Poop Is A Palindrome

“Let me be clear – it's not the beginning of a long series of rate cuts.”
-Jerome Powell, 7/31/19

Sometimes inefficiency is a specific objective. 

A main principle of dieting anchors on this, although you probably don’t approach it from that perspective.  Protein is metabolically expensive and takes around 2X the amount of energy to process and utilize by the body.  Along with cultivating a more favorable hormonal, fat-loss milieu, less efficient means more calories used up in the metabolic process and less calories that can be potentially stored later on.  

One person’s metabolic inefficiency is another person’s diet optimization.  

Sometimes it’s simply knowledge that bridges the divide between inefficiency and optimization, revealing them to be the same thing viewed from alternate perspectives.

Back to the Global Macro Grind ….

Sometimes inefficient and optimized are simply just opposites.

There’s been no lack of coverage around the non-optimized blowout in the GC repo market, but we continue to get questions on it so let’s quickly review and contextualize. 

As we walk through the setup here, keep in mind that, at its core, the problem is simply a shortage of dollars.    

First, what is the GC (General Collateral) Repo market and what is the connection to the Fed Funds market:

1. General Collateral is pretty much exactly what it sounds like.  You post collateral in the form of some security in exchange for cash. …
2. If cash/dollar liquidity is tight, the price for that cash goes up, which is what we’ve seen in recent days.  Liquidity conditions in funding markets tend to be non-linear … once you hit some critical threshold, conditions shift to acute, quickly. 
3. Higher repo market rates also tend to drag the effective Fed Funds rate higher.   If liquidity conditions are that tight, it will manifest across funding markets.  And, also, if I have excess cash, why lend unsecured at the Fed Funds Rate (2%) when I can lend secured at 7%?
4. We provided a layman’esque primer on the mechanics of policy implementation back in July (see: Macro Mosquitoes) amisdst some emergent stress in the Fed Funds market and presaged the probability for developments of the kind we’ve seen over the last few days in the repo market.

Fed Repo Facility:

1. Again, “Repo” sounds technical and fancy but all it means is:  I give you a bond, you give me cash and I promise to buy that bond back later (and pay some rate as the cost for obtaining that cash).
2. The Fed opened the Overnight Repo facility to provide dollar liquidity and renormalize the apparent imbalance between dollar supply and dollar demand.  They do this because they don’t want the real or signaling effects of frozen funding markets to metastasize and because they don’t want to lose control of the Fed Funds market due to spill over effects (described above).   

So, there is a shortage of dollars. Why?

The funding market stress is symptomatic of some larger thematic dynamics we’ve been recurrently highlighting in recent months, but there are some discrete, identifiable factors at play:

1. QT = I give you bonds, you give me dollars = dollar supply ↓
2. Fiscal Stimulus/Deficit spending = I give you bonds, you give me dollars = dollars supply ↓
3. Debt Ceiling resolution = Treasury rebuilding cash balances at the Fed after “extraordinary measures” during Debt Ceiling = reserves/dollar supply ↓
4. Growth Slowing/Trade Volume ↓ | lower global trade volumes = less dollars flowing through the global financial system
5. Idiosyncratic:  Coupons settlements and Corporates needing short-term funding for tax payments combined with the factors above drove an acute imbalance in the repo market. 

Remember, the decline in dollar supply is coming amidst a broad increase in dollar demand:

1. Global Quad 4 along with the ongoing relative growth and policy divergence domestically (relative attractiveness of domestic assets and ongoing positive rate differential) have maintained the bid for $USD’s.
2. Dollar denominated debt issuance ramped significantly over the last decade (dollars are needed, globally, to pay/service that debt).
3. The economy continues to expand on both a real and nominal basis, meaning the amount of “excess” or “ample” reserves needed in the banking system to ensure adequate liquidity continues to increase. Post-GFC regulatory requirements only add to the required “excess”.

*Note:  nobody knew/knows the precise amount of reserves necessary to maintain fluid functioning in funding markets.  It has been an empirical experiment playing out in real-time.  To some extent, its simply a “do it until something breaks” exercise.

Again, the whole funding market discussion can be as technical and esoteric as you’d like but, at its core, the problem is that there are not enough dollars. 

There are effectively two solutions for the Fed: 

1. Stand ready to provide dollar liquidity (i.e. standing repo facility of the kind we’ve seen the last two days)
2. Increase reserves back to “excess”.  Increasing reserves basically = balance sheet expansion = QE … and do so on an ongoing basis at a scale in line with nominal growth/liquidity needs.

I imagine we’ll get some version of an update regarding those two options alongside the Fed decision this afternoon. 

That redux swallowed more of my word quota for this morning that I was expecting but I just wanted to quickly connect some dots vis-à-vis yesterday’s lone high-frequency domestic data release:

• Industrial Production  = 31-Month Low: Most of yesterday’s headlines contextualized the data as solid.  We’d take the other side of that.   3Q into 4Q19 represent some of the hardest base effects of the cycle and the moderately strong sequential (+64bps M/M) was not enough to effectively hurdle existing year-over-year comps.  Indeed, against a harder RoC comp in August, the solid sequential gain was only enough to muster +0.34% Y/Y growth, marking the slowest pace of growth in 31-months.   
• Manufacturing Contraction:  Manufacturing Production (the largest component in the IP Index) continued to sink, contracting -0.4% Y/Y while printing negative for a second month. 
• Durables Contraction:  Production of Consumer Durables fell -0.2% sequentially while falling to -0.4% Y/Y. 

The August IP data come on the heels of a worsening Empire Manufacturing reading for September, signaling that the Industrial indigestion fomenting within the domestic economy’s cyclical underbelly is not gearing up for inflection. 

As it stands, with growth (globally and locally) slowing, inventory-to-sales ratio’s at 10Y highs, Export Orders in contraction, Capex Plans in Trend retreat, (still) unfavorable comps, and Backlogs and New Orders both falling in the latest data, the manufacturing activity mosaic continues to tell a congruous story

Remember, Export Orders lead the slope in OUS Corporate Profits (both are headed lower), Capex Plans lead actual Capex (both are headed lower), and the trend New Orders lead Durable and Capital Goods Order growth (both are headed lower).

… and with the latest raft of “lowest since” China data, yesterday’s -10% Y/Y print in Indonesia Export Growth, this morning -8.2% Y/Y growth in Japanese Export growth, and FedEx’s reporting of reality (again), the global activity mosaic continues to tell a congruous Quad 4 story as well, for now.     

In short, unless industrial impotence somehow represents macro optimization (which it might to the extent optimization = asset reflation by driving further, active easing out of central banks) there doesn’t appear to be much upside risk to Durable Goods/Capital Goods/Mfg activity into EPS season.

If this morning’s data or the intensity of the factor rotation Dramamine ride over the last week+ has your cortisol levels peaked, I’ll leave you with some psycho-emotional exfoliation compliments of my 6 year old daughter who dropped this gem while talking in her sleep last night:

“Poop is a palindrome"

Why yes, yes it is.

Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND signals in brackets) are now:

UST 10yr Yield 1.41-1.96% (bearish)
SPX 2 (bullish)
RUT 1 (bearish) 
REITS (VNQ) 91.23-94.16 (bullish)
Shanghai Comp 2 (bearish)
VIX 13.36-18.19 (neutral)
USD 97.51-99.10 (bullish)
Oil (WTI) 52.51-62.18 (neutral)
Gold 1 (bullish)
Copper 2.55-2.69 (bearish)

Best of luck out there today.

Christian B. Drake