Fees High, Foes Dumb — Has Amazon Become Too Big to Slight?

Greetings from parking lot traffic in Manhattan on what is finally a warm, sunny day that has strangely enough brought out more drivers. Walk already and take in some Vitamin D. You look like you need it!

Today is, of course, that other Fed day, the day the Minutes are released three weeks to the minute after the FOMC statement is released. This is also the second ‘clean’ set of Minutes we will see of the Jay Powell era. No longer are the Minutes manipulated as Yellen advocated, a tradition to which we can all agree to say, “Good riddance!”

Unvarnished Minutes also mean we will not see any mention of risky assets’ recent recovery, not even a nod to the easing of trade tensions and subsequent ratcheting back up of the rhetoric, nor a recognition that the yield on the benchmark 10-year Treasury has pierced through the 3% ceiling and retreated anew. Nope – we should not see evidence of any events that have taken place since Federal Reserve policymakers met earlier this month. And we’ll be more honest for it.

That is not to say there is no reason to parse the Minutes. They will reveal the impetus behind the Fed’s adding the word “symmetric” to its approach to inflation. Why the abandoning of the hard 2% target after Ben Bernanke fought so hard to set it in place? (Another “Good riddance!” to that, at least in my book.)

While many see “symmetric” as flexibility-additive, my chastened former central banker fear is that it means just that come the next downturn, as in too flexible in a dovish way. If the Fed targets a range of say 1.5-2.5%, it means that they can let inflation run hot and cold. They can keep tightening even if inflation rises above 2% but they can also keep policy loose for longer yet come the next easing cycle.

If there’s one thing that should give you pause, it’s the idea that at some point in the future, the Fed could keep interest rates too low for even longer than anything we’ve got on record. But I’m getting ahead of myself, I hope.

For the moment, the investing world is fixated on the holidays, which will bring with them the final FOMC meeting of the year. In the event you’ve muted the FedSpeak for your sanity’s sake, it’s beginning to look a lot like we will not get a Christmas rate hike marking the first December in three years we go without.

Call it the flat-yield-curve, rising-mortgage-rate and recession-threat must-have 2018 stocking stuffer – the absence of a December rate hike.

What you can expect for the holidays is more of us will be capitalizing on our new and improved (for Jeff Bezos) Amazon Prime membership. Make that $20 price increase count! But stop and ask yourself if this is a good thing. Do we really want to become more beholden to this company?

For more on the Amazonification of a nation, please enjoy this week’s latest installment, Fees High, Foes Dumb: Has Amazon Become Too Big to Slight?

Hoping you’re not manipulating a single Minute of your day and as always, wishing you well,

Danielle

 

For a full archive of my writing, please visit my website Money Strong LLC at www.DiMartinoBooth.com

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Brussels Bound by Way of Tokyo — Will Europe Succumb to Recession Before Interest Rates are Positive?

Bonjour de Bruxelles! Call what we refer to as Brussels the land of surprises for this initiate including the fact that the primary language spoken here is French. That aspect alone saved yours truly who studied the language for seven years and can only manage to say hello in Dutch because it’s “Hallo.”

What else can I tell you about this trek taken at the invitation of some European Parliamentarians who asked me to speak here on the perils of Quantitative Easing? For starters, Americans have zero concept of bureaucracy. I was almost relieved to find out that my hosts were associated with the one and only European Parliament given there are six other parliaments in Brussels. Seven parliaments, one town!

Not surprisingly, Brussels has a similar feel to that of Washington D.C. but much more relaxed given the bureaucrats have bureaucratic underlings. A tour of the Parliament building had the feeling of a vast city center filled with humanity, but strangely absent of energy. My hosts were the first to concede that not near enough gets done here, not enough meaningful decisions made, precisely because there are too many institutions, too many committees within those institutions and sub-committees within those committees.

This historic city a short 48-minute flight from Heathrow apparently has a climate that’s right up there with London or Seattle if you prefer. Luckily, I brought the sunshine with me which meant the streets were teeming with happy bureaucrats taking in their Vitamin D. Sadly, the local specialty, Moules Frites, was not on the menu – only eat the mussels in months that contain the letter ‘R.’ The fact that billiards merits prime time sports coverage did not assuage my culinary disappointment, but it did make me marvel at cultural differences. Whatever would they make of college football madness?

The people here are lovely. The sheer scope and depth of the bureaucracy, however, leaves little mystery as to the source of the anger that’s barely beneath the surface in so many European countries.

