The Treasury Department’s TIC update for the month of June 2021 was, well, interesting. Not in a good way, either (post-2014, is it ever actually good?) There are just too many nuggets to digest in one sitting, so here I’ll merely go over three major developments: an update to the May 2021 big dollar warning; a big, nasty wince given this particular China twofer; and what the hell must be going on without US banks being able to borrow US T-bills from foreign non-banks (yes, you read that right).
Last month first; the TIC data gave us one of those preliminary global dollar shortage alarms when for the month of May 2021, it recorded foreign selling of all types of US$ assets outpaced foreign buying. A net negative, especially for private holders, a rarity at the level Treasury logged therefore telling us something important about the inability of the offshore money world to fluidly, efficiently, and necessarily gather US$ funding.
The details of this “selling”, the very long history behind it, and how to properly account for interpret the minus sign, all are described here.
Buying (net) returned in June, according to these updated figures. Crisis canceled? No, not quite. The month-to-month behavior especially at the beginning stages of past global (euro)dollar events tend to be this noisy. It hasn’t been unusual for there to be the big minus/warning one month, then seemingly back to normal the very next.
The substance of this omen is itself that any month turns negative at any time; if the dollars are indeed flowing, let alone flooding as advertised, there shouldn’t be one at all. That there was indicates trouble the entire global system has already been trying to work around which raises the possibilities of rippling effects for months hereafter.
Should this monthly downturn – regardless of the subsequent rebound in net buying – come along with other such dollar shortage indications (which have been increasingly plentiful) then we’d expect more of this to come.
One of these other is China. Economic woes, the PBOC longtime devoid of new dollar flows, and now something that always makes me just cringe.
For the last half of last year, on into late January this year, CNY was unstoppable. Once left for dead because of 2020’s GFC2 shortage, it rebounded like the proverbial Phoenix – even though, as noted above, the magnitude was inconsistent with what we’d otherwise have expected to be its cause, meaning a very clear record of unambiguous, huge inflows.
In terms of TIC data, it would have been a surge in UST’s being held by various Chinese pockets – including any of those storing these “reserves” over in Belgium (Euroclear) for use in derivatives markets (already a clue). But we’d already seen this same hollow rebound in CNY before, just a few years ago back during Reflation #3 in 2017 and January 2018.
How Chinese officials manage these various inflection points once the hollowness is exposed, from reflation to dollar shortage, Euro$ #4, in that case, also tells us something important about them. During 2018’s turnaround, CNY kind of hung in there for a few months before eventually the shortage turned drastic and China’s official sector did nothing to stop it. CNY went DOWN hard, confirming it was about to get BAD everywhere as it eventually did.
Back in 2015, by contrast, the Chinese government took a far more managed approach to attempting to manage the growing dollar shortage presented by Euro$ #3 – including the piece that can only make you cringe in the wrong kind of anticipation. Here it is:
Between late March 2015 and early August, CNY went near perfect sideways, as if guided by an unseen giant keeping the exchange value absolutely steady; too steady. There was only one possible way this could have been done, via extremely costly stealth intervention. The idea behind it was simple enough, to buy time for the situation to work itself out (back when these central bankers still thought these dollar shortages might ever be temporary problems).
In reality, it was like coiling a spring (the nightmare scenario); once loaded with too much dollar stress, the thing snaps. Thus, CNY in August 2015 (it was never currency “devaluation” as some kind of export “stimulus”) which was followed, relatedly, just two weeks later by a flash crash across Wall Street’s invulnerable equities.
Not only has CNY in 2021 stopped rising since around January, look what it’s done since late June. Shudder as well as cringe:
That’s not all. We can “map” China’s reserves levels in the form of UST’s, including Belgium, from the TIC data in order to more completely check CNY trends. Sure enough, CNY has struggled during the very same months (since February) that UST’s “disappear” again from both Belgium and mainland China.
The same months, you recall, when anti-reflation came to subsume global bond markets as well as various large parts of the global economy (only starting with China).
Together, sideways CNY in a narrow range plus the anti-reflation if not outright deflation dollar shortage suggested by falling Chinese holdings of UST’s all point to an increasingly troubling global monetary situation – not necessarily crisis, but certainly disconcerting. So much that, if our view of CNY since June is correct, stealth measures undertaken if only to hope and play for time.
Maybe this time will be the first time it works out.
