Home Morning Commentary

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Tensions with North Korea have escalated again after the country’s diplomats stated that the US had effectively declared war on the country. While the United States and North Korea have essentially been at war since declaring a ceasefire to the original conflict over 50 years ago, the rhetoric is clearly aimed at accusing the United States of starting conflict again with the country. However, the Whitehouse in a statement yesterday flatly denied that war has been declared, and reiterated that diplomatic solutions are still on the table. The VIX spiked sharply on the news, and will likely be up over 7% by market open on Tuesday. Keep an eye on this situation as more volatility is likely.

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We have written a lot about European politics over the months, but something on the horizon may be different; Spain wants to split apart.  Yes, that’s the current argument in Spain.

Although it may sound like conjecture, it is not.  A quite serious move is happening now and the following article from the Washington Post has the latest details.. Is this another possible nail in the coffin of the Euro?

From… Puigdemont’s message in the Washington Post

After three centuries under Spanish rule, on Oct. 1, citizens of Catalonia will finally have the chance to exercise their right to self-determination. More than 5 million eligible voters will have the right to decide on a simple question: “Do you want Catalonia to become an independent state in the form of a republic?”

The way to this historic referendum was paved by a majority decision of the Catalonian parliament. In our last regional election in September 2015, pro-independence parties won 47.8 percent of the vote, which gave them an absolute majority of seats. Unionist parties won 39.1 percent of the votes, a clear defeat, while the rest of the votes went to parties that defend the right to self-determination but are not necessarily in favor of independence. So there can be no denying the democratic legitimacy of our current Catalonian government. For this reason, after making several unsuccessful efforts to agree on the terms of the referendum with Spanish President Mariano Rajoy, I initiated the referendum.

In stark contrast to the governments of Canada or Britain, Madrid has refused to accept this democratic challenge, and has opted instead for the path of authoritarian repression. In most parts of the developed world, police protect ballot boxes, polling stations, and voters. In Catalonia today, the situation is the opposite. Spanish security forces are confiscating ballots and ballot boxes, stripping campaign posters from the walls, and intimidating citizens. They have arrested officials of the Catalan government, tapped telephones, raided private residences, and banned political rallies.

It seems incredible that this could happen in Spain in the 21st century. One French journalist recently noted that the Spanish government is acting more like Nicolás Maduro’s Venezuelan dictatorship than a healthy European democracy. And consider the fact that Catalonia, Spain, and other European countries are currently on maximum alert against jihadi terrorism. Instead of working to prevent possible attacks, Spain’s police forces are working to prevent the exercise of democracy. This is profoundly irresponsible.

The Spanish government has also gravely violated the freedom of expression and of information. Not only has it prohibited both public and private media from broadcasting advertisements about the referendum, it has also moved to block Catalan government websites that inform the public about the vote. Madrid has even blocked proxy servers, a procedure employed by only the most totalitarian regimes. The Spanish government not only wants to keep Catalans from voting, but also to prevent them from being informed.

The Spanish government has to understand that its behavior is unacceptable from the point of view of democracy and civil rights. Four decades after the death of the dictator Francisco Franco, we still find that authoritarian instincts rule at the heart of the Madrid government. Respect for minorities is a fundamental human right, and the right of self-determination is an irrevocable right of all nations.

Our commitment to the right of self-determination and to the will of the Catalan people to decide its own future remains unshaken. The repression of the Spanish government will not be able to change that. On Oct. 1, citizens of Catalonia will exercise their right to decide whether they want to become a new independent republic, just like other peoples of the world have done before them. This is the moment of the people of Catalonia, but we are not alone in this fight. We call on democrats around the world to give support to this long struggle between freedom and authoritarianism.

Carles Puigdemont

We shall watch this closely as a general development and how it may affect the Euro. Will there be war?  Will Catalonia become independent without strife?  If so, will the new state of Catalonia join the EU?  If not, one must wonder just how badly this will affect the Euro, as a massive portion of Spain’s GDP is gone.  That’s just the beginning; there are many more questions to follow…

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Yesterday I wrote, “Today Janet Yellen said that the FOMC would not raise interest rates with a 0.25% hike, but would stop using interest that its massive supply of bonds were earning to buy more bonds.  In other words, she announced the complete end of Quantitative Easing (QE) and the beginning of Quantitative Tightening (QT).  The teflon market yawned yet again; it was mostly docile once more.”

