GLOBAL ECONOMICS AND POLITICS

Leo Haviland provides clients with original, provocative, cutting-edge fundamental supply/demand and technical research on major financial marketplaces and trends. He also offers independent consulting and risk management advice.

Haviland’s expertise is macro. He focuses on the intertwining of equity, debt, currency, and commodity arenas, including the political players, regulatory approaches, social factors, and rhetoric that affect them. In a changing and dynamic global economy, Haviland’s mission remains constant – to give timely, value-added marketplace insights and foresights.

Leo Haviland has three decades of experience in the Wall Street trading environment. He has worked for Goldman Sachs, Sempra Energy Trading, and other institutions. In his research and sales career in stock, interest rate, foreign exchange, and commodity battlefields, he has dealt with numerous and diverse financial institutions and individuals. Haviland is a graduate of the University of Chicago (Phi Beta Kappa) and the Cornell Law School.


 

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SHAKIN’ ALL OVER: MARKETPLACE CONVERGENCE AND DIVERGENCE © Leo Haviland June 18, 2018

OVERVIEW AND CONCLUSION

Financial wizards not only offer competing opinions regarding past, current, and future trends for stock, interest rate, currency, and commodity marketplaces. Their rhetoric displays diverse viewpoints regarding alleged relationships within and between those categories. For example, within the global stock constellation, various apostles elect to compare the travels of the S+P 500 with those of the Nasdaq Composite or with an emerging marketplace stock benchmark. Alternatively, some visionaries herald their subjective insights and foresights about connections between stocks (such as the S+P 500) and interest rates (such as the United States 10 year government note), perhaps also including the US dollar and the commodities galaxy in their investigations.

Luminaries tell stories offering their cultural perspective regarding apparent convergence and divergence (lead/lag) relationships within and between marketplace domains. Viewpoints regarding convergence and divergence encompass not only price direction (trend), but also the timing (start and end date; duration) of a given move as well as the distance it travelled. In any case, these links (associations; patterns) can alter, sometimes substantially and occasionally permanently. Marketplace history, including that related to convergence and divergence, is not marketplace destiny, whether entirely or even partly.

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History reveals that the S+P 500 and emerging marketplace stocks “in general” (MSCI Emerging Stock Markets Index, from Morgan Stanley; “MXEF”) often have had very important trend changes in the same direction “around” the same time.

After establishing important bottoms together in first quarter 2016, the key American stock indices and those of other important advanced nations and the “overall” emerging stock marketplace traded closely together from the directional and marketplace timing perspective. Though the bull moves since first quarter 2016 in these assorted domains did not all voyage the same distance, all were very substantial. Their rallies since around the time of the November 2016 United States Presidential election were impressive. Both emerging marketplace equities and the S+P 500 established important peaks in first quarter 2018 (MXEF 1279 on 1/29/18; S+P 500 2873 on 1/26/18).

Yet whereas since its first quarter 2018 summit prices for the emerging stock marketplace arena have eroded significantly and currently rest at their calendar 2018 lows, the S+P 500 has retraced much of its dive and now (6/15/18 close 2780; stock price data in this essay is through 6/15/18) stands only slightly over three percent from its 1Q18 top. This divergence, though not massive, is noteworthy. A similar but more extreme divergence between these stock benchmarks existed from spring 2011 (and note particularly since around second half 2014) through about May 2015. The S+P 500 kept going up and achieved new highs over its spring 2011 one, but the MXEF failed to do so.

After spring 2015, convergence developed, with a bear trend in the S+P 500 accompanying the existing downhill one in the emerging marketplace stock group. An important factor assisting this was the decisive climb in the broad real trade-weighted United States dollar (“TWD”) above its critical resistance around 96.6. A similar convergence is likely to occur in the present MXEF and S+P 500 marketplace relationship, with the significant divergence disappearing and both equity realms falling “together”.

US corporate earnings indeed have been quite strong, with share buybacks and mergers and acquisitions robust. Nevertheless, one bearish factor for stocks in the current landscape is the broad real trade-weighted dollar’s recent advance over the 96.2/96.6 barrier (compare 2015); also recall the TWD rally beginning in spring 2008 during the 2007-09 global economic disaster). The ascending US yield trend (which began in July 2016, accelerating in 1Q18) has encouraged the TWD’s modest rally in the past few months. Trade war talk and potential tariffs probably have assisted the TWD’s appreciation. The US is a net importer nation; some exporters (which include many developing nations) may depreciate their currency to maintain market share within the US.

