end customer markets, not the statutory tax rate. IBM's effective tax rate, for example, is 11% and that's not atypical.

Indeed, a recent study of the largest US companies with positive net income over a six year period  showed that the average effective tax rate was only 14%. That is, the big cap internationals have already given themselves a big tax cut "selfie" by moving their tax books to the Caribbean, the Channel isles and other tax havens in addition to the impact of economically-driven off-shoring.

In this context, the smiling dufus the Trump White House named as CEA Chairman, Kevin Hassett, needs be thoroughly debunked. He now claims—contrary to all evidence and logic— that the corporate income tax is shifted onto wages and that the 20% rate is therefore worth $4,000 per household in higher earnings!

That's complete malarkey, of course.Then again, contrary to all evidence and logic, Hassett also predicted the Dow would hit 36,000 in the year 2000.

In short, the Dems have never cared about the deficit and are now just harrumphing about it because the Brady bill does not benefit their constituencies and because it being pursued on a strictly partisan basis. And now that the Donald has left the Congressional GOP crazed and desperate for a "win," they, too, have thrown fiscal sanity to the winds and, instead, are signing up for a double catastrophe.

That is, they are embracing a giant, politically-stupid "trickle down" tax cut that will not make it to the legislative finish line, but will be a huge loser in the 2018 campaigns.

At the same time, they have punted completely on the spending side of the equation by using the FY 2018 budget resolution as a phony vehicle for parliamentary maneuver (i.e. 51-vote reconciliation in the Senate), thereby guaranteeing that the automatic spending machine for entitlements and debt service—70% of the total—will roll forward unmolested.

And that gets to the other aggravating factor. Namely, for the first time in 30 years, the Fed will be embarking upon a huge, unprecedented demonetization campaign that will dramatically expand the supply of existing treasury debt looking for a home among real money savers—even as the doomsday machines drives annual Federal borrowing above the $1 trillion per year mark.

And there is no respite in sight as far as the eye can see owing to the surging numbers of baby boomers retiring and their impact on social security payments and the medical entitlements.

Indeed, we estimate that in the next four years, the US alone will add $5 trillion to the Treasury float—even as the Fed disgorges upwards of $2 trillion of existing debt securities. At the same time, the other central banks—led by the ECB and the People's Bank of China—will be forced to exit the bond buying business as well or experience economically devastating declines in their exchange rate against the dollar.

That means, in turn, that the safety valve of the bond supply being sequestered in foreign central banks will also disappear from the global fixed income markets, thereby adding to the yield crunch coming down the pike.

Needless to say, the entire world economy will reel under the impact of rising yields because current asset valuations and the cash management practices of business and households alike are predicated upon ultra- low yields.

In this regard, the 100 months of so-called recovery have been wasted from a deleveraging point of view. In the case of the US household sector, for example, the 20-year surge in debt obligations prior to the 2008 crisis caused total liabilities outstanding to soar by 5.2X, and to rise from 57% of GDP when Greenspan launched the era of bubble finance in Q3 1987 to nearly 100% of GDP on the eve of the crisis.

Nevertheless, after a small net reduction in debt immediately after the crisis, total household liabilities have continued to rise, and now exceed $15.1 trillion. Accordingly, just 250 basis points of interest normalization will cause the carry cost of household debt to rise by upwards of $400 billion per year or nearly triple the amounts of the ballyhooed tax cut.

Needless to say, US households will be far from alone—and also far from the most vulnerable balance sheets—-in the coming global reset of debt costs. At present, the Red Ponzi is staggering under $40 trillion of state and private debt or more than 3.5X its nominal GDP—-as vastly overstated and unsustainable as its official GDP figures actually are.

But during the weeks since the coronation of Mr. Xi occurred at China's 19th communist party Congress, its bond yields have been rising sharply to three year highs; and its yield curve has plunged into negative territory for the longest continuous period on record.

We can't even imagine the carnage that will occur among China's vastly inflated financial and real estate assets when global yields commence their inexorable rise. Nor is it easy to anticipate the crescendo of negative feedbacks that will incessantly pound its debt-driven hot-house economy.

But we are quite sure that Wall Street's current phony "synchronized global growth" meme will vanish almost instantly when the latest short-lived China credit impulse disappears from the world trading system.

The fundamentals currently don't matter, as is underscored in the chart below. That is, fundamentals don't matter until they do—-and then the reset in the stock market will be devastating, as well.

As Lance Roberts succinctly explained in a post last weekend:

 “The chart below expands that analysis to include four measures combined: Economic growth, Top-line Sales Growth, Reported Earnings, and Corporate Profits After Tax. While quarterly data is not yet available for the 3rd quarter, officially, what is shown is the market has grown substantially faster than all other measures. Since 2014, the economy has only grown by a little less than 9%, top-line revenues by just 3% along with corporate profits after tax, and reported earnings by just 2%. All of that while asset prices have grown by 29% through Q2.”



At the end of the day, you can't borrow your way to prosperity. That's the oldest rule in the book of sound money and sustainable finance.

And it's about ready to be learned all over again.


What Could Go Wrong?

Authored by James Howard Kunstler via Kunstler.com,

Everybody and his uncle, and his uncle’s mother’s uncle, believes that the stock markets will be zooming to new record highs this week…

And probably so, because it is the time of year to fatten up, just as the Thanksgiving turkeys are happily fattening up – prior to their mass slaughter.

President Trump’s new Federal Reserve chair, Jerome “Jay” Powell, “a low interest-rate kind of guy,” was obviously picked because he is Janet Yellen minus testicles, the grayest of gray go-along Fed go-fers, going about his life-long errand-boy duties in the thickets of financial lawyerdom like a bustling little rodent girdling the trunks of every living shrub on behalf of the asset-stripping business that is private equity (eight years with the Deep State-ish Carlyle Group) while subsisting on the rich insect life in the leaf litter below his busy little paws.

Powell’s contribution to the discourse of finance was his famous utterance that the lack of inflation is “kind of a mystery.” Oh, yes, indeed, a riddle wrapped in an enigma inside a mystery dropped in a doggie bag with half a pastrami sandwich. Unless you consider that all the “money” pumped out of the Fed and the world’s other central banks flows through a hose to only two destinations: the bond and stock markets, where this hot-air-like “money” inflates zeppelin-sized bubbles that have no relation to on-the-ground economies where real people have to make things and trade things.

Powell might have gone a bit further and declared contemporary finance itself “a mystery,” because it has been engineered deliberately so by the equivalent of stage magicians devising ever more astounding ruses, deceptions, and mis-directions as they enjoy sure-thing revenue streams their magic tricks generate. This is vulgarly known as “the rich getting richer.” The catch is, they’re getting richer on revenue streams of pure air, and there is a lot of perilous distance between the air they’re suspended in and the hard ground below.

Powell noted that the economy is growing robustly and unemployment is supernaturally low. Like his colleagues and auditors in the investment banking community, he’s just making this shit up. As the late Joseph Goebbels used to say describing his misinformation technique, if you’re going to lie, make sure it’s a whopper.

The economy isn’t growing and can’t grow.

The economy is a revenant of something that used to exist, an industrial economy that has rolled over and died and come back as a moldy ghoul feeding on the ghostly memories of itself. Stocks go up because the unprecedented low interest rates established by the Fed allow company CEOs to “lever-up” issuing bonds (i.e. borrow “money” from, cough cough, “investors”) and then use the borrowed “money” to buy back their own stock to raise the share value, so they can justify their companies’ boards-of-directors jacking up their salaries and bonuses – based on the ghost of the idea that higher stock prices represent the creation of more actual things of value (front-end-loaders, pepperoni sticks, oil drilling rigs).

The economy is actually contracting because we can’t afford the energy it takes to run the things we do – mostly just driving around – and unemployment is not historically low, it’s simply mis-represented by not including the tens of millions of people who have dropped out of the work force. And an epic wickedness combined with cowardice drives the old legacy news business to look the other way and concoct its good times “narrative.” If any of the reporters at The New York Times and The Wall Street Journal really understand the legerdemain at work in these “mysteries” of finance, they’re afraid to say. The companies they work for are dying, like so many other enterprises in the non-financial realm of the used-to-be economy, and they don’t want to be out of paycheck until the lights finally go out.

The “narrative” is firmest before it its falseness is proved by the turn of events, and there are an awful lot of events out there waiting to present, like debutantes dressing for a winter ball. The debt ceiling… North Korea… Mueller… Hillarygate….the state pension funds….That so many agree the USA has entered a permanent plateau of exquisite prosperity is a sure sign of its imminent implosion. What could go wrong?


The Greatest Fear Today: The Lack Of Fear

Authored by James Rickards via The Daily Reckoning,

Market crashes often happen not when everyone is worried about them, but when no one is worried about them.

Complacency and overconfidence are good leading indicators of an overvalued market set for a correction or worse. Prominent magazine covers are notorious for declaring a boundless bull market right at the top just before a crash or correction.

October 19 saw the thirtieth anniversary of the greatest one-day percentage stock market crash in U.S. history – a 22% fall on October 19, 1987. In today’s Dow points, a 22% decline would equal a one-day drop of over 5,000 points!

I remember October 19, 1987 well. I was chief credit officer of a major government bond dealer. We didn’t have the internet back then, but we did have trading screens with live quotes. I couldn’t believe what I was watching at first, but by 2:00 in the afternoon we were all glued to our screens.

It was like being a passenger on a plane that was crashing, but you had no way out of the plane. Our firm was fine (bonds rallied as stocks crashed), but we were concerned about counterparties going bankrupt and not being able to pay us on our winning bets in bonds.

What’s troubling is that a lot of commentators said that the kind of crash that took place in 1987 couldn’t happen today and that markets were much safer. It’s true that circuit breakers and market closures could temporarily halt a slide better than we did in 1987. But those devices buy time, they don’t solve the underlying fear and panic that causes market crashes.

In any case, when I hear market pros say “It can’t happen again” it sounds to me like another market crash is just around the corner.

The problem with a market meltdown in today’s even more deeply interconnected markets, is that once it strikes, it’s difficult to contain. It can spread rapidly. Likewise, there’s no guarantee that a stock market meltdown will be contained to stocks.

Panic can quickly spread to bonds, emerging markets, and currencies in a general liquidity crisis as happened in 2008.

Why should investors be so concerned right now?

For almost a year, one of the most profitable trading strategies has been to sell volatility. That’s about to change…

Since the election of Donald Trump stocks have been a one-way bet. They almost always go up, and have hit record highs day after day. The strategy of selling volatility has been so profitable that promoters tout it to investors as a source of “steady, low-risk income.”

Nothing could be further from the truth.

Yes, sellers of volatility have made steady profits the past year. But the strategy is extremely risky and you could lose all of your profits in a single bad day.

Think of this strategy as betting your life’s savings on red at a roulette table. If the wheel comes up red, you double your money. But if you keep playing eventually the wheel will come up black and you’ll lose everything.

That’s what it’s like to sell volatility. It feels good for a while, but eventually a black swan appears like the black number on the roulette wheel, and the sellers get wiped out. I focus on the shocks and unexpected events that others don’t see.

The chart below shows a 20-year history of volatility spikes. You can observe long periods of relatively low volatility such as 2004 to 2007, and 2013 to mid-2015, but these are inevitably followed by volatility super-spikes.

During these super-spikes the sellers of volatility are crushed, sometimes to the point of bankruptcy because they can’t cover their bets.

