Who to Fear: Iran or the Fed? | The Big Conversation | Refinitiv


ROGER HIRST: The first trading day of 2020
saw the S&P make another new all time high before news of the U.S. attack on an Iranian
general reversed the gains on the following day. Now, although geopolitics are dominating the
headlines, it could be a change in momentum of the US Federal Reserve’s repo operations
that poses the greater short term threat to equity markets. And that’s the big conversation. Last year, 2019 started off on the back foot
after global turmoil in the fourth quarter of 2018 had led to a 20 percent decline in
the S&P 500 and close to close basis. This, however, set up global markets for one
of the best years of the last decade, with the S&P 500 gaining nearly 30 percent through
2019 and surging 13 percent off the September 2019 lows with that momentum spilling over
into the first trading day of this year. Obviously geopolitical events have given markets
an early jolt in 2020 and are a reminder that politics rather than economics may currently
be the biggest catalyst for financial markets. Let’s not forget last year, markets soared
despite a dismal performance from global manufacturing, which even today is implying recessionary
levels in many parts of the world. The US December ISM Manufacturing Index fell
even deeper into contraction territory last week or is still above outright recession
territory, which is usually considered to be a prince anywhere below 45. So can the latest geopolitical shockwaves
become the catalyst for a reversal? Clearly, there’s a lot of uncertainty and
events could already have changed between filming this on Monday, the 6th of January
and its release on Wednesday, the 8th of January. But the US equity market may be facing greater
uncertainty from something far more mundane and arcane, which is the withdrawal of emergency
liquidity from the US funding markets. But before we touch on that, let’s take a
look at the initial reaction to events in the Middle East. On Friday, the 2nd of January, so far as the
crude oil prices immediately spiked, as would have been expected, with both the US based
West Texas and the global benchmark, which is Brent, rising around 4 percent on the initial
news and then further on Monday. And it should be noted, however, that this
initial reaction was far less than the spike in oil prices that we saw after the missile
attack on Saudi oil facilities in September of last year. But what should be noted both then and now
was the impact on the spread between Brent and West Texas. In September, the spread of Brent over West
Texas jumped as soon as the futures markets reopened on fears of a supply disruption. But within a few hours, only this move had
given up nearly all of those gains. And I think this reflected a new dynamic,
which is that the US is now a net exporter of oil, so that supply issues in the Saudi
sphere with those facilities being impacted, is seen as being far less serious than a disruption
would have been a decade ago. And of course, in a world where central banks,
particularly those of US, Europe and Japan, are looking for any excuse whatsoever to open
the liquidity spigots even wider, this geopolitical uncertainty may be just the excuse to keep
the fourth quarter accommodation going into 2020. But let’s assume for now, the US Fed in particular
is going to try and normalize its policy. Last year, we saw a pickup in liquidity provision
that broadly fell into two parts. The first one was a sudden surge in overnight
US Treasury repo costs. Very broadly, this is the costs of funding
a bank’s balance sheet in the short term markets. Now there were fears that the funding markets
could grind to a halt again, as they had in 2008. So the New York Fed stepped in with both overnight
funding and term funding, which is usually out to around about 14 days. And although this did stabilize the funding
costs, the size of those provisions continued to grow and grow as a number of key players
continued to hoard capital. And if this first phase was a reactive phase,
the second phase was pre-emptive, driven by concern that funding costs over year end,
turn funding, could also blow out as they had often done in the past. So the Fed therefore further increased the
size of its funding operations and then added some new regular facilities to ensure ample
liquidity from December the 15th to January the 14th, with a specific focus on the 30th,
December to January 2nd window i.e. around that turn. Well, the year came and went. The year end, rather than a collapse like
2018, we had a surge in equity prices probably because of this Fed backstop, a bit like the
run up we had in 1999 when authorities provided liquidity to protect against Y2K uncertainty. By the end of last year, the Fed’s balance
sheet had been expanding at a rapid pace, although it hasn’t reached the previous highs. The move has been dramatic. Whether this is true QE or not is irrelevant. The messaging was as important as the mechanics
because the Fed signalled that on a short term basis they would do whatever it takes
to stabilize markets. And the S&P 500 in particular appears to have
ebbed and flowed with these liquidity injections with a one week lag to changes in the Fed’s
balance sheet. But in some ways, the key point here is that
these supposed to be short term operations. Although they are still being undertaken,
some of that early liquidity should have dropped off on Monday, Tuesday and Friday of this
week. Though there are another three 35 billion
dollar facilities to come between now and mid-January. However, if there are any signs of equity
market weakness on the removal of that liquidity, won’t the Fed simply roll these facilities
on an ongoing basis? And that’s certainly the core expectation
of market. Short term funding that is constantly rolled,
well, effectively that becomes long term funding. And as mentioned previously, those geopolitical
tensions themselves may be just the excuse that the Fed is looking for to keep their
operations running. If that becomes the case, it’s worth remembering
what happened in Q1 2000 of the global authorities had injected a precautionary amount of liquidity
ahead of the Y2K event, having already loosened policy in 1998 after the collapse of Long-Term
Capital Management. The Nasdaq rallied another 25 percent before
eventually it collapsed under the weight of its own ludicrous valuation, which was its
own central bank induced Minsky moment, which led to a two and a half year decline in the
US equity market. So central bankers can still be far more dangerous