A big reason why dollar shortage indications are showing up all over the map, something we’ve obsessed about since, oh, January: T-bills. The third section of this TIC review takes us to the utterly confusing cross border trade of bills and their primacy in problematic repo periods.
Repo is the true lender-of-last resort in the world given how the US Federal Reserve is not a central bank (a fact that is tacitly acknowledged by what the Fed nowadays does, or tries to do). If Jay won’t, somebody’s got to do it. The problem has been that repo volumes go up when times are good, or less bad (reflation), and then they disappear when less bad goes right back to outright bad.
Outright bad is acute dollar shortage largely predicated upon collateral shortages (which you can read all about here; collateral multiplier and all that stuff). Expansion of the multiplier and repo, then collapse which herds everyone into limited supply and redistribution of acceptable collateral.
The intensity of this negative pullback in collateral has been dictated by how stupid and reckless the financial system gets in the period before the inevitable downward spiral. The more junk that ends up in it on the way up, helping expand the multiplier, the more the multiplier will likely shrink as dealers’ eventual risk-aversion always seems to end up inversely proportion to that prior stupidity. Rinse. Repeat.
This collateral situation and potential for eventual tightness is further complicated by QE, stripping the system of its best issues, as well as Treasury refunding meaning reducing gross supply at some of the worst possible times (such as early 2011 contributing much to the destructiveness of Euro$ #2).
With that background in mind, first the reflation:
That’s a pretty sizable increase in US banks borrowing securities (repledged, undoubtedly) under repurchase agreements with foreign entities; both FOI’s, or official institutions like central banks, as well as “other” which includes both banks and non-banks.
Now, here’s the punchline (to clarify: the data above and the figures below are from separate entries in TIC, which means they are not directly related):
This makes sense given the reduced supply of bills; fewer bills, or ST Treas Secs, have been borrowed since really January (there’s that February inflection again) by US banks from these various foreigners even though the other data tells us repo collateral borrowing has gone way up during these same months.
More collateral being borrowed, yet it doesn’t seem to be, it can’t be since January, T-bills. This, obviously, begs the question as to what security is being borrowed either through repledging or other means?
Whatever that might be, these results are certainly consistent with T-bill prices and low yields.
Admittedly, the indirect indication of junk concern/bottleneck potential is speculative on my part and is not drawn from these TIC series alone. However, the TIC data is importantly consistent with each aspect of that speculation. In other words, not only is it not being ruled out, these indications are actually more evidence on its side.
In terms of deflationary potential, one more thing pointing toward potential repo junk piled in on the way up:
Suddenly, the rest of the world wants US corporate bonds again, meaning that a ton of them, more than at any time since before 2008, at the same time US banks can’t borrow nearly as many T-bills from foreign institutions, official and otherwise, even though their usage and conditions of repo have reflationary jumped along the way.
Where vaccine and “stimulus” hysteria once rule in unchallenged reflationary excessiveness, it actually didn’t last very long at all. Instead, the opposite indications continue to pile up one after another, at times several all at once. Though headline TIC rebounded, that may prove the exception.
This doesn’t mean bad, bad things tomorrow, or that such might be unavoidable. For now, there are just too many things which continue to seriously raise those possibilities. Deflation potential truly seems to have proliferated in very meaningful ways. But we already knew this.
Goldman Raises Year-End Oil Price Target To $90
Goldman Raises Year-End Oil Price Target To $90
Just days after Goldman’s head commodity analyst Jeff Currie told Bloomberg TV that the bank…
Just days after Goldman's head commodity analyst Jeff Currie told Bloomberg TV that the bank anticipates oil spiking to $90 if the winter is colder than usual, on Sunday afternoon Goldman went ahead and made that its base case and in a note from energy strategist Damien Courvalin, he writes that with Brent prices reaching new highs since October 2018, the bank now forecasts that this rally will continue, "with our year-end Brent forecast of $90/bbl vs. $80/bbl previously."
What tipped the scales is that while Goldman has long held a bullish oil view, "the current global oil supply-demand deficit is larger than we expected, with the recovery in global demand from the Delta impact even faster than our above consensus forecast and with global supply remaining short of our below consensus forecasts."
Among the supply factors cited by Goldman is hurricane Ida - the "most bullish hurricane in US history" - which more than offset the ramp-up in OPEC+ production since July with non-OPEC+ non-shale production continuing to disappoint.
Meanwhile, as noted above, on the demand side Goldman cited low hospitalization rates which are leading more countries to re-open, including to international travel in particularly COVID-averse countries in Asia.