The period from mid-2015 to late 2016 saw some brief volatility spikes associated with the Chinese devaluation (August and December 2015), Brexit (June 23, 2016) and the election of Donald Trump (Nov. 8, 2016). But, none of these spikes reached the super-spike levels of 2008 – 2012.

In short, we have been on a volatility holiday. Volatility is historically low and has remained so for an unusually long period of time. The sellers of volatility have been collecting “steady income,” yet this is really just a winning streak at the volatility casino.

I expect the wheel of fortune to turn and for luck to run out for the sellers.

The Trap of Complacency

Here are the key volatility drivers we should be most concerned about:

The North Korean nuclear crisis is simply not going away. In fact, it seems to be getting worse. Intelligence indicates that North Korea successfully tested a hydrogen bomb in September. This is a major development.

An atomic weapon has to hit the target to destroy it. A hydrogen bomb just has to come close. This means than North Korea can pose an existential threat to U.S. cities even if its missile guidance systems are not quite perfected. Close is good enough.

A hydrogen bomb also gives North Korea the ability to unleash an electromagnetic pulse (EMP). In this scenario, the hydrogen bomb does not even strike the earth; it is detonated near the edge of space. The resulting electromagnetic wave from the release of energy could knock out the entire U.S. power grid.

Trump will not allow that to happen, and you can expect a U.S. attack, maybe early next year.

Another ticking time bomb for a volatility spike is Washington, DC dysfunction, and the potential for a government shutdown in December…

Analysts who warn about government shutdowns are often viewed as the boy who cried wolf. We’ve had a few government shutdowns in recent years, most recently in 2013, and two in the 1990s.

These were considered true government shutdowns in the sense that Congress did not authorize spending for any agency, and all “non-essential” government employees were put on furlough. (Critical functions such as military, TSA, postal service and air traffic control continue regardless of any shutdown).

These shutdowns don’t last long. They are usually for one political party or the other to make its point about spending priorities, and are soon compromised in the form of higher spending and a return to business as usual.

Government shutdowns because of lack of spending authority are different from government shutdowns due to lack of borrowing authority and the Treasury’s inability to pay its bills, or hitting the so-called “debt ceiling.”

We had a debt ceiling shutdown in 2011. Those are far more dangerous to markets because they call into question the Treasury’s ability to pay the national debt. We’ve had two near shutdowns this year; one in March, and again at the end of September. Both times Congress passed a last minute “continuing resolution” or CR that keeps government funding at current levels and keeps the doors open until a final budget can be worked out.

The current CR expires on December 8.

This time the odds are high that the government actually will shut down. Why should investors be any more concerned about this shutdown than the one in 2013 or the near misses earlier this year?

There are several causes for concern.

The first is that there is less room for compromise. The White House wants funding for the Wall with Mexico. Many Republican members of Congress want to defund Planned Parenthood. The Democrats will not vote for the Wall or to defund Planned Parenthood, but do want more funding for Obamacare.

There is no middle ground on any of these issues so the chance of a long shutdown is quite high.

The second reason is that this shutdown comes at a time when the U.S. in facing an increased risk of war with North Korea, and Congress has many other tasks on its plate including tax reform, confirmation of a new Fed Chairman, the “Dreamers” legislation, and more. Political dysfunction in Washington can easily spill over into markets.

This time the wolf may be real.

In short, the catalysts for a volatility spike are all in place. We could even get a record super-spike in volatility if several of these catalysts converge.

The “risk on / risk off” dynamic that has dominated most markets since 2013 is coming to an end. From now on it may just be “risk off” without much relief. The illusion of low volatility, ample liquidity, and ever rising stock prices is over.

It has been nine years since the last financial panic so a new one tomorrow should come as no surprise.

The safe havens will be the euro, cash, gold and low-debt emerging markets such as Russia. The areas to avoid are U.S. stocks, China, South Korea and heavily indebted emerging markets.

It may not look like it now, but it could be a volatile and bumpy ride ahead.


Yawning Debt Trap Proves the Great Recession is Still On

This article by David Haggith was published on The Great Recession Blog:

Published in the US before 1923 and public domain in the US. Used to represent people piling up America's national debt.

While David Stockman stated early this year with resolute certainty that the debt ceiling debate would blow congress up and send the nation reeling over the financial precipice, I avoided jumping on the debt-ceiling bandwagon. While I was convinced major rifts in the economy would start to show up in the summer, I was not convinced they would have anything to do with the debt ceiling debate. If there is anything you can be certain of this in endless recovery-mode economy, it is that the US will just keep pushing its bags of bonds up a hill until it can finally push no more. So, I figured another punt down the road was more likely.


The Debt Ceiling Debate that Didn’t Happen


The reason I didn’t think that debate would blow apart is that Republicans have more than once experienced the political reality that comes from taking the nation to the brink of default or of shutting down government. Each time that kind of thing has happened, it has hurt Republicans far more than it has hurt Democrats. I doubted establishment Repubs (the majority) had the stomach to take us through another credit downgrade, though I’ve noted such an event was possible.

Unsurprisingly to me, then, Congress did the only thing it seems to be capable of any more and just kicked that can a little further down the road with hardly a kerfuffle about it. Hurricane Harvey made things a lot easier for congress to kick the can again by providing a good excuse to dodge that unwanted debate on the basis of massive human suffering that truly did need tending to. Much-talked-about government shutdown put off for a better time

The debate was entirely avoided even as the national debt broke over the $20 trillion mark this summer, keeping US debt at more than 100% of GDP, which is the stratosphere we’ve been in since 2011.


A group of progressive economists affiliated with the University of Massachusetts predicted in 2013 that a debt burden [that reaches 90% of GDP for five years] would result in an annual growth rate of just 2.2 percent, which means economic stagnation. (Reason.com)


We’re already well past that five-year marker. Not surprisiing, then, that the Congressional Budgeting Office expects economic growth to stay at 1.8% through 2027.


George Will observed that the difference between 2 percent annual growth and 3 percent annual growth is the difference between a positive, forward-looking country in which politics recede from everyday life and a Hobbesian nightmare in which interest groups slug it out over a barely growing pie. Note that he was talking about 2 percent annual growth, which seems positively aspirational in the 21st century. (Reason.com)


By James Montgomery Flagg. (Cartoon by James Montgomery Flagg, via [1]) [Public domain], via Wikimedia Commons

Nation caught in a debt trap


The biggest (or most likely threat) from the national debt is what economists refer to as a debt trap. The nation can be considered caught in a debt trap if the Federal Reserve loses the ability to raise interest because the rise in interest would immediately drown the economy or cause the nation to default on its debt. So long as interest rates are low, the US government can afford its huge debt; however, we are now at a point where, if interest rates rise to historically normal levels, we’re in big trouble. That means we are in, at least, enough of a debt trap that interest rates can never be allowed to normalize.

Several debt traps are shaping up besides the one formed from government debt. One is the corporate debt trap, where corporations have kept earnings per share high by taking out huge piles of debt year after year to buy back shares. If businesses have to refinance all this debt at a higher interest rate, they could be in big trouble. We hear over and over that today’s high stock valuations are justified by the fact that earnings keep growing; but it is not top-line revenue that is growing, it is earnings per share, and most of that “growth” is due to corporations taking out debt in order to buy back shares and thus reduce the number of shares over which those earnings are divided. If interest rises, corporations will no longer be able to afford to buy back shares on debt, and that support for the market will crash. They might not even be able to afford to pay off the debt they have already taken on. So, there is another reason the Fed can never allow interest to normalize by historic standards.

Yet another debt trap now exists in personal credit where many households have reached peak debt. Household debt maxed out this summer above the level it had hit at the peak of the 2007 credit bubble — one more of those big signs of trouble in the economy that I said we could anticipate seeing by the time summer rolled around.

Income, in the meantime, has not improved in order to support this higher level of debt, now at a level that already proved unsupportable in the past. That puts the US back in the unstable position where households that already carry all the debt they can afford can be suddenly sunk if they have any variable-interest credit cards or an adjustable-rate mortgage. That is yet another reason the Fed can never allow interest rates to normalize.


Harvard economist Kenneth Rogoff warns that a sudden spike in interest rates is the biggest threat to the global economy…. People have got used to ultra-low interest rates….  “If something was to happen that pushes interest rates up, we could see a lot of soft spots — places where there is high debt — start to unravel,”Rogoff said. (NewsMax)


It should be no surprise, then, that the number of credit-card accounts moving into delinquency swung upward for the third consecutive quarter this summer, a nine-month trend not seen since the bottom of the 2009 crisis. Yet another summertime crack in the economy — one that is not large yet but will become large quickly if the Fed allows interest to move upward any more than it already has.

In short, the national economy is riddled with high debt everywhere, which leaves every area of the economy with little wiggle room. So, the one certain thing about the huge piles of debt that have built up in the last few years is that we have reached the point where they are actually starting to box the Fed in to where raising interest to combat inflation will not be possible because it will cause damage throughout the economy. The tide has already closed in around the Fed to where it can no longer move to normalize interest in any direction without going deeper into rising waters.

S&P’s chief economist, Beth Ann Bovino, wrote recently that “failure to raise the debt limit would likely be more catastrophic to the economy than the 2008 failure of Lehman Brothers and would erase any of the gains of the subsequent recovery.”


The Great Recession is still with us


If you want to get a sense of how the debt trap affects the nation’s real net worth, consider what the total gross domestic product of the United States looks like if you subtract all that debt that we’ve added each year in order to create that product:



US GDP Minus Debt Graph from Federal Reserve

Note: Federal Reserve Economic Data sheets express GDP in billions while Federal Debt is expressed in millions, so in this chart they multiply their data numbers for GDP by 1,000 in order to express both in terms of the number of millions (there being a thousand millions in every billion).



That is essentially the debt trap in a snapshot. And that’s just subtracting the federal debt from GDP. What would it look like if we subtracted out all the business debt that was piled up in the creation of our total domestic product and all the personal debt? You can see the picture looked positive right up until the Great Recession hit, and it has deteriorated precipitously ever since.

Based on this picture we have remained in a huge depression since the financial crisis. I have been saying all along that we are still in the Great Recession, which is why I called my blog The Great Recession Blog. The Great Recession still defines our present economy. We never exited; we just propped the economy up (created positive GDP) with mountains of debt (federal and corporate) so that we cannot feel how deep that depression really is; but the debt trap will suck us into this abyss as soon we can no longer sustain the creation of that debt. We have not powered out, as the Fed planned. If we had, GDP would be growing faster than debt.

We are essentially at that point of stark realization now as the Federal Reserve reduces its reinvestment in government debt (bonds) this month. (A process slated to start slow but to become huge by the end of 2018.) Until now, when a government bond matured during this past decade of Fed stimulus so that the government became responsible for repaying the bond principle to the Fed, the government just issued another bond, and the Fed bought that. The new issuance gave the government the money it needed to pay off the first bond. Now that the Fed is backing away from buying new government bonds (starting to divest), the government will be forced to find other financiers.

That will most likely raise the interest the US government has to pay in order to attract new buyers of its bonds, making the national debt less and less sustainable. What happens, then, to GDP as the government finds it harder to maintain its huge deficit spending that is propping up GDP (because the things government buys with that debt have always been included in GDP calculations)?