Another bearish sign for both advanced nation and emerging marketplace stocks is the persistent climb in US Treasury yields. Rising global yields alongside a strengthening dollar is especially painful to emerging marketplace countries and thus their stock marketplaces. Many developing nations, including their corporations, have dollar-denominated debt. And underscore in this context another point: for America over the past century, sustained rising yields generally have led to American stock marketplace declines. Given the Federal Reserve Board’s ongoing tightening policy (and its normalizing balance sheet, as well as probable willingness to allow some overshooting of its two percent inflation target), growing substantial US federal deficits (aided by tax “reform” legislation enacted in December 2017), substantial US household credit demand, a low unemployment rate, and other factors, US government yields probably will tend to keep rising over the long run. The growing mountain of US public debt, including as a percentage of GDP, also tends to push up interest rates.

A confirming sign for equity feebleness in both the S+P 500 and the MXEF likely will be weakness in commodities prices. Commodities often have peaked (bottomed) around the same time as a crucial top (bottom) in important advanced nation or emerging marketplace stocks. However, there have sometimes been lags. Recall that in during the worldwide financial crisis following the glorious Goldilocks Era, commodities “in general” peaked after the S+P 500 and emerging marketplace stocks. The broad Goldman Sachs Commodity Index (“GSCI”) has declined since 5/22/18’s 498 high.

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Shakin' All Over- Marketplace Convergence and Divergence (6-18-18)

EUROZONE UNDER SIEGE: CURRENCY TRENDS AND POLITICS © Leo Haviland, March 20, 2017

“Oh, a storm is threat’ning
My very life today
If I don’t get some shelter
Oh yeah, I’m gonna fade away.
War, children, it’s just a shot away”. “Gimme Shelter”, The Rolling Stones

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OVERVIEW AND CONCLUSION

 

“America First!” and “Make America Great Again!” anthems inspire President Trump and many of his populist supporters. Many Americans of course have slogans, doctrines, and plans dramatically different from those of the President and his populist allies (and his establishment comrades). Despite America’s sharp and wide-ranging partisan divisions, most Americans believe that America should be great (whatever that may mean in practice). They also agree that America’s President and Congress (and other federal institutions), all else equal, should consider the country’s needs first. Perhaps a majority of “We the People of the United States” retain faith that America in some fashion should be first (the leading nation) around the globe as well.

 

Nowadays Europe, like America, has a so-called establishment (various elites) battling fiercely against an array of populist adversaries. Yet the European establishment includes not only most leaders (and the bureaucracy) of the European Union and the Eurozone (and the European Central Bank), but also the political (economic) establishments of most of Europe’s individual countries. So even though the European Union and Eurozone comprise various independent countries, and even though these nations contain diverse sets of right and left wing (and radical) political parties and economic ideologies, the overall European “establishment” ardently will promote “Europe First!” and “Eurozone First!” doctrines, particularly when the risks of European Union and (especially) Eurozone breakup appear rather high. Thus Europe/Eurozone preservation goals can trump narrower nationalist aims. Populist threats obviously are one source of such grave risks, which the United Kingdom’s June 2016 Brexit “Leave” vote underscored. However, Europe’s sovereign debt (banking; recall Greece and the European “periphery”) crisis a few years ago reveals that other issues may motivate the European establishment to rally fiercely around a banner and fervently embrace policies to keep Europe unified.

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Napoleon: “In forming the plan of a campaign, it is requisite to foresee everything the enemy may do, and to be prepared with the necessary means to counteract it.”

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The European establishments do not necessarily or always plan and act together. Yet despite their diversity, they are closing ranks, making statements and endorsing programs to ensure substantial European unity and their own places in power structures. On the national political front in several individual countries, this has included a shift to the right (particularly on the immigration issue). This mitigates some of the appeal of right wing (pro-nationalist; anti-globalist) populist candidates.

In the Eurozone context, a too frail Euro FX can reflect dangers to the Eurozone’s integrity. America is a key European trading partner. The Trump camp forcefully proclaims its hostility to excessive weakness of the Euro FX and other currencies (such as the Chinese renminbi) relative to the dollar. The Trump regime (and many other Americans) probably would be pleased with a somewhat weaker dollar relative to its recent lofty high. So on the trade and currency landscape, some European mainstream leaders in response have suggested they want neither trade wars nor further Euro FX currency depreciation. Related to this, what does the ECB’s March 2017 hint that it eventually will modify its current highly accommodative monetary policy indicate? It likewise probably signals a willingness to bolster the Euro FX.

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The Bank for International Settlements provides broad real effective exchange rates (“EER”) for the Eurozone (Euro FX area) and numerous other nations. The current sideways pattern in the Euro FX broad real effective exchange rate (“EER”) probably will persist for the short term. But as the 2017 European election calendar marches forward, the Euro FX EER probably will embark on a moderate bull trend. Major Euro FX EER support is well-entrenched and will not be broken by much, if at all. This Euro FX appreciation will occur not only on an EER basis, but also in the Euro FX cross rate relationship versus the US dollar. In general, determined efforts by the European establishment to retain power (defeat populists; avoid further European breakup) and bolster the Euro FX probably will succeed (at least for the next several months, and perhaps quite a bit longer).