I also quoted a Reuters article that suggested that the QT unwind of the mountain of debt that the Fed has accumulated over the last NINE YEARS will be like watching paint dry.  That is a possibility and the market certainly acted like it over the last few days; however, sometimes there is a lag effect to these well planned announcements.  Other times, they are ignored until another “event” makes it suddenly very important in the future.

Jim Rickards penned an article that discusses this via The Daily Reckoning  and you can read the full article here https://dailyreckoning.com/quantitative-tightening-lead-qe4/

The entire article is worth reading; however, the most pertinent section regarding QT is below that goes along with what we have been saying for some time now.

Now, with respect to quantitative tightening (QT), the same way they tapered QE, they’re going to “taper” QT. This time however, they’re going to taper upward. Meaning they’re going to go from $10 billion a month not being rolled over to $20 billion, $30 billion, etc.

Eventually, the amount of securities they don’t roll over will go up until the balance sheet controlled by the Fed comes down to the targeted figure. The projection is that it could take five years to achieve. The problem is we might not make it that far before the entire system collapses.

We’re in a new reality. But the Fed doesn’t realize it.

Here’s what the Fed wants you to believe…

The Fed wants you to think that QT will not have any impact.

Fed leadership speaks in code and has a word for this which you’ll hear called “background.”

The Fed wants this to run on background. Think of running on background like someone using a computer to access email while downloading something on background.

This is complete nonsense. They’ve spent eight years saying that quantitative easing was stimulative. Now they want the public to believe that a change to quantitative tightening is not going to slow the economy.

They continue to push that conditions are sustainable when printing money, but when they make money disappear, it will not have any impact. This approach falls down on its face — and it will have a big impact.

Markets continue to not be fully discounted because they don’t have enough information. Contradictions coming from the Fed’s happy talk wants us to believe that QT is not a contractionary policy, but it is.

My estimate is that every $500 billion of quantitative tightening could be equivalent to one .25 basis point rate hike. The Fed is about to embark on a policy to let the balance sheet run down.

The plan is to reduce the balance sheet $30 billion in the fourth quarter of 2017, then increase the quarterly tempo by an additional $30 billion per quarter until hitting a level of $150 billion per quarter by October 1, 2018.

Under that estimate, the balance sheet reduction would be about $600 billion by the end of 2018, and another $600 billion by the end of 2019.

That would be the equivalent of half a .25 basis point rate hike in each of the next two years in addition to any actual rate hikes.

While they might attempt to say that this method is just going to “run on background,” don’t believe it.

The decision by the Fed to not purchase new bonds will be just as detrimental to the growth of the economy as raising interest rates.

The Fed’s QT policy that aims to tighten monetary conditions, reduce the money supply and increase interest rates will cause the economy to hit a wall, if it hasn’t already.

The economy is slowing. Even without any action, retail sales, real incomes, auto sales and even labor force participation are all declining. Every important economic indicator shows that the U.S. economy is slowing right now. When you add in QT, we may very well be in a recession very soon.

Because they’re getting ready for a potential recession where they’ll have to cut rates yet again. Then it’s back to QE. You could call that QE4 or QE1 part 2. The Fed has essentially trapped itself into a state of perpetual manipulation.

The problem continues to be that the stock market is overpriced for this combination of higher rates and slower growth.

The one thing to know about bubbles is they last longer than you think and they pop when you least expect it. Under such conditions, it’s usually when the last guy throws in the towel that the bubble pops. We’re not there yet.

It will be very interesting indeed to see how this plays out over the long run. This QE followed by QT has NEVER been done before, so there is no precedent.

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Yesterday I wrote, “The Federal Open Market Committee (FOMC) is scheduled to announce its policy decisions on Wednesday September 20th. Over the last two trading sessions, the markets have been docile ahead of the announcement.”  Well, considering how a normal FOMC announcement moves the market wildy, I would say that Wednesday was yet another docile trading day with very low volume.