This unwinding scenario, of course, depends on what happens in the rest of the world because the US doesnt finance all of its debt internally. If Europe, for example, starts to collapse ahead of the US (as it now contemplates its own unwind), the US could once again prove to be the best looking horse in the glue factory and, so, still find ready foreign buyers at low interest for bonds that have to be issued to someone other than the Fed now that the Fed (the buyer of last resort) is backing away from repurchasing. That could purchase the US yet, again, a little more time. (That could just as easily swing the other way, of course, with the US collapsing first, sending money fleeing to Europe.)

Another way to look at our present situation since the Great Recession began — in order to see that its new economy stays with us — can be seen in this chart:



The trend line in GDP per capita (with government deficit spending still included in the calculation of GDP) broke off at the start of the Great Reession, and it clearly never recovered. It relentlessly sputters along at a decreased rate of growth. Moreover, it has only been maintained at that much lower trend because of the massive amounts of government debt and Fed stimulus. So, what happens to the new trend line when when that money is withdrawn from the economy and interest is allowed to rise?

The bags full of bonds we are pushing up the hill will become significantly heavier if interest rises and will exhaust us, and the present change in Fed repurchasing is a big enough change to tip that balance (given that the amount on the balance sheet the Fed is planning to now unwind is equal to more than 20% of GDP). That is why Jamie Dimon of JPMorgan Chase warned that we’ve never seen anything on the scale of what is about to happen and had better be careful.

One essential truth underlying this blog has always been that you cannot dig your way out of a debt-based financial crash by digging the debt trap deeper and deeper. I called my own site The Great Recession Blog because I believe the most fundamental truth about our current economy is that we are still in the Great Recession. It broke us for good in that we have not recovered from that event even with massive amounts of stimulus (beyond anything the world has ever attempted).  GDP looks marginally acceptable but only on the surface and is clearly continuously now on a lower trend. Underneath it all is a yawning pit of debt, more than capable of swallowing our entire economy.


The Dollar Funding Shortage: It Never Went Away And It’s Starting To Get Worse Again

Very quietly, in the last few weeks, cross currency basis swaps (CCBS) related to the dollar have reversed their rise and started moving deeper into negative territory… again. This might not be of much interest to buyers of global equity markets at this point, but it is signalling ominous signs of growing funding stress in the financial “plumbing”.

As Bloomberg notes   “cross-currency basis swaps, which money managers and corporate treasurers outside the U.S. can use to borrow in dollars, remain close to the widest levels since January even after quarter-end, when such financing strains typically dissipate. The market was a key indicator of stress during the financial crisis, and while it’s nowhere near the alarming levels of that era, it’s still garnering the attention of analysts.”  

In simple terms, the CCBS is the cost in basis points (typically for three months) of swapping these currencies into dollars over and above prevailing interest rate differentials. In a benign environment the CCBS should trade at zero, not in negative territory. The latter implies a shortage of US dollar balance sheet (credit) offered by the global banking system. As the chart above shows, dollar liquidity became extremely tight in December 2016, especially for Yen borrowers, although it not nearly as bad as what happened in May of 2015 when we first brought attention to this little followed corner of the financial system. Despite the weakness in the dollar during much of the current year, the dollar liquidity issue never completely disappeared.

There are several reasons why, like in recent years, financing in dollars is becoming more expensive.

Among the reasons cited by strategists, are the political tensions in Spain related to Catalonia’s independence push and the slow pace of Brexit talks, which may be heightening the perception of credit risk for the region’s banks. Combine that with the prospect that a U.S. tax overhaul could trigger dollar repatriation, and the outlook for monetary-policy divergence with the Federal Reserve starting to unwind its balance sheet, and analysts see the trend only worsening.”

"This is keeping a lot of people feeling uneasy,’ said Gennadiy Goldberg, an interest-rate strategist at TD Securities in New York. ‘This now seems more of a political story, with Catalonia, U.K. Brexit negotiations and potential U.S. tax reform and repatriation. Spreads could keep widening. While Republican efforts to get a tax plan through the Senate may be off to a rocky start, any framework that spurs U.S. companies to repatriate cash could compound the scramble for dollar financing. Although that’s probably a story that will play out in the second quarter, it may already be factoring into expectations."

While we couldn’t disagree, there’s one important factor they’re missing, the US Treasury’s account (Treasury General Account) with the Federal Reserve.

By running down this account by $400bn in the first quarter of 2017 (mainly due to the debt ceiling issue), the Treasury effectively increased dollar liquidity (bank reserves) by the same amount. This not only helped to ease the dollar funding problem, but was a factor in the dollar’s weakness.

Since last month, the Treasury has rebuilt the balance in its account at the Fed from $38bn on 6 September 2017 to $170bn on 11 October 2017, for a net increase of $132bn…not insignificant. Obviously, if and when the Treasury rebuilds its account at the Fed to the previous level, dollar liquidity could become extremely tight again, especially if the Fed is tapering its balance sheet at the same time.

We have been wondering whether the Fed governors fully understand this, although some of the boys at 33 Liberty no doubt do. Credit guys also understand it “there’s another reason the strain is set to grow. The Fed is set to boost the pace of its balance-sheet roll-off each quarter, potentially putting upward pressure on U.S. rates relative to Europe and making it tougher for global investors to get dollar funding," according to Mark Cabana, head of U.S. short rates strategy at Bank of America Corp.”

Clearly the issue is attracting the attention of investors as BoA analyst, Cabana writes in a recent report, and explains that “we have received a number of client questions recently about the outlook for banking reserves both in the near and medium term due to the Fed's balance sheet unwind and potential swings in Treasury's cash balance.

In summary, Cabana expects a large reserve drain in Q2 2018 with banking reserves dropping by more than $1 trillion by the end of 2019, which “highlights the potential for funding strains to emerge around Q2 next year and uncertainties around the Fed's longer-run policy framework… This reserve drain and the Fed’s portfolio unwind should pressure funding conditions tighter through wider FRA-OIS and more negative XCCY (cross currency basis swaps) levels.”

Here are his views in more detail for the rest of this year, next year and 2019-20.

Reserves through Year End: The aggregate amount of reserves outstanding will decline only modestly between now and the end of the year, minimizing any near-term funding pressures. The $30 bn reduction from the Fed's portfolio this quarter along with near-term fluctuations in Treasury's cash balance due to the debt limit will result in only modest swings in overall reserve levels. Treasury's cash balance will need to decline ~$100 bn between now and December 8, but should rebound to ~$200 bn by year end via corporate tax receipts and ~$70 bn in bill supply during the last 3 weeks of the year.


Reserves in 2018: A more material drain of over $600 bn bank reserves during 2018 should occur due to the increased pace of Fed portfolio unwind and build in the Treasury cash balance post debt limit resolution. The Fed is projected to have $381 bn in Treasury and agency MBS roll off of their portfolio next year with the pace of reduction accelerating to $90 bn in Q2 and around $115 bn in each of Q3 & Q4 (the Fed is expected to have monthly redemptions below the cap in these quarters).

The sharpest reserve drain is likely to come from a boost in Treasury's cash balance after the debt limit resolution in March. Treasury will likely increase the cash balance to $350 – $400 bn early in Q2 through tax receipts and higher bill supply. This reserve drain and the Fed's portfolio unwind should pressure funding conditions tighter through wider FRA-OIS and more negative XCCY basis levels.

Reserves in 2019 & 2020: Large reserve drains of $400 – $500 bn are expected in each of these years. This will primarily be driven by the expected $425 and $337 bn Fed portfolio reduction as well as growth in currency in circulation, which we project to average around 5% per year ($80-90 bn / yr). We also expect slightly lower usage of the Fed's reverse repo facilities as the Fed's balance sheet shrinks due to more attractive short-term investment opportunities amidst higher Treasury supply.


We expect to see signs of reserve scarcity emerge at some point over the course of 2020 or in early 2021. While the total amount of required reserves is currently unknown we have previously estimated that required level of reserves in the system is likely between $600 bn – 1 tn. This is consistent with the NY Fed's surveys of primary dealers and market participants where the median respondent believes reserve balances will total $613bn, while the 75th and 25th percentile of responses were $1tn and $406 bn. As reserve scarcity is reached, we expect to see continued upward movement in LIBOR as well as higher rates and volumes in the fed funds / OBFR markets.”

Cabana finishes with a discussion about how bank reserves will fit into monetary policy and the potential appointment of a new Fed Chairman.

Framework question: A key question in thinking about the longer-term outlook for reserves is the monetary policy operating regime that the Fed will employ, which will be heavily influenced by the next Fed Chair. As our economists recently noted, if Chair Yellen or Governor Powell leads the Fed they would likely be in favor of maintaining a "floor" regime (relying on IOER & ON RRP). In contrast, Fed Chair contenders Warsh and Taylor would likely favor a "corridor" system that relies on a scarcity of reserves that would reduce IOER usage, increase fed funds trading activity, and require frequent open market operations to adjust reserves in order to hit the Fed's target.


It seems current staff at the Fed have a strong preference to maintain a "floor" regime. The November 2016 FOMC meeting minutes noted a number of advantages of such a system and recent Fed research has highlighted that abundant reserves can smooth interbank payments, reduce daylight overdrafts at the Fed, and lead to less discount window usage. A "floor" system would also aid in satisfying bank LCR HQLA requirements while reducing the need for frequent open market operations to smooth volatility in Treasury and financial market utility deposits at the Fed. This regime would keep fed funds below IOER and likely ensure that the ON RRP remains a key fixture of the Fed's monetary policy well into the future.

Negative cross currency basis swaps indicate that the structural tightness in dollar liquidity never disappeared despite the weaker dollar. If dollar funding markets get a lot tighter again, this won’t be good news for EM markets with offshore (Euro) dollar debt in the region of $10 trillion. Rolling over dollar debt periodically will be uncomfortable, to say the least, for some of the region’s banks.


Key Events And FX Week Ahead: Central Banks Send Markets Into A Coma, Someone Say Something New Please!

European politics returns with a bang this week, when not only will attention be focused on Austria to see if the right wing Freedom Party joins the People's Party in a historic governing coalition, in an embarrassing blow to Europe's establishment, but also whether Catalan President Puidgemont will (again) fomally – and this time clearly – announce whether he has declared independence as Spain's PM Rajoy demanded last week. Elsewhere, EU leaders meet on Thursday to discuss the progress of the Brexit talks and whether transition and trade negotiations can begin. The official declaration seems highly unlikely to declare that ‘sufficient’ progress has been made, but there are some signs that EU leaders will agree to at least internal discussions on the terms required to agree a transition arrangement. Traders and European leaders will also have an eye on the Czech election (Friday and 21 October), where with signs that the enthusiasm for Western Europe is waning in some of the post-Soviet states, Russophile Andrej Babïs is expected to form the next government, putting more grit into the anti-EU machine.

In Asia, eyes will be on Japan's snap election next Sunday, where according to a Mainichi report, the eRuling Liberal Democratic Party could win between 281 to 303 seats vs. 284 it holds now according to an Oct. 13-15 poll. LDP coalition partner Komeito could win 30-33 seats vs. 35 seats currently held. LDP-Komeito coalition set to surpass 2/3 lower house majority of 310 seats. Yuriko Koike’s Party of Hope may win between 42 to 54 seats; Constitutional Democratic Party of Japan 45-49 seats.

Economic data includes revised European inflation data (Tuesday), the ZEW survey (Tuesday) which is expected to show an increase, and German PPI (Friday) which consensus predicts will hit 2.9% YoY. In the US, we get industrial production and capacity utilization (Tuesday) which are expected to show a pick-up in September, but housing data: permits (Wednesday), starts (Wednesday) and sales (Friday) may show a hurricane-related decrease.