Finally, from a seasonal standpoint, Courvalin sees winter demand risks as "further now squarely skewed to the upside" as the global gas shortage will increase oil fired power generation.
From a fundamental standpoint, the current c.4.5 mb/d observable inventory draws are the largest on record, including for global SPRs and oil on water, and follow the longest deficit on record, started in June 2020.
For the oil bears, Goldman does not see this deficit as reversing in coming months as its scale will overwhelm both the willingness and ability for OPEC+ to ramp up, with the shale supply response just starting.
This sets the stage for inventories to fall to their lowest level since 2013 by year-end (after adjusting for pipeline fill), supporting further backwardation in the oil forward curve where positioning remains low.
But what about a production response? While Goldman does expect short-cycle production to respond by 2022 at the bank's higher price forecast, from core-OPEC, Russia and shale, this according to Goldman, will only lay bare the structural nature of the oil market repricing. To be sure, there will likely be a time to be tactically bearish in 2022, especially if a US-Iran deal is eventually reached. The bank's base-case assumption is for such an agreement to be reached in April, leading the bank to then trim its price target to an $80/bbl price forecast in 2Q22-4Q22 (vs. its 4Q21-1Q22 $85/bbl quarterly average forecast). This would, however, remain a tactical call and a likely timespread trade according to Courvalin, with long-dated oil prices poised to reset higher from current levels, especially as the hedging momentum shifts from US producer selling to airline buying (a move which Goldman says to position for with a long Dec-22 Brent and short Dec-22 Brent put trade recommendations).
Meanwhile, the lack of long-cycle capex response - here you can thank the green crazy sweeping the world - the quickly diminishing OPEC spare capacity (Goldman expects normalization by early 2022), the inability for shale producers to sustain production growth (given their low reinvestment rate targets) and oil service and carbon cost inflation will all instead point to the need for sustainably higher long-dated oil prices. Remarkably, Goldman now expects the market to return to a structural deficit by 2H23, which leads it to raise its 2023 oil price forecast from $65/bbl to $85/bbl, and the mid-cycle valuation oil price used by Goldman's equity analysts to $70/bbl.
Translation: expect a slew of price hikes on energy stocks in the coming days from Goldman.
Finally, where could Goldman's forecast - which would infuriate the white house as gasoline prices are about to explode higher - be wrong? For what it's worth, the bank sees the greatest risk on the timeline of its bullish view. On the demand side, it would take a potentially new variant that renders vaccine ineffective. Beyond that, however, the bank expects limited downside risk from China, with its economists not expecting a hard landing and with our demand growth forecast driven by DMs and other EMs instead. This leaves near-term risks having to come from the supply side, most notably OPEC+, which next meets on October 4. And while an aggressively faster ramp-up in production by year-end would soften (but not derail) our projected deficit, it would only further delay the shale rebound, which would reinforce the structural nature of the next rally given binding under-investment in oil services by 2023. In addition, a large ramp-up in OPEC+ production would simply fast-forward the decline in global spare capacity to historically low levels, replacing a cyclical tight market with a structural one.
The full report as usual available to pro subscribers in the usual place.
Weekly Market Pulse: Not So Evergrande
US stocks sold off last Monday due to fears over the potential – likely – failure of China Evergrande, a real estate developer that has suddenly discovered…
US stocks sold off last Monday due to fears over the potential – likely – failure of China Evergrande, a real estate developer that has suddenly discovered the perils of leverage. Well that and the perils of being in an industry not currently favored by Xi Jinping. He has declared that houses are for living in not speculating on and ordered the state controlled banks to lend accordingly. Evergrande is known as a real estate developer and it certainly is but it is also a sprawling company with investments in multiple industries including, of course, an electric car company. Cutting off its financing isn’t just going to affect the Chinese real estate market. And real estate accounts for roughly 70% of household net worth in China so everyone in the country is going to take a hit. But is there a connection to the US or other developed country stock markets?
Real estate represents anywhere from 15 to 25% of the Chinese economy depending on what source you want to believe. The exact number isn’t really important, just suffice it to say that construction is a very large part of China’s economy and speculating on real estate is a national pastime. But the impact of it goes well beyond China. It is well known – according to the news reports I read – that China’s share of global commodity consumption is large and a large part of that goes to the construction industry. I read some research last week that claimed China’s property sector accounted for 20% of global steel and copper output. That sure sounds big and scary – as I’m sure the authors intended – but I would just point out that copper prices are near their all time highs and actually finished higher last week. The general commodity indexes were higher too. If Evergrande’s demise is going to materially impact commodity demand you wouldn’t know it from last week’s action. Maybe China’s commodity consumption isn’t “well known” in the commodity pits.