Today Janet Yellen said that the FOMC would not raise interest rates with a 0.25% hike, but would stop using interest that its massive supply of bonds were earning to buy more bonds.  In other words, she announced the complete end of Quantitative Easing (QE) and the beginning of Quantitative Tightening (QT).  The teflon market yawned yet again; it was mostly docile once.

Part of the FOMC statement: Hurricanes Harvey, Irma, and Maria have devastated many communities, inflicting severe hardship. Storm-related disruptions and rebuilding will affect economic activity in the near term, but past experience suggests that the storms are unlikely to materially alter the course of the national economy over the medium term.

Higher prices for gasoline and some other items in the aftermath of the hurricanes will likely boost inflation temporarily; apart from that effect, inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.

The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

In October, the Committee will initiate the balance sheet normalization program described in the June 2017 Addendum to the Committee’s Policy Normalization Principles and Plans.”

In fact, it was so lame that Reuters reported something appropriate: Financial markets were barely moved by the Fed decision and the new economic projections and based on the immediate market reaction it looked as if the Fed was right when it said that the portfolio runoff would be as exciting as ‘watching paint dry’.”

Will there be real action Thursday?  Was it just delayed a day?

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The Federal Open Market Committee (FOMC) is scheduled to announce its policy decisions on Wednesday September 20th. Over the last two trading sessions, the markets have been docile ahead of the announcement. While Hurricane Maria is still a major concern as we await the damage is will cause in Puerto Rico, the FOMC meeting has clearly taken center stage. Even potentially alarming comments by President Trump regarding possible military conflict with North Korea did not move the markets at all, so clearly traders don’t believe there is much else to focus upon at this time.

At present, the markets are pricing in a slightly better than 50% chance that another rate hike will occur by the end of 2017. More importantly at this point is the expectation of a formal announcement by the FOMC of reduction in its current balance sheet. This will be a monumental development considering that the Fed has been committed to bond purchases since the financial crisis of 2008-2009. Other central banks globally are still committed to quantitative easing policies, so there may not be a great of a response by the market if this announcement does indeed occur. Lastly, traders are still looking for a signal as to whether or not Janet Yellen will renew her position as FOMC chairperson after her current term expires in February 2018. With all of these things in mind, Wednesday is looking to be a volatile day.

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The markets were fairly calm on Monday as traders focused on upcoming economic decisions from the Federal Reserve, as well as kept an eye on the progress of hurricane Maria. Volumes for the SPY etf, which tracks the S&P 500 index, were lower than the recent average, a pattern that we have seen multiple times over the last few months. However, we can expect an increase in volume and volatility this week as the markets respond to the impacts of potential devastation to Puerto Rico from Hurricane Maria, as well as the outcome of the FOMC meeting scheduled for Wednesday of this week.

With a currently active hurricane season that has already seen strong damage in Texas and Florida, it seems that the US will have more budget overruns as Congress may need to approve yet another recovery package. Hurricane Maris is currently a category 5 hurricane, and thus would cause severe devastation if it makes landfall on Puerto Rico. Fortunately, the storm is not expected to impact the mainland United States.

As far as the FOMC is concerned, it seems like the odds are 50/50 that a rate hike is coming. My guess is that we will not get a clear statement of intent on Wednesday, thus leaving the door open to a possible hike in December. However, it seems that most market participants are convinced that no hike will come on Wednesday. We’ll keep an eye on these two developments this week.

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North Korea is back in the news, because it wasn’t in the news over the weekend.  What I mean is, because North Korea did not test fire another I.C.B.M. during the weekend, its inactivity has led to an equity rally as I type this Sunday evening.  Since it is the lack of activity by North Korea that caused the price movement, it is back in the news.

The lack of action by the North Koreans is good news, but may temporary.  The US is pushing for new sanctions against the regime this week, and it may be at that time that Kim Jong-un fires another I.C.B.M.  

The response to the potential sanctions was expected: Warning Washington it said that if it did “rig up the illegal and unlawful ‘resolution’ on harsher sanctions, the DPRK shall make absolutely sure that the U.S. pays due price.” The said “the forthcoming measures to be taken by the DPRK will cause the U.S. the greatest pain and suffering it had ever gone through in its entire history. The world will witness how the DPRK tames the U.S. gangsters by taking (a) series of action tougher than they have ever envisaged.”