The 19th Chinese Communist Party Congress is the Asian set piece event of the week on Wednesday (see our preview here), and it builds to the appointment of the Central Committee and the Politburo Standing Committee on 24 October. The vast majority of commentators expect further consolidation of control by President Xi, and all the important decisions seem likely to have been made already. However, the names that are selected will give an insight to the direction of Chinese economic and foreign policy over the next five years. Consensus is that social financing, money supply data (early in the week) and GDP (Thursday) will show continuing strength in the economy (accompanied by the usual fretting as to whether such a high pace of credit growth can be continued indefinitely).

Following this week’s taster, earnings season gets into full swing next week. After some banks struggled despite earnings being in line with or even exceeding expectations, attention will turn to companies meeting (or missing) targets in the week ahead.

A full breakdown of the week's events in the table below, courtesy of ING:


With the key events out of the way, here are the main catalyst FX traders will be focusing on, courtesy of Shant Movsesian and Rajan Dhall MSTA of fxdailyterminal.com.

FX Week Ahead – Central banks speakers send markets into a coma . . . someone say something new please!

The past week has seen the speaker schedule littered with the familiar names from the Fed and the ECB spouting the same concerns as they do week in, week out; inflation, wage growth, gradual expansion, policy needs to stay accommodative etc etc.  Much, if not all of the rhetoric is ingrained in the market and now to the point where we really to do need to see some evidence (one way or the other) on which way the economic momentum is building up in order to get some differentiation among the major currencies – interest rate spreads aren't moving. 

After Friday's CPI data out of the US, we saw the USD duly taking a hit – all on the miss on expectations, which saw the core unchanged at 1.7%.  The headline rate rose through 2.0% on oil price and no doubt the squeeze on agricultural products affected by the extreme weather conditions, and was explained away to see the greenback down on the week.  Given the corrective nature of the USD gains seen of late, there will be plenty of sellers out there waiting for the opportunity to get in on the longer term trend of weakness, but looking across the board, we can only see this justified to any degree against the JPY. 

If we look at the relative levels in USD/JPY compared to long end rates, 110.00-114.00 looks about right, but if one believes the benchmark 10yr Note tests back to 2.50%, then we can naturally expect a move to the upper end of the range, safe in the knowledge that major risk events (North Korea, US debt ceiling, etc) all have temporary negative effects on unrelenting risk appetite, with US equities in particular pushing up to ever new highs.  Beyond 114.00 will take a significant amount of policy reform from president Trump's administration, and with market positioning heavily against the JPY, 115.00+ will be a mountain to climb at best.

Factor in the gradual improvement in the Japanese economy, and I maintain that it may soon be time to look upon the JPY on its own merits rather than just a safe haven (a safe haven for Japanese investors only).  Data here next week offers up industrial production and trade data in the early half of the week – Japanese stocks look good value in a sea of ballooning valuations. 

There is very little out of the US to get excited about, with capacity utilisation and production numbers here also, but which have tended to have little impact on the USD as the market obsesses over inflation.  Wage growth I can understand, but last month's data was hampered by Hurricane season so we have to wait on that one.  

More Fed speakers on the schedule, but literally, how much more can they say that we don't already realise for ourselves?  Expect more backtracking along the way; that seems par for the course, with Atlanta's Bostic now umming and arring over whether Dec is a done deal in comments on Friday – the week before he seemed in line with adding another 25bps.  Yellen, George and Rosengren are all happy to commit to another hike this year, but Evans is sitting on the fence again and Kaplan is only whisker away from joining Kashkari in a somewhat discredited uber dove camp.  

However, it is at the BoE where the credibility stakes are really running high, and there is much at risk ahead with inflation, employment and retail sales stats all down on the slate for consideration.  That said, the MPC have pretty much nailed on a move in Nov, though they continue to draw the ire from a number of quarters – the British Chamber of Commerce the latest to question their change in stance.  Among the comments made by Gov Carney last week, one caught my attention; that of policy change not being automatic.  My mind swiftly harked back to the Aug meeting when 'the bank' near immediately cut 25bps to stem the negative tide from the Brexit vote and there were plenty of us who saw this as unnecessary and quite frankly pointless, given the magnitude of consequences that we (the UK) now potentially face in severing membership with the union. 

Brexit talks are clearly not progressing – the notion of soft or hard Brexit has always put wry smile on my face, as there is only hard Brexit to look to no matter how the UK approach the negotiations.  If Theresa May and parliament roll over and pay the settlement asked of them in order to progress to the next round of talks on trade, then we can use the word soft in this instance, but otherwise, the EU are not going to give up much ground.  Reports that a 2yr transitional deal is already being discussed has given some hope to GBP bulls, but to think this won't come at a significant cost is blind optimism over reality. 

Even so, there is potential for a Cable push higher this week, but we would not expect this to extend very far.  1.3500 would be impressive, but so will the selling interest waiting up a these levels.  We saw how short lived the moves were above 1.3600, so I cannot see past a very hard fought up-turn under the circumstances and this will come from the algo driven moves on soundbites and off-the-cuff comments.  

EUR/GBP is a little more difficult to gauge given politics has reared its ugly head with Spain and Catalonia drawing up battle-lines.  As if the hung parliament in Germany wasn't enough to prompt some caution in the positive longer term outlook on Europe, this latest development brings the unity factor back into question – indeed, will it ever go away? 

This does not seem to stop the demand for EUR/USD however, but that was in and around 1.1700.  Nearing 1.1900, the price action has not been so confident and with good reason.  Net (EUR) longs are high, and have increased again according to the snapshot CFTC data, but were it not for the miss on US data on Friday, the resilience to the downside would have been seriously tested.  We feel it still will, and when the market is finally underwhelmed by the level of QE tapering due to be announced in a few week's time, the 1.1660 level will likely come under pressure again as rate differnentials eat into longs.  

ECB speakers aplenty also, but data wise, CPI on Tuesday is the focal point here.  No one is doubting the economic expansion under way – but from a very low base it has to be said, but the pace of EUR gains this year has been meteoric, and one which has not followed core yields – 10yr Bunds still fluctuating inside 40-45bps.  A large element of safe haven demand has to be factored in here, but if this is the case, then we also have to start considering when Germany will argue more aggressively to firmer policy tightening to rein in on national inflation.  One policy does not fit all – many said it before and will say it again.  The EUR does not feel like such a one way ticket now!

Interest in the AUD, has been pretty tame of late, lagging a little in the early part of last week, but coming back with a little more force as a result of the sag in the USD.  Domestically, the RBA minutes are expected to reflect the cautious rhetoric of Gov Lowe, but employment has been one of their concerns, and we get the Sep data out on Wednesday.  0.7730 was a level we were watching and which held well, but on the upside, traders will fade this through 0.7900 unless we get some clear evidence that wages will push through on spending and inflation thereon. 

China's GDP stats couls also impact to a degree this, but the much lower than expected trade surplus did not seem to unnerve the market given demand for raw materials out of Australia – fact not opinion.  

In NZ, we are supposed to find out which way the NZ First party will go to form government on Monday.  The end of (last) week NZD move higher was somewhat presumptuous, with plenty of reasons to believe that Labour could win out given policy overlap between the 2 parties.  The start of the week also releases Q3 inflation, where the year on year rate is expected to rise from 1.7% to 1.8%.  A combination of the above results could see us testing back towards and through 0.7050, but higher up, we will struggle much past 0.7300-25 while the USD decides what to do.  AUD/NZD is right in the middle of the 1.0825-1.1150 range which has held since late Aug, and should maintain these limits for the time being despite the near term risks mentioned above.

For Canada, next Friday's inflation report is one to watch, though on Monday we also get the BoC business outlook survey.  Since the strong Q1 and Q2 GDP results  and rate hikes in response, we have seen some mixed jobs data, while growth over Jul was flat.  The central bank have quietly signalled their monitoring of mid-long end rates, just as they have on the currency, and it has been pretty orderly since then, with a propensity to err on the upside given the domestic stats so far.  The market here is still net long CAD, but this may start to neutralise a little should the prospects for a return to 1.2000 fade.  NAFTA negotiations under way are not proving harmful, nor we feel with they, with Trump and Trudeau sharing constructive and amiable talks in the meantime.  Oil prices are holding up well to offer healthier margins for most oil producers – Canada comfortable with WTI at $40-60 we are told.  

All pretty quiet in the Scandies this week with only Norwegian trade and Swedish employment to look to  All we need to do here is monitor a NOK/SEK rate stuck in a range and back on a 1.0200 handle since. When that breaks out, we will start looking into these pairs with a little more detail, but little to differentiate here at this point. 


White House Reveals What It Wants In Exchange For Keeping “Dreamers”

On Sunday night, the White House revealed that it is seeking more funds from Congress to fund Trump’s wall along the U.S.-Mexico border, more resources to hire thousands more immigration officers, cutting the number of new legal immigrants and generally demanding a steep price for legislation under consideration to help so-called Dreamers. According to the WSJ, “the White House documents, sent to congressional leaders in both parties on Sunday, amount to a lengthy wish list of longstanding conservative immigration goals.” While White House officials told reporters that they want these to be included in any immigration deal, they stopped short of saying the White House will insist on them.

As The Hill adds, Trump’s new “immigration principles and policies” call for a crackdown on border security, more resources to catch individuals residing in the country illegally, as well as a merit-based system that limits chain migration to spouses and children.

Border patrol agents stand next to a border fence used for training
at the U.S. Border Patrol Academy in Artesia, New Mexico

Claiming that in order to properly protect the nation’s borders, the White House said Congress must also approve of the construction of a border wall to deter human trafficking, drug trafficking and other cartels. “Success of border walls are undeniable from the perspective of their operators,” U.S. Customs and Border Protection Acting Deputy Commissioner Ronald Vitiello said Sunday. The plan also takes a hardline stance against unaccompanied minors who enter the country.

Trump also went after sanctuary cities, calling on Congress to cut funding from certain grants and agreements to punish the “states and localities that refuse to cooperate with Federal authorities.”   Additionally, the administration is advocating for a “refugee ceiling” that caps how many are let into the country to an unspecified “appropriate level.”

“[T]he refugee ceiling needs to be realigned with American priorities,” according to a press release that points to the nation’s historically high average of resettling refugees compared to “the rest of the world combined.”

The plan also suggests measures that allow for a swift deportation process once ICE or other authorities detect and catch those residing in the country illegally.

But the most notable feature was the return of demands for a border wall. The Trump White House had previously called for border security measures as part of a Dreamer deal but had agreed to take the wall off the table. Now the administration is again insisting on it.

“These findings outline reforms that must be included as part of any legislation addressing the status of Deferred Action for Childhood Arrivals (DACA) recipients,” President Trump said in a statement following the announcement of the proposal on Sunday. “Without these reforms, illegal immigration and chain migration, which severely and unfairly burden American workers and taxpayers, will continue without end.”

The just released proposed plan is meant to guide the administration’s discussions with Congress to replace Deferred Action for Childhood Arrivals (DACA), an Obama-era program that shielded nearly 800,000 so-called “Dreamers” from deportation and also allowed them to secure work permits. The administration said many agencies weighed in to give policy recommendations in order to improve the immigration system including the Department of Justice, Department of Homeland Security, ICE, and U.S. Customs and Border Control.