Without a doubt, this frustration extends to the inefficacy of Mario Draghi’s European Central Bank. Our housing is expensive. Theirs is dearer yet. Our government has spent with abandon thanks to interest rates being held at artificially low levels. Their governments have “enjoyed” even lower borrowing costs. Ergo, their countries have been even less compelled to pursue fiscal reforms leaving them that much less prepared for the next crisis. And while their economies are also looking quite late stage, their central bank is still knee deep in QE and getting more skittish about a full taper to say nothing of the radicalness of an actual increase in interest rates (to less negative territory, mind you).

The move north of 3% in our 10-year Treasury yield is doing nothing to calm the nerves. Europe’s bond market renders that of the U.S. a screaming bargain on a relative basis. Some serious strategists have begun to ask the very question I ask this week: Is normalization even conceivable for the ECB?

With that, the day is ending here so I will leave you with this week’s newsletter: Brussels Bound by Way of Tokyo: Will Europe Succumb to Recession Before Interest Rates are Positive?

 

Hoping you too can see lovely Bruxelles one day and as always, wishing you well,

 

Danielle

 

Please enjoy my latest Bloomberg column:  The Dark Lining in the Silver Jobs Cloud

 

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DiMartino Booth, Wendys 5.15.18

Something’s Amiss in the U.S. Jobs Market

The pace of employment cuts in the service sector is accelerating.

It’s difficult to discern given the incessant headlines lamenting the dearth of skilled workers, but something is amiss in the powerhouse U.S. services sector, which accounts for some 80 percent of the economy.

The headline figures say very little. The Institute for Supply Management’s April survey of non-manufacturing industries showed that activity slowed for a third consecutive month, dropping its index to the lowest since December. Still, at 56.8 the index is materially higher than the 50 mark that is the dividing line between expansion and contraction. Moreover, all 18 industries surveyed by ISM saw growth last month.

By the looks of things, the service sector is in fine shape. As the ISM itself said, “Overall the respondents remain positive about business conditions.” But there was this caveat: “The respondents have expressed concern regarding the uncertainty about tariffs and the effect on the cost of goods.”

The April jobs report from the ADP Research Institute was noteworthy in that the services sector created the fewest jobs since November. And the U.S. nonfarm payrolls data show service sector job growth has averaged just 135,000 over the past six months, a marked slowdown from 2016’s monthly average of 170,000. As for what the future holds, take a look at the Challenger, Gray & Christmas monthly survey data. It showed that in the first four months of this year, employers announced 176,460 job cuts, an 8.4 percent increase from the 162,803 reported in the same period of 2017.

It would be easy enough to assign all of the blame to the retail sector. There is ample evidence that the bloodshed in this sector continues. Some 64,370 job cuts have been announced this year thus far, a 28 percent jump over 2017. According to Challenger’s tracking, 2,460 retail stores have closed this year on top of the 9,241 that shuttered in 2017. But the story is broader than one sector. Health Care/Products job cuts total 17,450 this year, up from 11,269 over the same period last year. It’s key to note that the trend in this sector has accelerated in recent months. Meanwhile, the service sector announced 14,665 cuts, up from 8,263 last year.

John Challenger, the firm’s chief executive officer, has been a flag bearer of the positive labor market trends in the current recovery, so it was notable that he warned “an increase in large-scale job cut announcements could be on the horizon.”

Challenger has been at the helm of his firm for two decades, so it likely hasn’t been lost on him that the past six months have seen $1.53 trillion in announced mergers and acquisitions, which would make 2018 a record year for deals if they are all completed and top the previous high set in 2015. Challenger has seen this M&A film before and knows how it ends. After deals close, “synergies” are extracted, which is a polite way of saying layoffs happen. While the number of firms in the Challenger survey citing M&A as the reason they cut jobs pales in comparison to closings, M&A as the culprit is nevertheless at a 12-month high.

With M&A as a fresh driver, the jobs bifurcation that’s emerged between the goods-producing and services sector is likely to persist until supply chains have been replenished and the inventory rebuilding concluded. With the threat of tariffs, though, it’s conceivable that the gap widens.

It has always been the case that goods-producing workers collect a fatter paycheck vis-à-vis their services-providing counterparts. The downside, of course, is the secular decline in manufacturing which has decimated the ranks of manufacturing employees. It is still remarkable that average weekly earnings for the goods-producing sector are running at 4.7 percent over last year versus those of the services sector, which are up by only 2.3 percent.