for markets than politicians, but undermining risk assets is not part of their intentional
programming. There’s been a lot of chatter, again, about
the recent re steepening of the U.S. yield curve at the end of last year. As you’re probably aware, the U.S. yield curve
has followed a similar pattern ahead of the last few U.S. recessions. First, the curve inverts. That’s when the 10 year yield falls below
that of the two year yield or the two year yield rises above that of the 10 year. And this inversion usually occurs well in
advance of a recessionary event. There was a brief inversion on this part of
the curve in the middle of 2018. However, the countdown to a recessionary event
usually comes from the re-steepening of the curve. But as with the inversion, the re-steepening
can begin many months in advance of recessionary events. By the end of 2019, the curve had significantly
re-steepened off the lows, in fact, taking it to a 12 month high. Now, not withstanding the decline in long
dated yields and the back of last week’s political events, the initial re steepening again sparked
renewed calls for an imminent recession. And these calls were given additional impetus
by last week’s ISM manufacturing data, which as noted in the previous section, had fallen
further into contraction territory. although the market PMI version has remained
resolute above 50 throughout. And as we noted in our top charts for 2020
segment at the end of last year, we must also be on watch for a deterioration in consumer
confidence. Although the labour differential has rebounded
to zero, a fall below zero has been a precursor to the last three recessions. Consumer confidence itself continues to test
the 10 year uptrend. Remember, when this indicator turns, it can
turn extremely rapidly. This is a broad generalization, but previous
inversions prior to recessions saw the initial flattening and inversion caused by two year
yields rising. And this is as growth picked up. It forced the Fed to raise rates such as the
front end yield converged on the long end yields. Now, through much of 2018, it was true that
the flattening was indeed due to higher two year yields. But from November 2018 through to September
2019, it was the rapid decline in the long dated yield, such as the 10 year space that
drove the flattening of the yield curve. Now, low growth may have been a key dynamic,
but it was also the result of central bank activity and the actions of a few commercial
banks who were rebalancing their loan and bond portfolios i.e. This was not the normal flattening dynamic
that we’d seen prior to previous recessions. And this dynamic has also influenced the recent
re-steepening. Prior to previous recessions, the restructuring
had resulted from the Fed cutting rates in order to offset the slowdown that they had
manufactured via the previous tightening cycle. And this is all part of a fairly normal and
recurring business cycle that has existed for much of the post-war era. On this occasion, however, most of the steepening
has come from a rise in the 10 year yield from those excessively depressed levels in
September 2019. So the dynamic of flattening and re steepening
of the US curve is therefore somewhat different than the dynamics that preceded previous recessions. Wage inflation has not yet picked up, which
has allowed unemployment rates to remain incredibly depressed, close in fact to the 50 year lows. And the Fed has not been forced to act based
on tight unemployment conditions, at least not yet. But there are risks that this liquidity that
is sloshing around the global system currently with a very low velocity could quickly build
momentum and force the hand of central banks. As we’ve mentioned in previous segments, geopolitics
may drive asset prices despite the best efforts of central banks. But for now, the dynamics of the inversion
and the risk deepening of the curve are giving a very different message from the dynamics
that preceded the previous recessionary events. And for now, the central banks continue to
provide historically abnormal amounts of liquidity in an attempt to keep a lid on asset price
volatility and keep this unnatural framework going that little bit longer. There are a couple of then and now charts
that have been doing the rounds for the S&P 500. One is from 2013 compared to today and one
from 1998. Now these sorts of comparisons are really
only useful as potential signposts. They will inevitably diverge is any time,
but market patterns tend, like everything else, to ride through the seasons. And it can give us clues as to what happens
next, especially if there are similarities in the backdrop. Perhaps the most striking of the comparisons
is that of the full year of 2013 with this year’s performance. In percentage terms, the S&P gained almost
30 percent on both occasions. What’s really striking is the markets then
and now have ebbed and flowed in a very similar pattern. Now if we roll on into 2014, we can see that
the S&P had a minor wobble toward the end of January. You may also recall that we had a bigger wobble
at the similar time in 2018 as well. So it’s worth bearing in mind that a sizeable
rally like we’ve seen is always susceptible to a smaller scale shakeout. The second pattern that has similarities with
today’s is the rally off the lows in 1998 compared to the rally off the lows in December
2018. The initial move of both markets was very,
very similar, though the 1998 move was far more powerful than that move off the December
2018 lows. But after roughly a similar sort of day count
between the S&P then and now, both markets had gained around about 35 percent this time
round, largely because the Federal Reserve has fuelled that rally into the end of 2019. In 1999, Y2K saw additional accommodation
from the Fed and other monetary authorities. In 2019, issues with the repo markets saw
the Fed become more accommodative, juicing markets into year end. In 2000, the Nasdaq added another 25 percent
before reversing and even the S&P 500 surged to a new high. Now, although we shouldn’t be committing ourselves
to invest based on spurious past patterns, on both occasions. although momentum was faltering and showing
high volatility, it continued to the upside for at least a few more months. So if the Fed show few signs of withdrawing
the emergency liquidity that they put in at the end of last year, then I don’t think is
unreasonable to expect the same sort of thing this time round in terms of further upside
unless the geopolitics emphatically take over. But that will probably take some time to play
out.