The principles also lay out changes to the legal immigration system that Mr. Trump has already endorsed, including large cuts to green cards issued for family members and shifting existing employment-based green cards to a skills-based system.

It is no surprise that Democrats are opposed to most of these ideas outright and don’t support others unless they are part of a comprehensive package that includes a path to citizenship for almost all of the estimated 11 million people living in the U.S. illegally. They will certainly throw up Trump’s renewed attempt to push through “the wall.”

“The administration can’t be serious about compromise or helping the Dreamers if they begin with a list that is anathema to the Dreamers, to the immigrant community and to the vast majority of Americans,” Senate Minority Leader Chuck Schumer (D., N.Y.) and House Minority Leader Nancy Pelosi (D., Calif.) said in a joint statement Sunday.

This may be a problem because suddenly it appears that all the goodwill that Trump had built up with the Democrats last month, when in exchange for avoiding a government shutdown he caved on his DACA executive order, may have vaporized:

Last month, Mr. Trump met with the pair for dinner and, afterward, it seemed that a deal to legalize Dreamers might be at hand. All three of them suggested that they had agreed to pair protections for the young migrants with border security provisions that didn’t include the controversial proposal for a wall along the U.S. border with Mexico.


But immediately after that, many congressional Republicans said they would seek to extract more significant enforcement provisions as part of any deal. And on Sunday, a White House official said that the only agreement was that dealing with Dreamers was a priority and that they would try to come to a resolution as quickly as possible.

As the WSJ adds, many of the proposals outlined are included in legislation that has passed the GOP-controlled House but wasn’t considered in the Senate, in part because they likely don’t have support from the 60 senators that would be needed to pass them.

As for the Dreamers, there was some additional confusion, because a White House official said that the administration wasn’t interested in providing these people with a path to citizenship, as the Dream Act provides. But last week, two administration officials told a Senate committee young people should have the opportunity for citizenship.

Finally, should this proposal indeed sour the tentative ceasefire that had emerged between Trump and the Democrats last month, suddenly not only is tax reform before year end looking impossible shaky, but if Trump has just made the DACA legislation impossible, then not only is the threat of a government shutdown again back on the table, but it may be time to start worrying about the next debt ceiling hike which is due exactly two months from today.


Trump To Sign Executive Order Rolling Back Obamacare Regulations

It appears another 'chat with Chuck' may result in a deal 'win' for President Trump.

In a brief comment to reporters at The White House, Trump said this afternoon that he would be open to a one- or two-year deal as a way to reform the nation's healthcare system…

"So if we could do a one-year deal or two-year deal as a temporary measure, you’ll have block granting ultimately to the states, which is what Republicans want."

With Republican efforts to repeal, replace, or re-anything Obamacare falling short numerous times, Trump is looking for a 'win' and it appears he may get one.

The Hill reports that Trump will sign an executive order next week aimed at rolling back health insurance regulations put in place by former President Obama in an effort to undo his predecessor's signature health care law, according to The Wall Street Journal.

The order will direct the Departments of Health and Human Services (HHS), Labor, and Treasury to make it easier for individuals to group together and purchase insurance through "association health plans," according to the report.


The president also directs the agencies in the order to roll back the Obama administration regulations of “short-term medical insurance,” which is a cheap limited protection option that the former administration claimed was did not provide adequate coverage for individuals.


The regulation requiring insurance plans to cover a set of package benefits will also be rolled back, according to The Journal.


The order is seen as an effort from the president to roll back parts of ObamaCare after his administration and Republicans failed to fulfill their seven-year campaign promise to repeal and replace the law.

While the move has been anticipated by industry officials and political observers in the days since the GOP repeal effort crashed, the move is most likely to unsettle Republicans, who have already watched Trump partner with congressional Democrats on a debt ceiling deal.


The US Government Lost Nearly $1 Trillion In FY2017… Again!

Authored by Simon Black via SovereignMan.com,

There was a time, centuries ago, that France was the dominant superpower in the world.

They had it all. Overseas colonies. An enormous military. Social welfare programs like public hospitals and beautiful monuments.

Most of it was financed by debt.

France, like most superpowers before (and after), felt entitled to overspend as much as they wanted.

And their debts started to grow. And grow.

By the eve of the French revolution in 1788, the national debt of France was so large that the government had to spend 50% of tax revenue just to pay interest to its lenders.

Yet despite being in such dire financial straits the French government was still unable to cut spending.

All of France’s generous social welfare programs, plus its expansive military, were all considered untouchable.

So the spending continued. In 1788, in fact, the French government overspent its tax revenue by 20%, increasing the debt even more.

Unsurprisingly revolution came the very next year.

There are presently a handful of countries in the world today in similar financial condition– places like Greece, which are so bankrupt they cannot even afford to pay for basic public services.

But the country that has the most unsustainable public finances, by far, is the United States.

The US government’s ‘Fiscal Year’ runs from October 1st through September 30th. So FY2017 just ended last Friday.

During that period, according to the Department of Treasury’s financial statements, the US government took in $2.95 trillion in federal tax deposits.

And on top of that, the government generated additional revenue through fees and ‘investments’, including $62 billion in interest received on student loans, and $16 billion from Department of Justice programs like Civil Asset Forfeiture (where they simply steal property from private citizens).

So in total, government revenue exceeded $3 trillion.

That sounds like an enormous amount of money. And it is. That’s more than the combined GDPs of the poorest 130 countries in the world.

But the US government managed to spend WAY more than that– the budget for the last fiscal year was $4.1 trillion.

So to make up the shortfall they added $671 billion to the national debt– and this number would have been even larger had it not been for the debt ceiling fiasco.

Plus they whittled down their cash balance by $194 billion.

So in total, the federal government’s cash deficit was $865 billion for the last fiscal year.

And, again, that number would have been even worse if not for the debt ceiling that legally froze the national debt in place.

That’s astounding.

Just like in 2016 (where the cash deficit was $1 trillion), this past fiscal year saw no major recession. No full-scale war. No financial crisis or bank bailout.

It was just another year… business as usual.

And yet they still managed to overspend by nearly $1 trillion, with costs exceeding revenue by more than 20% (just like the French in 1788).

What’s going to happen to these numbers when there actually is a major war to fund? Or major recession? Banking crisis?

More importantly, they’ve been overspending like this for decades without any regard for the long-term consequences.

That’s why the national debt exceeds $20 trillion today. And including its pension shortfalls, the government estimates its total ‘net worth’ to be NEGATIVE $65 trillion.

Thousands of people are joining the ranks of Social Security and Medicare recipients each day, pushing up the costs of those programs even more.

Yet their Boards of Trustees warn that both Social Security and Medicare are quickly running out of money, raising the specter of a major bailout.

Plus there’s trillions of dollars more in needed spending to maintain the nation’s infrastructure. The list of long-term expenses goes on and on.

The obvious truth is that none of this is sustainable.

From the Roman Empire to the French in 1788, history tells us that the world’s dominant superpower almost invariably spends itself into decline, ignoring the consequences along the way.

It would be foolish to presume that this time will end up any different… especially given that there’s zero sign of any changes to the trajectory.

Congress has already put forward a new spending bill for this Fiscal Year– another 4+ trillion, not including any emergency spending that might arise (like hurricane relief, for example).

So we’re already looking at another nearly $1 trillion loss for the coming fiscal year, especially given that there’s almost no growth to tax revenue.

Don’t take this the wrong way– the sky is definitely not falling. The world isn’t coming to an end. And the US isn’t going to descend into financial chaos tomorrow morning.

But at a certain point, a rational person has to take note of such obvious and overwhelming data, and take some basic steps to reduce your exposure to the consequences.

For example, if your country is objectively insolvent, it probably doesn’t make sense to keep 100% of your assets and savings within its jurisdiction…

… especially if your government has a proud history of Civil Asset Forfeiture, AND you happen to be living in the most litigious society that has ever existed in the history of the world.

It’s easy (and incredibly cost effective) to move a portion of your savings to a safe, stable jurisdiction overseas that’s out of harm’s way.

Or to hold physical gold and silver in a safety deposit box overseas. Or even cryptocurrency as an alternative.

This isn’t some crazy idea for tin-foil hat-wearing doomsayers.

Rational, reasonable, normal have a Plan B.

And in light of the circumstances and all the data, it would be truly bizarre to NOT have one.

Do you have a Plan B?


Previewing The September “Hurricane-Disrupted” Jobs Report

Tomorrow’s hurricane-affected September jobs report will be… confusing. That is the (lack of) consensus from Wall Street analysts, who expect an average print of 80,000 (down from the 3-month average of 185K), however with huge variance on either side, with 4 economists predicting a loss of jobs, three expecting a print higher than 150K and one optimistic forecaster going as high as 260,000.

The amusing breakdown by bank is as follows:

  • Hugh Johnson 153k
  • Stadnard Chartered 150k
  • UBS 125k
  • JPMorgan 100k
  • Bank of America 80k
  • Citi 70k
  • Wells Fargo 55k
  • Goldman Sachs 50k
  • Deutsche Bank 50k
  • SocGen -25k
  • Jefferies -45k

Of course, the numbers are so scattered (as to make tomorrow’s report meaningless) due to the negative distortions from hurricanes Harvey, Irma, and Maria. The payroll survey is designed to ask employers about their number of employees for the pay period that includes the 12th of the month. Hurricane Irma made landfall just prior to the workweek containing the 12th of September. For workers who are paid on a weekly basis, if they were not able to work that week following Irma’s landfall, they may not be counted in the payroll report.

Still, while jobs may be depressed due to the hurricanes, the impact on average hourly earnings would be the opposite. As Citi’s desk notes, the hurricanes themselves may put upward pressure on earnings given overtime paid as companies have a hard time finding workers. The street is fairly split on this fact, with 23 of the 57 economist submissions so far with an estimate of 0.2 or below (2 estimates at 0.1%) and the rest calling for 0.3% or above (4 estimates at 0.4%), although this may understate risk for a positive surprise.

With that in mind, here is a summary of what to expects tomorrow at 8:30am, courtesy of RanSquawk

US NONFARM PAYROLL PREVIEW – SEP 2017, ANALYST FORECASTS (forecast, range, previous):

  • Non-farm Payrolls: 80k (-45k to 209k, Prev. 156k)
  • Unemployment Rate: 4.4% (4.3% to 4.6%, Prev. 4.4%)
  • Average Earnings Y/Y: 2.5% (2.4% to 2.7%, Prev. 2.5%)
  • Average Earnings M/M: 0.3% (0.1% to 0.4%, Prev. 0.1%)
  • Average Work Week Hours: 34.4 hrs (34.2 to 34.6 hrs, Prev. 34.4 hrs)
  • Private Payrolls: 83k (-25k to 199k Prev. 165k)
  • Manufacturing Payrolls: 10k (-20k to 40k, Prev. 36k)
  • Government Payrolls: No forecasts (Prev. -9k)
  • U6 Unemployment Rate: No forecasts (Prev. 8.6%)
  • Labour Force Participation: No forecasts (Prev. 62.9%)


Headline non-farm payrolls have averaged 176k in the first eight months of 2017, slightly lower than the 187k 2017 average. But the trend rate of payroll growth has picked up in recent months; on a  three-month rolling average basis, payroll growth averaged 185k in August, which is roughly in-line with the trend over the last three-months, and above the 175k twelve-month rolling average. Over the last five years, payrolls in September has averaged 204k, though it is worth noting that this month’s data will be distorted by the impact of Hurricanes Harvey, Irma, and Maria.