Goods-producing and Service-Providing Sector
Wages No Longer Trending Together

The wage gap would be even more pronounced if not for the record number of hours factory workers are clocking. Service-sector workers have seen the opposite, a veritable flat-lining in their workweek.

Goods-producing workweek soars while Service-Sector
Workweek Flatlines

DiMartino Booth 5.5.goods.services

While no doubt a welcome development for goods-producing workers, there is a real risk that this trend will burn itself out. Second-quarter gross domestic product could well be the peak for the current cycle if there is no follow-through in demand following the panic buying ahead of potential tariff impositions, evidence of which is apparent in the Challenger data. Companies announced plans to hire more than 350,000 employees in the first four months of 2017, far above the 210,000 in actual hires.

More than any other data, the need to hire workers speaks to demand building in the economy’s pipeline, or lack thereof. The message may continue to be lost in the noise, but it’s increasingly likely that the recent weakness in the services sector is anything but an aberration.

 

 

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Danielle DiMartino Booth — A BEAUTIFUL RELEVERAGING.sm

A Beautiful Releveraging? — The Devil Advocates for a Debt Jubilee

Welcome back to 2017, where bad is back where it belongs, that is being oh so good. Inflation? Who cares? Rising interest rates? No harm, no foul. WTI north of $70? Fill ‘er up. Pricey tech stocks. Hit the bid, baby!

The euphoric mood suits this past week’s exercise. The Great Contagion was a huge hit, at least as far as eyeball count goes. I’d like to reiterate my gratitude for your allowing me to publish it as a free report.

That said, the message didn’t go over well in certain circles, which stands to reason. It was not a friendly message for those predicting a recession might occur before the next presidential election, a predictable prediction through which a Mack truck can be driven. That’s all good and well. I anticipated the criticism and its sources.

What was less expected though was a meeting I had with a good friend, a veteran trader. He calmly explained to me that all was well, that I did not have a firm grasp on the ways of the world in which we both live, that place called Wall Street. Recession was not coming. Debt doesn’t matter. And while we’re at it, the bigger the better when it comes to the size of central bank balance sheets. I can safely say there’s nothing as grating as a colleague asserting naivete.

Confirmation bias, however, is a toxicity. So rather than dig my heels in and stick my tongue out at him, I chose to approach the matter as maturely as possible. I explored my contact base for someone who would rebut my premises in a well thought out, composed manner. And I found him. We had a deep, rich conversation and graciously agreed to disagree on some counts.

Full disclosure – my eyes were opened by the process. I can even say that I appreciate many of the counterarguments in retrospect. But don’t take that as a sign that this was an enjoyable endeavor to undertake. Writing this week’s newsletter ranked right up there with a root canal.

But that’s just life. Sometimes we have to give in to pain in order to make forward progress. It beats the hell out of the alternative.

Without further delay, please enjoy this week’s: A Beautiful Releveraging?The Devil Advocates for a Debt Jubilee.

With hopes that you take a moment to question your closely-held truths, and wishing you well,

 

Danielle

 

 

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THE GREAT CONTAGION, DiMartino Booth

The Great Contagion

Hyperbole is such a vile term. Defined as “extravagant exaggeration,” we are nothing short of drowning in it. What little is left of journalistic integrity is sacrificed daily at the altar of hyperbole. Politicians have raised their rhetoric to such deafening volumes their speech writers are at the risk of running low on exclamation points. Even the once ensconced billionaires’ boys club members with a yen to pontificate clamor for any available turn at the podium. Along the way, grace and understatement have been condemned as signs of weakness. Go big or go home, baby! Loud and proud! (Can someone please hit mute?)

There are blessedly exceptions. Peggy Noonan personifies refinement in the written word. And then there is Bill Gates, whose dignified actions negate the need to generate noise pollution. At over $35 billion, the vast sums he has donated distinguish him as the world’s most generous philanthropist. It was thus a surprise to hear Gates’ warnings that a pandemic could wipe out 33 million people in six months. As alarming a prospect as it is, Gates was simply pointing out a severe lack of vigilance: “We need to invest in other approaches like antiviral drugs and antibody therapies that can be stockpiled or rapidly manufactured to stop the spread of pandemic diseases or treat people who have been exposed.” As unprepared as the world is, the United States in particular is vulnerable. The Bill & Melinda Gates Foundation pledged $12 million to fund a challenge to devise a universal vaccine.