This could lead to an interesting week.  Be prepared for more volatility.

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Apple stock has been weak for a few days and the new news certainly won’t help much going forward.  But don’t get too concerned just yet, it’s only down a few days from its all-time high.  If the reported glitch, however, turns into a larger news story, it could get worse.

So what’s the deal?  “Production glitches.”

As reported by the WSJ:  Apple Inc.’s new iPhone, which is expected to be unveiled Tuesday, was plagued by production glitches early in the manufacturing process this summer, according to people familiar with the situation, which could result in extended supply shortfalls and shipping delays when customers start ordering the device later this month. New iPhones are typically in short supply when first released. But if shortfalls of the new phone extend beyond the initial sales period, which is expected to begin September 22, they could weaken analysts’ and investors’ projections for sales in the crucial holiday period.

The production glitches led to a setback of about a month in the manufacturing timetable. Foxconn Technology Group, the Apple contractor that assembles iPhones, has been ramping up production at its manufacturing complex in Zhengzhou, China. The company is paying bonuses to employees who can help bring new hires on board at its Zhengzhou plant, which Foxconn said in June employs about 250,000 people.

Surprisingly, the Mouse in the south has problems too, and not just the coming financial losses it will take from hurricane Irma. At the BofA Media Communications Conference in NY, Disney CEO Bob Iger said its outlook was much worse than The Street was expecting and this year’s earnings will be in line with last year’s earnings.  What? No profit increase? Boooo!

With that, DIS plummeted about 4%.  But don’t worry, the markets will be open again another day, which is all any stocks needs to go up again.

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The markets were able to recover some of the prior day’s losses due to what sounds like de-escalation of the North Korean affair (for now) and what politicians always do when it comes to a tough economic issue: kick the can down the road.  Two developments like this on the same day would always help markets rally.

While president Trump was leaving the White House, a reporter asked a qn that is on everyone’s mind: “will there be military action in North Korea?”  His response was tweeted by the reporter as such…


With that, the US markets staged a slow but steady rally for four hours.  It was so slow and steady, it seemed surreal.

How did the S&P500 remain in such a sloth-like march higher?  That’s where part II comes in: Kick the can down the road.  The Democrats came to a deal with president Trump that was once again tweeted and moved the markets (higher of course):  TRUMP SAYS ‘WE ESSENTIALLY CAME TO A DEAL’ WITH DEMOCRATIC LEADERS AND ‘I THINK THE DEAL WILL BE VERY GOOD’

The debt ceiling “deadline” has been moved to the middle of December.  In the meantime, Congress will spend without a thought to the new pile of debt and without even considering a balanced budget.  

Come mid-December, one wonders if the same will happen.

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The US markets were bearish yesterday as traders digested the impact of several events. First we have the situation with North Korea, which has yet to be resolved and is likely to escalate further unless a breakthrough in negotiations occurs, but as this point that seems unlikely. Also the coming impact of hurricane Irma could be devastating as the storm has now reached category 5 status and is also the strongest recorded Atlantic storm in history, with the potential of becoming even stronger still depending upon the path it ends up taking. But as long as it hits the  United States at its current strength, widespread devastation is clearly going to occur. It can only be hoped that the storm will lose momentum or fail to hit the continental US. And then we have the comments from FOMC members. Governor Kashkari’s statements suggested that the FOMC raised rates too quickly and that the economy may have suffered as a result. FOMC members also showed caution in their inflation expectations.

The other major topic was the repeal and potential replacement of DACA. As was expected, the White House moved to end the Obama-era program and leave it to Congress to decide if it is to be continued. President Trump and Attorney Sessions argued that the policy had been adopted by circumventing Congress in the first place, and therefore it was prudent to push the decision back to Congress to reach a new bill or end the entire program within 6 months. Some analysts speculated that this decision would potentially drain the US economy of as much as $400 billion over the next decade. This potential loss of course is not due to the expense of removing people, but rather is projected as a potential cost of losing the jobs these people are currently engaged in as well as potentially not being able to replace those workers. However, it should also be noted that other immigrants or current citizens or legal residents could replace those who might ultimately have to leave. But clearly the decision creates uncertainty, and thus more volatility. We’ll keep an eye on all of these things for further developments.