“Expectations are heavily discounted due to the recent hurricanes,” write analysts at Lloyds. “The natural disaster is going to leave the data unclean for a while and the release would have to be significantly weaker than anticipated for the market to start discounting a December rate hike from the Fed.”


Analysts at Capital Economics estimate that the hurricanes may have cut payrolls growth in half. “We already know that Hurricane Harvey caused jobless claims to spike in Texas. The rise in claims was smaller than that seen post-Katrina in 2005, but was larger than the impact from Ike in 2008. The rise in claims in Florida following Hurricane Irma so far has been negligible.”

State-Level Jobless Claims Data Suggests a Larger-than-Normal Payrolls Impact from Hurricanes Harvey and Irma

In 2005, Hurricane Katrina resulted in two months where payroll growth languished beneath 100k (versus the six-month trend of around 250k being added on a monthly basis).

Hurricane Ike is a more troublesome example to look for clues about how payrolls react, given that Lehman Brothers collapsed two days after the hurricane hit, CapEco says.

Looking further back, Capital Economics notes that payroll growth fell by around 100k in the aftermath of Hurricane Andrew in 1992, which was the largest storm on record to hit Florida at the time.


In its latest policy statement, the FOMC noted that “job gains have remained solid in recent months, and the unemployment rate has stayed low”, but “market-based measures of inflation compensation remain low”. Accordingly, despite the expected distortions to this month’s data, analysts will be looking to see if the wage inflation story remains intact, reinforcing the narrative behind a December rate hike.

ING’s analysts believe “a decent wage number should help cement market pricing of a December hike,” and are more optimistic than consensus, forecasting annualised wage growth of 2.6%, arguing that calendar quirks may drive a strong print.

Last month’s data was disappointing, ING says, but can be attributed to a change in the number of work days between the calendar months. The bank notes that where there were two additional workdays in the August, there were two fewer in the September month.

“Of course, these statistical quirks tell us nothing about the economics. The tight labour market and increasing job-to-job flows should drive up the pace of pay rises over coming months. But it is a slow-moving picture and we may struggle to see growth above 3% this year.”


CLAIMS: The most recent data shows initial jobless claims at 268,250 on a four-week moving-average basis, higher than the 250,250 going into last month’s Employment Report. However, it seems that this jump was more mild than analysts had foreseen. “We feared a big spike in claims as a result of Hurricane Maria hitting Puerto Rico, but it didn’t happen,” writes Pantheon Macroeconomics. “Given the extent of the devastation and the subsequent drop in economic activity, this is odd.” Pantheon notes that the lingering impact of Harvey and Irma kept claims above the pre-storm trend around 240k, and  believes that a reversion to these levels will be seen in a matter of weeks. “We have no reason to think that the underlying labour market has changed much since August,” Pantheon says.

ADP: The ADP’s measure of payroll growth was more-or-less in-line with expectations, showing the addition of 135k payrolls in September. But the tone of the commentary was generally positive; Moody’s chief economist Mark Zandi said “Hurricanes Harvey and Irma hurt the job market in September, but looking through the storms, the job market remains sturdy and strong.”

CHALLENGER JOB CUTS: Challenger reported announced job cuts by US employers fell 4.4% MM, while they lodged a 27% YY fall. Looking at Q3 as a whole, job cuts were down by 6.2% QQ and were 22.5% lower than Q3 2016. The data continues to paint a picture of a healthy labour market. “Job cuts have remained low since the second half of last year. As companies grapple with potential deregulation and changes to health care costs in a tight labour market, employers are holding on to their existing workforces while many positions requiring skilled labour go unfilled,” Challenger noted.

ISM SURVEYS: The employment sub-indices for both the manufacturing and non-manufacturing ISM surveys rose in September by 0.4pts and 0.6pts respectively. That marked the 12th straight month of employment growth in the manufacturing sector, and the 43rd consecutive month of growth in the non-manufacturing sector. And this is similar to the findings from the IHS Markit PMIs; for the manufacturing sector, employment growth was the fastest in nine months, though Markit noted that growth was running hotter than output, which signals that productivity may be slipping. The services PMI, however, saw employment growth slip to a three-month low, though Markit said it was still “solid” in September.

* * *


Barclays: We look for nonfarm payrolls to expand by 75k, down from 156k in August. Informing our view are initial and continuing jobless claims, which have risen following the landfall of Hurricanes Harvey and Irma. Offsetting this to some degree are other factors like part-time employment for economic reasons and the employment diffusion index, which have shown improvement in recent months. Elsewhere in the report, we look for private payrolls to rise by 70k. We also expect average hourly earnings to rise by 0.3% m/m and 2.6% y/y, while average weekly hours remain unchanged at 34.4. With the slowdown in employment growth on the month, we expect an unchanged unemployment rate at 4.4%.

Deutsche Bank: we expect only a 50k gain on headline nonfarm payrolls (+50k private). However, this may be enough to keep the unemployment rate steady at 4.4%. In fact, the “weather workers” series within the Household survey should provide a reasonable sense of the magnitude of the hurricane related disruptions to the payroll data.

Goldman Sachs: We estimate that nonfarm payroll growth slowed to +50k in September, below consensus of +80k and the 3- month average pace of +185k. Our forecast reflects the widespread flooding and power outages caused by Hurricanes Harvey and Irma, which affected over 10% of the population and caused over $100bn in damages. The impact on tomorrow’s report is highly uncertain, but our base-case assumes a significant impact of -125k that partially offsets continued job growth in the rest of the country. We also expect the hurricanes to weigh on the household survey results, and given the high unrounded level of last month’s unemployment rate (4.442%), we believe the September jobless rate is more likely to round up than down (we estimate a rise to 4.5%). Finally, we estimate average hourly earnings increased 0.4% month over month and 2.7% year over year, reflecting positive calendar effects.

Citi: Hurricane-related distortions to September payrolls imply market sensitivity to this month’s jobs tally will be lower than usual. Focus will be on wage growth for signs of inflation given last week’s soft PCE deflator print. We expect growth in average hourly earnings of 0.3% MoM (on-consensus) and 2.6% YoY (above-consensus), but see risks of a 0.4% print from a possible hurricane boost. Our forecast is for nonfarm payrolls growth of 70K (consensus: 80K) based on an analysis of initial claims data around past hurricanes. It would likely take a substantially below-consensus print (around flat or negative payrolls) to induce a large market reaction. Instead, the market may be more sensitive to upside surprises as a strong reading would imply either a smaller-than-expected impact from the hurricanes or stronger ex-hurricane job growth. Any hurricane-related softness in the September report will likely subsequently revert and boost the October payrolls report, as activity in the hurricane-affected areas returns to normal. Hurricane-related boosts to average hourly earnings will be temporary. Still, boosts to GDP growth from reconstruction will contribute to further labor market tightening, and with solid underlying growth, should lead to stronger wages over time.

ING: With this month’s payrolls number likely to be “written off” given the effect of recent hurricanes, a decent wage number should help cement market pricing of a December hike. But in reality, if the Fed decides not to move at the end of the year, it’s unlikely to be because of economics. Instead, the new debt ceiling deadline falls almost right on top of the December meeting and given the divisive nature of US politics, it could go down to the wire. A substantial pick-up in market volatility on the possibility of a government shutdown could conceivably see the Fed delay until 2018 – although that’s not our base case.

RBC: The survey period for the September employment report (the week that includes the 12th of the month) began as Hurricane Irma was making landfall in Florida and as Texas was still reeling from the effects of Hurricane Harvey. Thus, we will be shocked if we don’t see a significant slowing in nonfarm payroll growth on the month. Our best guess (given what Texas and Florida have added to payroll growth recently and trends in unemployment insurance claims in these states in the wake of the Hurricanes) is that headline and nonfarm payroll growth will slow to around 50K on the month, against a 6-month trend of around 160K. There is incredible uncertainty in this forecast and this is also reflected in the range of Street estimates (from -25K to +145K, if we throw out the highest and lowest guesstimates). Given the probability we get a very messy report is high, the market is likely to fade any weakness.

SocGen: Hurricane Harvey may have led to a decline in nonfarm payrolls in September, which would mark the first negative reading in seven years. Quantifying the hurricane’s impact on job growth is fraught with uncertainty, but we suspect that Harvey’s impact was similar to the drag on payrolls seen in the wake of Hurricane Katrina in 2005.


It Has Never Been Cheaper To Hedge A Market Crash Using This One Trade

In mid-August, at the height of the North Korea geopolitical turbulence, and amid uncertainty about the Fed balance sheet unwind, fears of a government shutdown and the US debt ceiling, as well as the fate of Trump tax reform and Obamacare repeal, when the VIX soared following a series of missile launches by Kim Jong Un only to crash right back to near all time lows, we used an analysis from BofA’s derivatives analyst Benjamin Bowler to show “How To Hedge A Near-Term Market Shock: Here Are The Best Trades

As we said then “if the events from last week demonstrated something, it is that just when there appears to be virtually no risk, is when the likelihood of a historic surge in volatility is greatest, as many experienced first hand last Thursday. Hence the need to hedge. But what?  And using which product?” As Bowler explained “the decision about whether it’s rational to hedge is really a matter of looking at the price of tail insurance embedded into option markets and asking if the probabilities they assign are “fair” or not.” As he further wrote, when it comes to predicting what the next “severe tail event” could look like, “we find that not only are some markets like Gold pricing in a very low probability of Korean risk escalation, there are significant differences across assets in terms of what they imply about potential risks.”

He then presented the chart below which shows how historical worst 3M drawdowns since 2006 are priced by 3M 25- delta options across asset classes; hedges that are most underpricing their historical drawdowns are at the top and those most overpricing their tails are at the bottom. What the chart shows is that gold call options imply less than a 1 in 100 chance of a severe tail event over the next month, despite being among the most reactive assets to rising Korean tensions last week. With record low Gold vol slaved to record low real rates vol, this represents a loose anchor which likely won’t hold in any significant geopolitical risk escalation. In contrast to gold, Nikkei is at the other end of the spectrum with options assigning over a 5% chance of a near term tail-event.

In other words, as of mid-August, BofA’s analysis found that Gold was pricing in the smallest probability of a “tail event”. The implication also is that should a “tail event” occur, the return from a gold-based hedge would be the one with the highest return (more details in the full article).

Fast forward almost two months to today, when not only have there been no crashes since mid-August, but complacency has returned to all time highs as the VIX is back within shouting distance of an 8-handle, after a record low September; of note, the VIX closed at 9.51 on Friday, down 0.08 points week-over-week. It was the third consecutive close below 10 and the eighth during September. It has remained in that ballpark since.

And with complacency once again the norm, traders, at least those who are not confident that stocks will keep rising in perpetuity, are again looking to reload hedging trades, and obviously, the cheaper the better.

Which brings us to the latest analysis from BofA’s Benjamin Bowler released overnight, who has again broken down the cheapest way to hedge against a market crash.

What he finds is more of the same, namely gold. As he writes, “gold traded in a wide range between 1,159 and 1,349 in 2017, pulled in multiple directions by the forces that drive it-the main two being US rates and geopolitical risks and to a lesser extent, dollar strength, oil prices and Asian demand.”