Given the opportunity, it would be instructive to ask Gates his views on the global economy and financial system’s preparedness for its next outbreak of contagion. His lack of expertise in the field could even work to his advantage. Perhaps he would simply determine that money has been so conspicuous in its abundance, at such ridiculously low prices, and for so very long that this will not end well. Using credit creation leading up to the financial crisis as a yardstick, he might add that this episode will take an even greater toll than the last. No hyperbole. Pure observation. Refreshingly simple and elegant.

Looking back to the last crisis is instructive to understanding what the future holds. The Federal Reserve and other central banks extended overly accommodative monetary policy in the aftermath of the 2001 recession. Politicians, for their part, looked the other way as happy homeowners made for compliant voters. This charade did not end well as documented in the first of this three-part series. I wrote The Great Abdication after being inside the Fed for nearly a decade throughout the financial crisis and the recession that ravaged the country as no other in modern time.

As is always the case when interest rates are suppressed for far too long, nefarious behavior broke out in the credit markets. Asset price bubbles, especially in US residential real estate, formed and swelled to magnificent proportions. As we know, when distortions stunt the price discovery mechanism and obfuscate the consequences of risk-taking for protracted periods of time, bubbles burst, and outbreaks of contagion ensue.

At the outset of the last crisis, following Bear Stearns’ rapid decline, systemic risk mutated in the least expected places. It always does. For every teetering AIG and Citigroup, there was a BNP Paribas or Belgian Fortis that followed. On the brink of collapse, the financial system threatened to bring down the global economy.

As for the source of systemic risk today, wouldn’t it be nice to be able to finish that sentence definitively? Last year, Janet Yellen stated that she did not think we would see another financial crisis in our lifetimes. The banking system was infinitely stronger than it was back in 2007. That’s true but such simplicity is dangerously misleading. As has been widely reported, debt has continued to amass in the years since the worst of the crisis passed. A credit crisis that began with untenable global debt of $140 trillion was “resolved” by accumulating another $70 trillion in credit. Got it.

Aside from commercial real estate, which will present formidable challenges to the conventional banking system, most of the debt build has occurred in the capital markets, the shadow banking system and critically, on central bank balance sheets. It follows that the next source of systemic risk will originate and spread from one of these conduits. Make no mistake – the interconnectivity between these credit engines is tangible, the linkages strong and in fact, too strong. Central bankers have once again lulled themselves into a peaceful place where they believe they have beat the business cycle into submission. Call it the second coming of the Great Moderation, a subject I explored last year in the second installment in this series, The Greater Moderation.

As for where we find ourselves today, years ago, my dear friend Peter Boockvar raised the idea of a central bank being a future source of systemic risk. It was the very conviction, the blind faith, the core of confidence investors place in central banks and the deity-like academics who rule them, that was a bubble in and of itself.

“In the mid 2000s, we had an easy-money driven credit bubble where rates were too low for too long,” said Boockvar in a recent conversation. “That bubble revealed itself mostly in housing.” OK, so maybe this is a warped way of looking at things, but it was somewhat comforting that the last bubble was so identifiable. The monster in the closet had form and even substance. We just couldn’t foresee systemic risk starting in subprime and manifesting itself in Germany’s Hypo Real Estate or Iceland’s Glitnir.

But that’s the nature of systemic risk. Acute upheavals in credit markets don’t recognize national borders or financial market sovereignty.

“Today’s bubble is in central bank balance sheets and the massive monetary inflation that’s created oceans of liquidity,” warned Boockvar. Although much of the liquidity created has made its way to excess reserves, it has nevertheless spilled into just about every asset class. The biggest risk to the economy and the financial markets is thus the reversal of these balance sheet builds and the ‘normalizing’ of interest rates.”

The good news for steadfast bullish investors is that so few actually buy into Peter’s way of thinking. The markets have been incredibly resilient in the face of the initial stages of quantitative tightening. It might appear that volatility has resurged. If you believe that, though, you’re focused on the wrong target. It is not stock market volatility that will be the primary disruptor, but rather volatility in the credit markets.

For the most part, bonds remain in a comatose state.