The doom and gloom crowd spent all of last week trying to convince investors – or themselves – that Evergrande is China’s “Lehman moment”, based on nothing more than the fact that Evergrande and Lehman both involved real estate. And in the case of Lehman that connection was incidental but superficially I guess the comparison made sense. There are certainly banks with exposure to Evergrande but the vast majority of them are Chinese. HSBC has been mentioned as having exposure but they stopped lending on Evergrande properties a few months ago. UBS was said to have exposure but the CEO said last week it was immaterial. Credit Suisse, which seems to be the new Citibank, involved in just about everything that has blown up the last few years, was so happy they avoided this one they almost broke an arm patting themselves on the back. US banks, as best I can tell, have no exposure. There are some junk bond funds with exposure but for the ones I looked at, it was a rounding error. There just doesn’t seem to be much interconnection with the rest of the global financial system and that was reflected in credit default swaps and credit spreads which barely moved on the week.
Evergrande appears to be mostly a domestic China concern, at least for now. The impact will be seen in Chinese growth figures which were already on the decline. What does that mean for the rest of the world? I don’t know yet but I am old enough to remember the last time the world’s second largest economy popped a real estate bubble. That was Japan in the early 90s and their economy certainly suffered over the next decade but you’d be hard pressed to find a big blowback on the rest of the global economy. Maybe China will be different but I can easily make a case that a Chinese economic slowdown would be beneficial to the rest of the world. Suppose those estimates of commodity consumption are correct and copper and steel prices take a tumble. That probably wouldn’t be pleasant for Chile and Brazil (iron ore) but I’d guess that the rest of the world would welcome cheaper steel and copper. There are plenty of things to worry about right here in the US with political wrangling over the debt ceiling, a possible government shutdown (which I generally take as a positive) and potential tax and spending hikes. I see no need – yet – to start worrying about Xi Jinping’s re-Maoing of the Chinese economy.
For stock investors I think the more important event last week was the rapid rise of the 10 year Treasury yield from Wednesday to Friday. I don’t mean to imply that higher rates mean stocks are going to fall because history says that isn’t the likely outcome. Rising rates are generally associated with rising growth expectations which doesn’t exactly strike fear into stock investor’s hearts. And that is what we saw last week as inflation expectations were unchanged as real rate rose exactly the same as nominal rates. Higher rates will affect which stocks perform well though and we started to see that last week. Higher rates and a steeper yield curve were positive for financials. Energy stocks also had a very good week. In general, I’d expect value stocks to perform better if rates keep rising while growth stocks take a breather.
The move in rates last week came with seemingly no trigger. There was no economic data or other event that should have changed growth expectations. Of course, there really wasn’t any spur for the bond rally of the last 6 months either. But eventually the data caught up with the market and it probably will again. I say probably because markets are not always right, just most of the time. What I think we’re going to see over the next few weeks is the market anticipating the end of the Delta surge and the resumption of the economic re-opening both here and in Europe. Whether it does or not or how long it might last or how far it might go I don’t know. But that investors will try to front run the virus isn’t exactly news. Of course people will try to get ahead of events.
During the course of an economic cycle, growth will ebb and flow. We’ve just come through a growth rate slowdown and bond yields now seem to be anticipating a growth rate upturn. I’m not convinced yet and there’s a lot of potential potholes ahead – mostly political – so I’ll continue to classify the environment as slowing growth/strong dollar but that may not last long. One thing I still don’t see is any change in the dollar trend. It is a short term uptrend and I’ve acknowledge that but the long term trend is no trend at all. The dollar index is in the bottom half of the range it’s been in for over 6 years and I don’t know what would change that. The lack of a dollar trend makes our job a bit more difficult and shorter term but we play the hand we’re dealt.
The economic data last week was a little better and better than expected but not significantly so. Housing starts improved as have sales over the last quarter but still well below last year’s peak. Existing home sales are still softening and we’re starting to see some price cuts which is the only thing that is going to have a big impact on sales.
The monthly reading of the CFNAI fell back a bit but the 3 month average moved higher to 0.43, a reading that indicates the economy continues to grow above trend. We had a slowdown but it didn’t amount to much.