50 comments

  1. The Fed needs a continuous state of war as does the M.I.C. Peace only shows the true weakness of the current system due to the highest levels of sovereign/commercial debt levels. Not including unfunded liabilities. The states has 21 Trillion of sovereign debt. It's unfunded liabilities are 10x that. Dwell on that.

  2. "the messaging was as important as the mechanics". The Fed do nothing real under the hood. They are not mechanics. They are message-makers, narrative engineers. "short-term operations" will be believed when they are seen.

  3. Okay go play

    **394 , 364 , 3194** box/Straight online @ 5 dimes including Canada

    I think Michigan played 493 on Saturday or Saturday……don't Quote me

  4. This idiot is clueless. Does he not realise that the reason US stocks have gone up is buy backs and the government putting billions into the stock market, sometimes daily.

  5. Awesome, this is a killer breakdown of the indicators. Looks like April 2020 we'll be in the next recession if the graphs continue as expected.

  6. Right from the kick, you start off wrong. As the world's two largest economies the US and China, as well as the EU to a certain extent should be focusing on Long Term Sustainability, including proper regulation of fiancial markets so the supposed 'experts' working within act like professionals and not like Termites.

    There is no guarantee that Democracy or a Republic will continue to be the favored global government. If the US has another financial melt down and another set of banksters is allowed to walk while Chinese banksters are put to death.

    Communism could easily become the favored system of government by the masses as The People couls begin to view YOUR CLASS, the Gold Collars as the enemy of The People, and see the US Government as impotent in bringing the Termite Class to justice.

  7. Well one thing is Absolute. We don't have to fear Iran, we can fear a war with Iran, but that is because the neocons and their newest puppet Trump wants one, and wont leave Iran any other choice but to fight back. We can and should fear the consequences of that war, but Iran itself poses no threat, as long as they are simply being left alone.

  8. 2021
    1. deflation leads to lower company earnings
    2. lower earnings lead to layoffs
    3. layoffs lead to people spending their savings
    4. spending savings lead to higher velocity of money
    5. velocity of money lead to inflation
    6. inflation leads to higher interest rates
    7. higher rates lead to more less lending options
    8. crash spiral for housing, market, debts, confidence, etc.

  9. Unemployment rate in USA is higher in the real world than in the mouth of politicians or official statistics. Don't believe the official statistics, they lie , and it's not coherent with others stats ( foods stamps … ) Unemployment rate in USA is more like 20% than 4% . It's the same in UK, France, Germany, and it's growing.

    The world is not made only of fools …

    The counterfeiters need a new conflict to save the banking scam.

    All mainstream media scream in chorus against Iran, like watchdogs of the global scam system.

    All the fake news around Iran serve this purpose : save the FED, and others central banks, save the global scam system, save the financial parasites, save the parasitism system. That won't happen … 🙂

  10. Of course just the effective launch of a Bigly amount of missiles from Iran into Iraq targeting American personnel is followed by "all is well" from Rusty Bathwater , is most heartening?

  11. What would the yield curve look like if the federal reserve was buying the treasuries instead of just borrowing them with treasury bills?
    The liquidity is from interest on excess reserves and not repo operations?

  12. In 1998 printing a trillion dollars to bailout LTCM was the cause with Y2K being the reason?
    The federal reserve is loaning a lot nightly against a strong wind of deflation what you going to give up?

  13. Powell is a well-meaning American!! He has never said Death to America, not has he threatened to shut down Fracking. You need a new title.

  14. Donald Trumps own words, "Iran will never be allowed to have a nuclear weapon." That's why the B-2 bombers are deployed to Diego Garcia. The bombings will start soon.

  15. Brilliant analysis. Fed will keep the party going as long as possible, until the REAL bond market ultimately reasserts itself. The endless recycling of petrodollars, the source of unlimited dollar support, will end in the next business cycle. Trump's war stance with Iran reveals the desperation of the Old World Order to create an event that portrays American indispensability while at the same time goosing the price of oil, to save the fossil fuel dinosaurs who are swimming in endless oversupply.

  16. your channel continously overlooks that it was the iranians that escalated mid east tensions by killing the american contractor, why?

  17. Well put. I would expander your list though. Israel, Iran, or the FED. Who should we be fearing more? The Communist take over of America is nearly complete. We don't have long left before America looks like Weimar Germany or pre Bolshevik Russia.

  18. Fear Iran? Are you kidding? Fear Trump, i.e. the people behind him, that tell him what to ultimately do.
    "Politics is the entertainment division of the MIC"

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