More importantly, on the implied vol side, short dated gold vol has been cheap for most of the year and gold calls have repeatedly screened as the cheapest proxy hedge. With the most recent US rates rebound, however, short dated gold implied vol has ticked up, while longer dated implied vol remains subdued. The price of a GLD 6m 95/105 strangle has averaged 3.8% in 2017 (7.4% since 2008) and has recently dropped to an all-time low just below 3%.

But most notably, as the chart below shows, “gold strangles with 6m maturity have never been cheaper in history.
His advice: “Position for gold’s divergence from its current price with a 6m 95/105
GLD strangle for 3%.

For institutional investors who find gold a little too “exotic” of a vol hedge, BofA also provides two other cheap market selloff hedging trade recommendations:

  • Trade #1: Hedge a coordinated bond/equity sell-off via long HYG Dec17 88 puts for 1.3% or 88/84 put spreads for 0.9% (ref. 88.8)
  • Trade #2: Hedge a flight-to-bonds risk-off event via long 0.4x IWM (Russell2000) Dec17 139 put (ref. 148.2) and short 1x HYG 85 put (ref. 88.8) for zero cost

The details:

Hedge a coordinated bond/equity sell-off via long HYG Dec17 88 puts for 1.3% or 88/84 put spreads for 0.9% (ref. 88.8): HYG’s sensitivity to both rates (see Chart 12) and equities makes it an ideal candidate to hedge a simultaneous sell-off in the two asset classes à la Taper tantrum in May-13, in light of high valuations, Fed balance sheet reduction and uncertainty over a change in leadership. With short dated vol on HYG on its 10yr floors and put skew rarely trading as expensive (see Chart 13), we consider HYG puts/put spreads attractive to hedge a coordinated bond+equity sell-off.

Hedge a flight-to-bonds risk-off event via long 0.4x IWM Dec17 139 put (ref. 148.2) and short 1x HYG 85 put (ref. 88.8) for zero cost: Small cap equities remain mired in a low vol regime with Russell2000 realizing the least vol in 20-years. This has contributed to compress the IWM-HYG implied vol spread to its lowest level over the past year (see Chart 14). Notably, in a risk-off event where investors flock into perceived safe-haven bonds, any sell-off in HYG is likely to be partly offset due to the diversification benefits stemming from its rates exposure. Hence, in such a scenario we prefer owning IWM puts against HYG puts, a strategy that at current pricing has offered a highly asymmetric risk-reward (see Chart 15).

The bottom line: for those worried that the current blow off top “Icarus rally” will end some time in the next few weeks, as BofA’s Michael Hartnett predicted yesterday, ignore S&P puts (or selling calls), and just buy either outright gold calls, or 6M gold strangles, which as noted above, have never been cheaper. Wary of gold? Then buy HYG puts/put spreads to hedge a coordinated bond+equity sell-off, or alternatively, own IWM puts against HYG puts, “a strategy that at current pricing has offered a highly asymmetric risk-reward.”


We Are Already In Depression (If Borrowing Money Is Not Income)

Via Baker & Company Advisory Group,

  • The U.S. economy is not as solid as it appears.
  • Statistical anomalies hide profound weakness.
  • I will examine actual GDP and actual employment.
  • Warning: not for the faint of heart.

Do you consider debt as income? Before you answer that, let’s perform a thought experiment. Imagine that you had taken a long cruise last fall and charged $10,000 to an American Express card. When you did your taxes this year, would have told the IRS that you had $10,000 income from American Express? Of course you wouldn’t. Suppose a major oil company issues $800 million worth of bonds to develop a new old field. Would the company report that as income to the stockholders or the IRS? Of course they wouldn’t. I am sure those sound like silly questions as the answer is a self evident “NO!” We do not consider borrowed money as income. It is a liability that must be paid back. Then why do we count Federal Government debt when measuring national income? I will leave speculation as to the “why” to the readers and focus on the fact that we do count new Treasury Debt as income.

The modern concept of GDP was first developed by the Department of Commerce in 1934. Commerce commissioned Nobel Laureate Simon Kuznets of the National Bureau of Economic Research to develop a set of national economic accounts. Professor Kuznets headed a small group within the Bureau of Foreign and Domestic Commerce’s Division of Economic Research. I picture them meeting to develop statistical measures that would help the government to determine if the economy was recovering from the Depression. They are debating on how to measure all of the various sources of income. One economist suggests that regardless of the source of his income, there are only two things he can do… Spend it or invest it and we know how to measure consumption and investment (& savings). This was the foundation of the expenditure approach to measure GDP. I can imagine another one of the economists suggesting that when we sell more to other countries, the excess should be added to national income and subtracted if we buy more than we sell (Balance of Trade). Then another economist suggests that there is a third alternative to the idea that he will either spend or invest his income and that is paying taxes. Since the government takes a portion of National Income and spends it, they decided to add Government spending into the GDP calculations. While each component of this basic formula for GDP breaks down into hundreds or thousands of sub-components, the final calculation is:


Where PI is private income (measured as consumption or investment)

Where BT is balance of trade

Where GS is government spending

So the final formula for GDP includes Government Spending. Notice that the government spending component does not take into account whether or not the government spent money taken out of private income (taxes) or borrowed it. When measuring National Income, we are giving equal weight to spending taxes on actual Private Income and money the Treasury borrows.

I suggest that government debt is not part of “ National Income” because it is not income. It is borrowed (often from sovereigns that are not our friends) and must be paid back eventually. We do not consider borrowed money as income anywhere else and it shouldn’t be considered as National Income. Debt is artificial stimulus not National Income! Governments must pay back debt either through higher taxes, inflation/depreciated currency, reduced services or some combination thereof. If we want an accurate picture of whether or not the economy is self sustaining, then we need to consider a measure I would like to introduce as “Actual National Income”which does not count artificial stimulus. Therefore to accurately measure the health of the economy, government debt must be subtracted from the formula. Please consider the GDP formula with the following modification.

Actual GDP = PI + BT + (GS – GB)

Where GB is government borrowing

So, if you acknowledge for the sake of argument that government debt is not actual national income, the following graph is how the U.S. economy looks like excluding stimulus. This is Actual GDP excluding artificial stimulus.

The data and chart comes from the Federal Reserve Economic Data base (FRED.) It is Gross domestic Product minus Treasury Debt. If you download them to a spread sheet GDP is expressed in billions so 1,000,000,000 is expressed as 1, while Federal Debt is expressed in millions so 1,000,000,000 is expressed as 1,000. That is why the chart is (Gross Domestic Product * 1000.)

The government has always borrowed and spent money but actual GDP has grown as far back as the Fed has data. That is until 2008. Then something in our economy broke. Since then it appears the economy has been in what would be considered a depression but masked by huge Federal Government stimulus borrowing. Have we reached a level of economic activity that could sustain itself without this artificial stimulus? What would happen if the Government was forced to balance the budget? You decide for yourself, but remember that would remove 5-7% of our GDP. An economic depression is generally defined as a severe downturn that lasts several years. Does this look like a severe downturn that is still lasting several years? This is what our GDP minus artificial stimulus looks like.

Does that chart look like the data on a self sustaining recovery? If it were self sustaining the slope would be rising as it was prior to 2008. It continues to decline and is therefore anything but self-sustaining. In economics, deficit spending has long been called “Fiscal Stimulus.” Since 2008, this artificial stimulus has averaged 7.45% of GDP. The arithmetic (GDP-GB) is quite simple; without the artificial stimulus created by spending the proceeds of newly issued Treasury bonds, our GDP has declined an average of 7.45% each year since 2007! The following data/proof is downloaded from the source of the previous chart.

From 1929 to the end of the Great Depression and WWII, the Fed increased its balance sheet from 6% of GDP to 16% of GDP. From 2008 to 2014 the Fed grew its balance sheet from 6% of GDP to over 22% of GDP. The effective FED Funds target rate sank to 0-¼% band at the end of 2008 and stayed there until the end of 2015, when they went to 1/4-1/2% and stayed there a year. In fact, the Fed did not start serially raising rates until the end of 2016. Essentially, the Fed sat at the zero boundary for 8 years. Many wonder why they took so long to start the process of normalizing rates.

The FED has given us 8 years of “0” rates and almost twice as much of an increase in balance sheet expansion as they used in the Great Depression and WWII. Why? Did they see something that was more dangerous than the dual threats to the U.S.’s actual existence than the Great Depression and WWII combined? Or perhaps they were just engaged in a reckless and potentially dangerous monetary experiment? I have been asking those questions since the Fed’s balance sheet expansion exceeded that of the Great Depression & WWII. I believe what I have been describing as “ Actual GDP” may provide the answer. The Fed & the Government may have seen a depression that had the potential to be more threatening, deeper and longer than that of the 1930’s. If that assumption is correct, then the Fed & the Government have successfully masked a depression, avoiding a negative feedback loop and giving the economy time to heal. Has it healed? Please refer to the first graph “GDP minus Federal Debt” chart and tell me if you think the actual economy has healed. It is still heading down so I believe an informed and rational answer would be NO. If it has not healed one wonders what the Fed is doing.

In a report published on Wednesday August 30, 2017, titled “With A Shutdown, There Will Be Blood”, U.S. chief economist at S&P, Beth Ann Bovino, writes that “failure to raise the debt limit would likely be more catastrophic to the economy than the 2008 failure of Lehman Brothers and would erase any of the gains of the subsequent recovery.” I believe Bivino is on to something, even though we now have a temporary extension of the debt ceiling. With the Federal Government borrowing and spending over 6-7% of GDP, then it stands to reason that without the Government’s ability to borrow new money, GDP would collapse 6-7% before a negative feedback loop type mechanism is engaged making it worse. It is just arithmetic. Since 2010 the amount of net new Treasury Bonds issued has averaged 6.5% of GDP. If the Federal Government were unable to issue new bonds then that amount would no longer be in GDP. Again, It is just arithmetic.

The labor market is reported as having created millions of jobs, but what kind of jobs? We often hear that we have full employment and a very tight labor market, that we have created so many jobs the Fed must raise rates. Since no one wants to raise a family working multiple part time jobs, let’s examine U.S. employment in terms of full time jobs,

The Federal Reserve data base (drawing on U.S. Bureau of Labor Statics) tells us there were 121,875,000 people employed with full time jobs in November of 2007 (just before the 2008 crises). As of August 2017 there were 125,755,000 people with full time jobs. That means our economy has added a paltry 3,880,000 full time jobs in almost 10 years as the population grew by about 23 million.

According to the National Center for Educational statistics there were 3,897,000 people who received a college degree including associates, bachelors, masters and PHDs in the school year 2016-2017.

The good news is that most of the people who graduated from college in the 2016/2017 school year can have full time jobs. The bad news is that in the 2016/2017 school year, those who dropped out of college, graduated from high school or dropped out of high school do not have a full time job. The really bad news is that everyone who graduated from college, who dropped out of college, graduated from high school or dropped out of high school from 2007 through 2016 do not have a full time job. There have not been enough full time jobs created in our economy for anyone out of high school or college in the last 9 out of 10 years. If the creation of enough full time jobs to employ only 1 year of college graduates out of 10 years sounds like a tight labor market to you and not a depression, then perhaps some of the readers would like you to share some of whatever you are smoking .

In conclusion, I believe the U.S. economy is in a depression masked by debt. I further believe there is no indication we have had an actual recovery of the actual economy.