For context sake, or in case you were absent for all of February, the VIX index, or so-called “fear gauge” is derived from options on the S&P 500. At its current 15-ish level, it’s up about 50% from last year yet still below its 18-ish long-term average. It got as high as 38 earlier on this year. Expect traders to remain quietly quiescent as long as the VIX doesn’t break above 20 which would imply yet another technical level had been breached, that of the 200-day moving average on the S&P 500.

Merrill Lynch’s MOVE index is similarly constructed, at least in spirit. This bond market volatility proxy is a yield-curve-weighted index based on the movement on 1-month Treasury options weighted on the 2, 5, 10, and 30-year Treasury contracts. At 50, the MOVE is currently about half its long-term average of 96 or 1.7 standard deviations below its long-term average. Take your pick of the two. It’s indisputable that the bond market is not near as nervous as its cousin, the stock market.

There are technical and fundamental reasons for the calm in the fixed income markets; one is both.

As you know, it’s no longer polite cocktail conversation to gush about the homeownership rate. In fact, in a reversal from 2006, it’s now a subject that invites hushed tones given the rate has stayed so low as rental and home prices pierce new highs. On a fundamental level, there is much less demand for mortgages. Technically, this translates into less risk that mortgage holders prepay their loans, which translates into less of a need for buyers of these mortgages to hedge against prepayment risk.

And then there’s the age-old (well post-Greenspan era) reach for yield. At the risk of revealing what you can see with your own eyes, the reckless European Central Bank has managed to navigate an entire economic cycle without even beginning to normalize rates. The tapering of the ECB’s balance sheet still appears to be on schedule for completion by year end barring a dovish fit of nerves that pushes Mario Draghi back into a holding pattern. Still, it can’t help that it’s beginning to look like global economic growth has peaked. That leaves investors contemplating a slowdown despite a third of European sovereign bonds still sporting negative yields. Where is an investor to look for a pick-up in yield?

This brings us back to volatility. For many, the flattening yield curve is something of an enigma. Why would the Federal Reserve be dead set on hiking rates if the yield curve is flattening? How can inflation be an imminent threat if long yields refuse to accede to the threat? Part of the answer is the relative value proposition vis-à-vis other even lower yielding sovereign debt, as just described. Reflecting this, volatility in the benchmark 10-year Treasury recently fell to a half-century low.

But it has to be more than this.

Could it be that QT is truly the non-event it was advertised to be, no agitators need apply? It is true that QT got off to quite the slow start, beginning at a barely detectable $10 billion per month. But that was quarters ago. The monthly run-off rate is on track to rise to $40 billion beginning in July and pick up to $50 billion a month in the quarter beginning September.

It’s feasible that for now, at a still hard to register $30 billion a month, investors are akin to the proverbial frog who thinks it’s enjoying a warm bath even as the heat rises. There is even a veritable army of angry trolls on social media who insist the Fed’s QT hasn’t even begun — a conspiracy you may not know exists. These are the same folks who live for the markets to go “kaboom!” when in fact, they are withstanding a slow bleed, as if medieval doctors were applying leeches to the patient.

Any of you economically astute readers will have long since gleaned that what we are debating here is whether it’s the flow of central bank liquidity into the markets that matter, or the stock of aggregate holdings amassed.

At the risk of showing my hand, those who insist it’s the stock that matters, can be kindly referred to as the denialists, the buy-the-dip investors who remain fixated on the mammoth size of the aggregate central bank balance sheet. As investors have learned the easy way, fungible is fun. It doesn’t matter which sugar daddy (country) has the check book out, it matters that he’s in a spending state of mind.

At last check, the combined heft of the world’s central banks weighed in at just over $22 trillion. As you can see, global QE actually increased in size following the Fed’s October 2014 taper. That ramp-up in unbridled international buying suited risk takers just fine. For the full year 2017, global QE climaxed, topping out at a record $2 trillion.

Quantitative Pleasing Goes Global

DiMartino Booth, globalCBbalance-sheets

By all accounts, the collective balance sheet growth is expected to continue through next summer. But that’s only half the story, which would leave Paul Harvey flat. It’s equally important to know the pace of the growth. And that peaked in March 2017.

In recent years, the savviest investors, who may or may not be bored to tears, have seized upon the frog metaphor and sold bond market volatility to profit off the slow pace at which the water is coming to a boil. One veteran interest rates trader who must remain unnamed observed a distinct pattern in the “pancaking” of the yield curve, to borrow his technical terminology.