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Eurozone Under Siege- Currency Trends and Politics (3-20-17)

EASING COMES, EASING GOES: US GOVERNMENT INTEREST RATES © Leo Haviland, March 13, 2017

In “Uncle John’s Band”, the Grateful Dead sing: “‘Cause when life looks like easy street, there is danger at your door”.

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OVERVIEW

Many marketplace generals nowadays have faith that rising United States government interest rates reflects both sustained adequate American economic growth and the likely development of inflation sufficient to satisfy the Federal Reserve Board’s two percent yardstick. In addition to GDP growth and rising inflation and inflation expectations, observers also should focus on other issues and their consequence for assorted marketplace trends and relationships.

Viewpoints of natural (equilibrium, fair or true value, normal, average, appropriate) prices and price overshooting or undershooting (expensive, cheap; too high, too low) reflect subjective opinions, not science. In any case, relatively few observers ask whether the Federal Reserve guardian will permit inflation benchmarks to exceed for a relatively long time (and somewhat decisively) its adored two percent signpost. Such overshooting by notable inflation variables will tend to propel government yields higher than many expect. The US Consumer Price Index (CPI-U) jumped 2.5 percent year-on-year in January 2017. Will personal consumption expenditure (PCE) inflation also overshoot the Fed’s two percent target?

The Fed likely will tolerate inflation target overshooting for some time because it wants to be confident that the achievement of its inflation goal will be durable. Such an indulgent policy regarding overshooting still permits the Fed to engage in gradual increases in policy rates (Federal Funds), especially as asset prices (such as American stocks and real estate) have soared since their dismal global economic crisis lows and as the prospective US fiscal outlook appears rather expansionary (and even overly stimulative).

Also, trust in the ability of the Fed and its allies such as the European Central Bank to manage inflation is widespread. How many audiences worry whether the years of devoted yield repression have created a reservoir of pent-up inflation, which the Fed’s gradual rollback of accommodation (permitting higher Federal Funds and government rates) will unveil and reflect?

America has a substantial public debt. Not much attention focuses on the likelihood and implications of growing American federal budget deficits, even without any legislative changes, over the next decade and beyond. See the US Congressional Budget Office’s “The Budget and Economic Outlook; 2017 to 2027” (1/24/17), as well as “Federal Debt and the Statutory Limit” (3/7/17). According to the NY Times (3/10/17, pA21), on 3/13/17 the CBO is expected to release its judgment on the proposed House Republican legislation, the American Health Care Act, aiming to repeal and replace the Affordable Care Act (Obamacare).

Moreover, the media, politicians, and Wall Street have spent much attention on President’s Trump’s potential tax “reform” and express hope regarding his misty infrastructure plans. But not many pundits stress that Trump’s tax scheme (even without reference to Obamacare), if enacted, likely will cause massive rises in budget deficits. The Fed may elect to raise rates more quickly (aggressively) than some predict if Congress adopts much or all of the fiscal scheme of Trump and his comrades. In any case, most people do not ask how enthusiastic foreigners (who own a huge slice of Treasury debt) will be to keep financing growing budget shortfalls. The Fed sheriff, unlike the European Central Bank and Bank of Japan, is no longer wedded to quantitative easing (securities purchasing tied into money printing), so it will not rush to add many UST obligations to its balance sheet.

Also, all else equal, substantial questions regarding national leadership quality can undermine both political and economic confidence in that nation. This situation can encourage higher interest rates, a weaker currency, or both. Donald Trump lacks government insider experience. Domestic and international faith in his political leadership ability (and in the US Congress as a whole) is not high. In the film “Easy Rider” (director Dennis Hopper) a character underlines that “it’s real hard to be free when you are bought and sold in the marketplace.”

Fierce, widespread, and substantial ongoing partisan political (economic) divisions likewise risk weakening America’s currency and promoting increased government interest rates. Trump’s victory did not unite an already significantly divided America. In America, there are liberals (progressives) and conservatives (traditionalists). Populists (both left and right wing) confront the establishment (elites). Globalists contend with nationalists.

Trump’s “Make America Great Again!” and “America First” slogans and many of his policy pronouncements obviously appeal to large numbers of Americans. However, they do not attract or inspire many (and arguably a majority of) citizens. Though both the House and Senate are Republican-controlled, not all Republicans warmly support Trump and his policies. Although Trump triumphed in the Electoral College, he decisively lost the popular vote tally. The popular vote outcome obviously reflects America’s sharp political divisions. Also, the Russian President “directed a vast cyberattack aimed at denying Hillary Clinton the presidency and installing Donald J. Trump in the Oval Office, the nation’s top intelligence agencies said in an extraordinary report” (NYTimes, 1/7/17, ppA1, 11). Trump’s popular vote defeat and the report on Russian political interference undermine Trump’s political “legitimacy” (faith in it) and thus his ability to lead effectively.