These observations could inform intermediate and long term strategies. I am not using these observations as a timing tool, but rather as a depth finder for assessing risk when the next crisis unfolds or when market participants realize the emperor, not only has no clothes, he maxed out his credit cards buying them.



Market Gives Up Trump-Tax-Hope Gains After UBS Says “Tax Reform Won’t Happen”

Well that de-escalated quickly…


Following yesterday's breathless rip higher in small cap stocks (which are down today) and 'high-tax' stock outperformance (which is collapsing today), it appears 'sell the news' is more today's meme as many on Wall Street question the chances of getting a bill through… and what its effect would be.

As UBS' Seth Carpenter wrote overnight: "We don't believe that tax reform or even sizable tax cuts will happen. Even if a tax cut of 1 percent of GDP somehow happens, it is not a game changer."

Larger tax cuts than we anticipate are likely the single, most-easily identifiable upside risk to our forecast. Our baseline forecast incorporates no fiscal stimulus in 2017. For 2018, we have incorporated only modest corporate and personal tax cuts. Even with the new tax proposal from the Administration, our outlook remains unchanged. We are sceptical that a large fiscal stimulus package that increases the deficit will occur. There has not been substantial legislation passed so far this year, despite control of the Congress and the White House by a single party. Moreover, the fiscally conservative wing of the Congress will have to confront another vote to raise the debt limit next year in the context of any decision made about fiscal policy.

We could, of course, be wrong. While we do not expect the passage of a substantial tax reform package, there will be strong motivation to pass something. There is clear, long-running desire for tax reform. Moreover, 2018 is a mid-term election year, and without major legislative achievements to date, there is a clear incentive for the governing party to demonstrate an ability to produce results. The Administration released an outline of a tax reform proposal, but the Congress will dictate the finalform of any legislation. Put differently, a proposal from an Administration is non-binding.

Tax reform has historically been extremely difficult, in part because there are many different views on what sectors should receive preferential treatment. Even for the Senate to reach 50 votes in order to pass a reform package, in our view, the Administration's proposal would have to be pared back. The debt ceiling was recently suspended until December. Given the Treasury Secretary's ability to use what are referred to as "extraordinary measures" to finance the government into 2018, a new vote on the debt limit will be necessary next year.

For fiscal conservatives, voting for a substantial increase in the debt limit while also voting for a tax package that will substantially increase the deficit will likely prove an uncomfortable set of votes, particularly because 2018 is a mid-term election year.

The estimates of the budgetary impact of the Administration's proposal range widely. We do not think it is useful to wade into that debate, as the Congress will craft any legislation that arises. A plausible—though still to our minds, extremely unlikely—scenario would be tax cuts that amount to roughly 1 percent of GDP. Tax cuts of this size would justifiably be seen as large and would probably achieve political goals. But in our view, even a tax package of this size would change our forecast by a matter of degree, not of kind.

Fiscal multipliers, which tell us how much each dollar of fiscal stimulus is worth for overall output, are notoriously difficult to estimate precisely. Most estimates find that multipliers from tax cuts are smaller than multipliers from spending. Moreover, if taxes are reduced for agents with a relatively low marginal propensity to spend, the multiplier will be lower still.  ad fiscal stimulus been enactedwhen the economy was far from full employment and the Fed was trying to be as accommodative as possible, the effects would likely have been larger. But with the unemployment rate at historically low levels and with the Fed already embarking on a path of policy tightening, fiscal stimulus will in part likely lead to further policy rate hikes to prevent an overheating in the economy.

The table below presents a range of estimates on fiscal multipliers from a survey published by the Congressional Budget Officeand the CBO's own work. We present the 25th and 75thpercentile of the distribution of the estimates.

Corporate tax cuts are generally found to have relatively low multipliers as do tax cuts for the upper-end of the income spectrum. Tax cuts for lower and middle class families tend to have higher multipliers, as these households tend to spend a larger fraction of additional disposable income. In transforming the dollar amount of a tax cut into stimulus, however, because of the progressive nature of the tax system, across-the-board tax cuts will tend to cut taxes substantially more for upper income households.

Taking all of these multipliers together, we believe a reasonable assumption is that a compromise tax cut that would come out of the Congress would have a multiplier of about 0.5 or less. That is, each dollar cut in taxes translates to 50 cents on output. In the case of a tax cut that amounts to 1 percent of GDP, then, we would expect to see something like a one-half percentage point increase in GDP. The specifics of the tax plan will matter greatly:  whether the tax cut is permanent or temporary will matter, how much focus is paid to business versus individual taxes, and other considerations. Regardless, a tax cut of roughly this size would push our forecast for 2018 up to no more than 2¾ percent if the tax cut is rapidly enacted. That type of growth would clearly be an acceleration compared to recent growth rates, and the unemployment rate would fall further than our current projection of 4.0 percent. We currently envision two rate hikes from the Fed in 2018, one in June and one in December. That outlook is less aggressive than the FOMC currently projects, because we think inflation will rise less rapidly than the Fed does. With a substantial tax cut, inflation could rise as rapidly as the Fed envisions, and the downside uncertainty to inflation would be meaningfully reduced. As a result, the Fed would likely hike three times next year under such a scenario. A fourth hike would be possible if the tax package is implemented this year and the data show a sharper-than-anticipated decline in the unemployment rate right away.

The takeaway for us  is to be wary. We see little likelihood of a meaningful tax cut. But even if taxes were cut substantially, the size of the package would likely be of a size that would lead to only a modest revision to our outlook.

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So back to the de-hoping cycle…


“The End Is Nigh”

Authored by Jeff Thomas via InternationalMan.com,

Recently, US Secretary of the Treasury Steve Mnuchin stated, "If China doesn't follow these sanctions [against North Korea], we will put additional sanctions on them and prevent them from accessing the US and international dollar system."

By this, he meant that the US would shut China out of the SWIFT system, through which the great majority of international settlements are facilitated. In stating this, the US government is doing nothing less than threatening economic warfare against China, which would unquestionably prove catastrophic to the global economy.

This is astonishingly shortsighted, as the US can no more do without trade with China than China can do without trade with the US. Further, the US will unquestionably pressure its other trading partners (particularly the EU) to endorse and follow the sanctions. This they will not comply with, as it would serve to cut their own economic throats. The relationships between the US and their partners have been wearing thin in recent years, and the present threat against China is very likely to prove to be the final straw. The net effect would be to place the US out on an economic limb, alone.

There may be those who disagree with this premise, under the assumption that, to cut China out of the SWIFT system would destroy China's ability to make international transactions, forcing them to cave to US demands.

However, China, Russia, and others have seen this day coming and have created their own SWIFT system, world cable network, and world banking system. All that's needed to kick it all into gear is a major international need to bypass SWIFT. The US government has just provided that need with this threat. There would certainly be teething pains in getting the new system running on a massive scale, but the sudden worldwide need would drive the implementation.

This threat by the US at a time when it's broke is, in effect, economic suicide.

But, just as the ink is drying on this announcement, the increasingly impetuous US president has cracked a deal with Democrats to permanently abolish the US debt ceiling. As the debt ceiling was the last safeguard in governmental fiscal responsibility, he's effectively chosen to assure that the US will experience economic collapse.

Again, economic suicide.

It could be argued that the insatiable ego of “The Donald” has driven him to recklessness. Indeed, it's been his habit, when opposed on anything he wishes to do, to lash out, often creating far more dangerous deals, and saying, effectively, "So, there. I showed you. I'll do as I please, no matter the damage." This would suggest that he's the "Lemming in Chief," leading the US over a fiscal cliff.

It could also be argued that he is, instead, the "Patsy in Chief," and is being cleverly played by those who understand his personality weaknesses and repeatedly goad him into unwise decisions that will benefit them, but will ultimately be disastrous for the country.

Either way, what we're witnessing is a train wreck about to happen, and we're all, to a greater or lesser extent, on that train.

For many years, in predicting the economic collapse of what was once known as the “free world,” I've stated my belief that, whilst we cannot predict the actual dates when the primary events will occur, we can observe the lead-up events—that they'll increase in both frequency and magnitude the closer we get to the collapse. We've recently been in the stage where lead-up events have become weekly. We now appear to be entering the stage where lead-up events become daily. Once we've reached this stage, it's time to fasten our seat belts.

So, in returning to the image above, is this the end of the world? In a word, no. Those who profess the coming end of the world have been with us for, literally, thousands of years. They're just as misguided and incorrect today as they've always been.

It is true, however, that the world as we know it is about to undergo the most dramatic change that we'll witness in our lifetimes. Most certainly, we're presently in the greatest economic bubble the world has ever seen, which assures us that, when it breaks, the damage it causes will be correspondingly great.

But let's have a second look at the image above. It seems apparent that the three men in it are part of a religious group, recommending that mankind repent. As can be seen on the placard in the middle, "Ye must be cleansed."

Regardless of any religious connotations to this placard, there's accuracy in its economic connotations. A collapse is inescapable at this point. The system must be cleansed, much in the way an alcoholic must dry out, or an addict must get the drugs out of his system, before the recovery can begin.

When a crisis of these proportions occurs, it's not possible to simply acknowledge the collapse, then begin anew the next day. Just like the alcoholic or the addict, we can't just hit the reset button and start anew. After a collapse, a long and painful process must begin to cleanse the system. In a collapse of the severity of the one we're facing, the cleansing promises to be quite long and quite painful.

Twenty years ago, in predicting the coming collapse, Harry Schultz predicted, “ten years down; ten years up.” It may well be that his prediction was actually conservative, and we're now looking at a longer period, as so much additional damage has been done since his prediction.

But, before we leave this topic, it's important to look at one more factor. Historically, economic wars have a habit of becoming shooting wars.

It's not commonly known that the US war with Japan was precipitated by the US repeatedly putting the squeeze on Japan economically.

President Roosevelt froze Japanese assets in the US. He subsequently succeeded in cutting Japan off from three-quarters of their international trade. Finally, he cut them off from almost 90% of their oil supply.

It could be argued that, at that point, Japan had no choice but to go to war, however badly it might turn out for them.

Could it be that the US government imagines that similar tactics will force China into a war, so that, when that war ends, the US would control China as it did Japan after 1945?

If that's their intent, the outcome would be unlikely to turn out as they imagine. Although the sabre rattling by US political leaders and retired generals is heard daily on the American news programmes, and the American people are clearly being indoctrinated to believe that war might be necessary, America has never been less ready for a war.

The US is a very different country from what it was in 1941. It does possess a sizable military; however, that military is no match for the combined forces of China and Russia. Moreover, the US is not the industrial giant it was in 1941. Its factories have largely closed and moved overseas. What remains is not sufficient for wartime production. The American people as a whole are heavily in debt and the government itself is broke.

By any standard, the actions being taken by the US are therefore reckless indeed. The end of the world is not nigh, but the end of the world as we know it most certainly is.

If there's a light at the end of the tunnel, it may lie in the fact that, in previous world wars, there were always countries that simply didn't take part. They sat it out in peace, while the rest of the world went mad. This is still true today.

*  *  *

Unfortunately, most people have no idea what really happens when an economy collapses, let alone how to prepare. We think everyone should own some physical gold. Gold is the ultimate form of wealth insurance. It's preserved wealth through every kind of crisis imaginable. It will preserve wealth during the next crisis, too. But if you want to be truly "crisis-proof," there's more to do… How will you protect yourself in the next crisis? We just released a PDF guide that will show you exactly how. Click here to download it now.