Outlook:

Today we get no releases of much interest (jobless claims, consumer credit). That means everyone can obsess over the China trade deal. It’s not surprising to us that Trump is backing down—bullies always do—and China is shown to be the one with the upper hand. China has to be careful not to arouse Trump’s childish petulance, however. One bothersome detail is the inability to agree on a meeting place. This may be like the two sides taking months to decide the shape of the negotiating table in the Korean War. Evidently suggested locations for the Xi-Trump signing have ranged from Alaska to Switzerland.  The date has not been nailed down, either.

To trade on this “news” is foolhardy. First, it’s not news. Second, a little common sense tells you that you are being played—played by China, played by Washington. Third, China is playing Trump, and that is a seriously dangerous thing to attempt. Fourth, even the best outcome—both sides cut tariffs, including the latest Sept and upcoming Dec US tariffs—it’s still only Phase One. A great deal remains to be done, including a more realistic estimate of farm good sales. The number $50 billion is just plain stupid when the actual amount is about $20 billion. China doesn’t need to more than double its imports of soy and pork. Then there’s tech and copyright and a whole groaning board of other things.

On the bright side, a deal should reduce uncertainty and goose activity, however bad it might be in reality. Sentiment can count more than facts, and that is certainly the case in politics. Trump can claim victory, even though it’s no such thing, and move on to the Wall (or something).

We have very little else of direct interest to the FX market, and it seems that the dollar benefits from risk appetite as much as risk aversion, thanks to that rising yield curve and despite the impeachment.

Tidbit: We reached out to the New York Fed for more information on the repo crisis. Yes, the gigantic US deficits and constant new issues are part of the problem. Yes, the Dodd Frank rules mandating “liquidity coverage ratios” (LCR) are part of the problem and should probably be revised. Yes, the initial problem day back in September was not anticipated by the NY Fed, disclosing a fault in its modelling. The models need some re-jiggering. But, net-net, it’s not insolvency or lack of credit-worthiness anywhere in the banking system. It really is plumbing. 

All the same, there is something else that can blow up. Again we found something at wolfstreet.com that explains some of the repo story. The writer describes a real estate investment trust that is not only wildly leveraged, but buys Fannie, Freddie, Ginny and CMO securities—all by definition long-term—and funds them in the repo market. The spread between short-term repo rates and the return on the long-dated assets is the profit source.

This company (Wolf names it) has $106 billion in total assets, of which $9 billion are receivables from reverse repos. Equity capital is $10 billion.  “…nearly all of the cash to fund its investments comes from the repo market;” as of June 30, $86 billion was owed to the repo market to fund $96 billion in liabilities. 

The pricing gain is razor thin. Over the first 6 months of the year, the cost of borrowing was 2.6% on that $86 billion, while the rate of return on the mortgage assets had to be much higher. Wolf doesn’t report that, but notes the 3-month T-bill yielded 2.3%, for a spread of only 30 bp.  Such a company suffers when the repo rate runs up to 10%, as it did in September.

Wolf opines hedge funds and others like this one company should not be permitted to access the repo market. It was never intended to be a funding source. “This is a corner of the financialized world that has nothing to do with the real economy, real investment, production, consumption, or jobs. It’s just some players trying to milk the financial system by taking huge leveraged risks and betting – and that’s the real bet here – that the Fed will step in and save their asses when the whole thing blows up. And that’s what the Fed is currently doing.” You have to admit he seems to have a point. We’d like to see a bigger survey of non-bank players in the repo market.

Politics: The public impeachment hearings begin next Wednesday and will be on TV, starting with Ambassador Taylor who very clearly identifies the Trump shakedown—he asked a foreign state to deliver something of value to him personally in return for US military aid and a White House meeting.

Meanwhile, Giuliani says all his work in Ukraine twisting arms in the shakedown was done as Trump’s lawyer, not at the request of the State Dept. He has hired the same lawyer as the first Trump personal lawyer, now languishing in jail for doing Trump’s bidding that turned out to be illegal.

And the former ambassador to the EU, one of those millionaires who bought the job (as did John Kennedy’s father in the 1930’s), has changed his story to agree, yes, it was the shakedown all the other witnesses saw. Talk of jailing him for perjury is what did the trick.

The accelerating pace of the impeachment inquiry suggests the charges will be this one simple thing that the public can understand—it is illegal for a president to ask a foreign person or state for a favor benefiting himself. The foreign party doesn’t have to deliver (and Ukraine did not). It’s enough that the president sought the benefit.

 


 

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