America has other substantial splits and fractures. It has rich versus poor, haves versus have-nots. Look at the nation’s substantial economic inequality. Consider divisions relating to race (ethnicity), gender, religion, age, geographic region, and urban/rural. Fiery quarrels rage over tax and spending policies and priorities, health care (Obamacare), trade policies, the appropriate degree of economic regulation, abortion rights, gun ownership, and environmental issues such as climate change.

With such ongoing, wide-ranging, and seemingly intractable American divisions and related passionate debates and accusations, worries increase regarding “how anything (good; productive; necessary) can get done”. Escalating doubts relating to leadership and concerns regarding the consequences of persistent divisiveness can encourage growing fears at home and abroad regarding the nation’s current and potential political and economic outlook. This horizon consequently may not necessarily encourage a “flight to quality” by buyers into the government debt securities of that country. Instead, particularly when inflation also is increasing and budget deficits likely will rise, low (deteriorating) confidence can spur interest rate rises.

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Easing Comes, Easing Goes- US Government Interest Rates (3-13-17)

TWO-STEPPING: US GOVERNMENT SECURITIES © Leo Haviland December 1, 2015

In the film noir “Double Indemnity” (Billy Wilder, director), Walter Neff describes the murder tale as “Kind of a crazy story with a crazy twist to it.”

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OVERVIEW AND CONCLUSION

Over the last seven years, through the last stage of the bloody worldwide economic crisis and the ensuing often fitful recovery, through dramatic and sometimes violent swings in assorted financial playgrounds, America’s heroic Federal Reserve ferociously has pinned the Federal Funds rate to the ground.

Many marketplace clairvoyants believe this widely-beloved guardian relatively soon will cautiously begin prodding the Funds rate higher. The next Fed gatherings are 12/15-16/15, 1/26-27/16, and 3/15-16/16. Maybe the courageous Fed will lift the rate up 25 basis points in its December 2015 meeting! In any case, as the widely-watched United States government two year note resides near the Fed Funds rate from the yield curve perspective, the two year US Treasury level and trend in part reflect marketplace opinions regarding Fed policy shifts and inflation.

In any case, the recent elevations in the two year US Treasury note a few basis points over .90 percent probably will not be broken by much in the near future. There indeed are some signs that United States inflation has edged toward the Fed’s two percent target. The Fed also proclaims its desire to normalize its highly accommodative policy. Yet the Fed embraces a gradual approach and does not want to make any missteps. Also, the international economy (look at the Eurozone and China) has slowed. So the Fed probably will patiently assess the consequences of its rate move for the United States (and global) economy and marketplaces (such as the S+P 500 and the US dollar).

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Yield levels and relationships obviously can fluctuate for all sorts of reasons. However, the falling rate trend for the US 10 year government note since early 2014 contrasts with the rising one for the UST two year note. The drop in 10 year UST yields, as it is occurring in the face of some US inflation and rising two year rates and artful Fed pillow talk about normalizing policy, arguably reflects economic weakness (mediocre GDP growth) in the US or elsewhere. In today’s interconnected world, feebleness elsewhere influences the American scene.

Note a related warning signal of actual or impending US economic weakness consistent with the fall in 10 year UST yields. Since the advent of money printing in the US in late 2008/early 2009, narrowing of the 10 year less two year spread roughly has coincided with the ending of that quantitative easing. This spread tightening (becoming less positive) in turn has reflected slower economic growth (or worries regarding potential weakness or recession). The agile Fed announced the actual first round of “tapering” (gradual ending of its latest QE venture) on 12/13/13, after several reductions in the QE program, tapering finished at end October 2014. The Treasury spread currently is close to its July 2012 depth.

Is a hunt for yield, fearful flight to quality, or need to own high-grade collateral more focused on the long end of the US government yield curve than the short end? Perhaps, but not necessarily. As the ECB extends its money printing program, is a shortage of long dated Eurozone government debt not only pushing yields there lower, but also thereby reducing yields for the UST long term instruments such as the 10 year? Perhaps. But economic weakness remains the most convincing reason for the sustained decline in UST 10 year yields since early 2014.

Consistent with the fall in the US 10 year yield and the narrowing of the 10 year versus two year yield spread, additional flags indicating weakness for the worldwide economy beckon. Although the S+P 500 remains high, emerging marketplace stocks in general and commodities continue to join hands in long-running substantial bear trends. The durable bull trend in the broad real trade-weighted dollar generally has danced in tune with the bear ones in emerging marketplace stocks and commodities.

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Two-Stepping- US Government Securities (12-1-15)