This week’s data includes durable goods, personal income and consumption, the Chicago PMI and the ISM manufacturing index. I think the two to keep an eye on are income and consumption. It will be interesting to see if either was impacted by the impending end of extended unemployment benefits.
Commodities had a good week which seems curious considering the potential growth impact of Evergrande. But as the title says, maybe it isn’t so Grande. Maybe it is just pequeno.
US and European stocks were up last week while the rest of the world was down. Is that because a China slowdown is good for the US and Europe and bad for Asia and Emerging markets more generally? Maybe but I think I’ll wait for more evidence on that front before making any big pronouncements.
Value outperformed last week across all market caps.
As I said above financials and energy led last week. Of equal importance I think is that real estate and utilities – both rate sensitive – lagged the field. If rates keep rising, that seems likely to continue as well.
The 10 year Treasury yield bottomed in March 2020 around 40 basis points. It rose and then fell back to about 50 basis points in August of last year. It rose too far, too fast (1.75%) and the last six months has been nothing but a correction of that trend. Now, it appears rates are resuming their rise. How far will they go? Assuming the Delta end/re-re-opening narrative takes hold and there are no surprises along the way – some very large assumptions – my inner trader says about 1.85% as a first target. But that’s just an extrapolation so I wouldn’t place any big bets on it. What most investors should know is that rates are in an uptrend because the economy continues to recover from COVID. We had a growth rate slowdown and so far that’s all it was. And the market says it is ending. I’ll take that over all the breathless Evergrande articles any day.
Joe Calhoundollar inflation commodities commodity markets bubble commodity demand ax copper iron steel
As Margins Begin To Slide, Will Corporations Choose To Defend Profits Or Absorb Transitory Shocks
As Margins Begin To Slide, Will Corporations Choose To Defend Profits Or Absorb Transitory Shocks
Having spent much of the summer warning…
Having spent much of the summer warning that as a result of surging labor costs, commodity prices and generally "transitory hyperinflation", corporate margins would tumble (which in the view of Morgan Stanley would lead to a 10% correction), three weeks ago we warned that we are about to see a surge in profit warnings as the realization that the current unprecedented ascent in prices is going to be anything but transitory.
If MS and BofA are right on slumping consumer demand and margin contraction we should start seeing Q3 earnings warnings in the next 2 weeks.— zerohedge (@zerohedge) August 30, 2021
Sure enough, shortly after we noted that "Profit Warnings Are Coming Fast And Furious As Q3 Profits Brace For Big Hit" it wasn't until Nike and FedEx's dismal outlooks that the world finally paid attention to the coming stagflationary wave.
As we reported last week, Fedex tumbled after it reported that not only did it miss Q1 earnings - just hours after announcing it was raising prices at the fastest pace in decades - but also slashed guidance, warning about sharply higher labor costs and operating expenses.Picking up on this, earlier today Nordea also chimed in saying that "FedEx adjusted down expectations and cited being 35% understaffed in various parts of the supply chain as an important reason why. This is not good!" Yes... after the fact.
We won't waste our readers' time on why margins are set to plunge, and drag profits along with them absent a continued surge in revenues - we have discussed that extensively in the past few months - but we will highlight a recent note from SocGen's Andrew Lapthorne who cuts through the noise and says that corporates now have to make a decision: defend high margins or absorb "transitory" shocks.
As Lapthorne writes last week, while the rest of the world's attention turns to China, his charts focused on corporate profitability given the concerns about rising costs, supply disruption and now higher energy costs. According to the SocGen strategist, reported EBIT growth in the US has jumped by over 30% and over 55% in Europe, a remarkable surge which has been accompanied by a sharp increase in profit margins as sales growth has easily outstripped the growth in costs. Indeed, as noted recently, US profit margins hit an all all-time high in Q2, leading to a substantial uplift in profit margins to all-time highs.
Why the focus on margins and profitability? As Lapthorne explains, "profit margins act as shock absorbers. If businesses can absorb price shocks and business disruption into their P&L instead of passing the problems onto customers then logic has it that short-term profitability would be hit, but bigger issues, such as the need for policy tightening, is reduced."
And while on aggregate profit margins are healthy enough - for now - to absorb some temporary pain, it will be interesting to see what path the corporates take: to defend margins and risk inflation taking hold, or allow profits suffer for a while?
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