It goes something like this: The Fed hikes, which leads to higher yields, which hits equities, and triggers a flurry of (paranoid) dovish Fedspeak. This turn of events leads to declining volatility, easier financial conditions, higher equity prices and in due time, another Fed rate hike. That kind of describes the past two-and-a-half years since the Fed embarked upon its tightening campaign in December 2015. The subsequent record-slow-pace of rate hikes amounts to 1.5 percentage points in the fed funds rate. (Wash, Rinse, Repeat, Yawn.)

The question is what’s next?

For starters, you can hopefully see that the pace of tightening matters and matters a lot, just as 2017, the record year for QE, mattered enough to annihilate volatility and send risky asset markets to peak levels. It follows that the rapidity with which the flow recedes is of the greatest import.

Full disclaimer: One month does not make a trend. But a picture can still be worth a million, or is it a trillion, dollars. Be that as it may, it’s remarkable to see the spike in Prices Paid in the latest ISM manufacturing report; this sub-index is now at the highest level in seven years. As for that attendant line in crash mode, think of it as a cash crunch among manufacturers. According to the National Association of Credit Management, dollar collections suffered their worst one-month and two-month declines on record, and that was for both manufacturing and services though the factory sector is featured on the graph below.

Can You Pass Along the Price Hikes or
Will You Have to Borrow to Cover the Tab?

While there is little doubt we’ve got a three-alarm inflation scare on our hands, what is less apparent is what firms’ coping mechanisms will be. Will they succeed in passing along these price hikes or will cash flows suffer to the extent they need to take on debt to pay their bills?

The question on most investors’ minds is whether one Jay Powell will chase the inflation scare too far? Will the Fed do as it always has and tighten the economy into recession?

What would you say if I said that was a given and the least of our worries? What if I was to tell you QT mattered that much and more because of how very incestuous QE came to be in the end?

In the event you’re thinking this is about to turn into some tirade about the Swiss owning a huge chunk of our stock market or Draghi buying U.S. corporate bonds, stop right there. Those are complicating factors. But they shouldn’t be the focal point.

The conventional wisdom is that the United States is in the best position to withstand an economic setback. Our central bank has tightened the most and therefore it has more ammunition to fight the next war. While there is some merit to this assumption, the bigger picture involves the prism through which you view this relative strength.

Go back to the debt build, that unrepentant debt build that’s taken place in recent years. Because so much of the credit issued has been in dollars, what happens in the United States cannot stay in the United States.

The vast majority of the $50 trillion or so in dollar-denominated debt is domestic, issued from within. But according to the Bank for International Settlements (BIS), some $11 trillion in debt denominated in dollars has been issued outside the country. As you can see, the growth rate of that debt, both developed and emerging market, took a baby step back during the financial crisis. But the pile-up resumed at an increasing pace shortly thereafter.

Got Dollars? Borrowing in Dollars
Is the Rage Outside Our Borders

This is not a revelation in any way. But holistic matters when it comes to connectivity. The BIS worries that non-bank borrowers outside the U.S. have an equivalent amount of off-balance sheet dollar obligations in the form of FX forwards and currency swaps. Add it up and you arrive at double the dollar-denominated debt outstanding, or around $22 trillion. It’s starting to sound like real money and, purely coincidentally, equals the sum total of global central bank balance sheets.

Enter Tobias Adrian, formerly of the New York Fed and now at the International Monetary Fund. In a posting he penned in April, he voiced concern about the vulnerability of flows (there’s that word again) to emerging markets. Adrian figures that flows could fall by $60 billion a year to emerging markets, about a quarter of annual inflows in the seven years through 2017. Less credit-worthy emerging markets would suffer greater funding droughts.

If it only ended there. Adrian went on to write that, “Internationally active non-US banks rely on short-term or wholesale sources for about 70 percent of their dollar funding. Moreover, these dollar liabilities are not always evenly matched with dollar assets in terms of size or maturity. This could leave banks exposed to dollar funding problems in the event of a sudden tightening in financial conditions and strains in markets.”

It might help if Adrian wasn’t considered one of the world’s preeminent experts on shadow banking. He witnessed what he describes today firsthand when we were both inside the Fed during the crisis. The cross-border linkages in dollar-denominated debt he’s detailed cannot be dismissed out of hand.

The one thing you may note these banking-system and financial-market synapses have in common is the dollars traveling along them. The transmission mechanism is dangerously homogeneous, which is reflected in the nearly nine in ten global transactions last year being denominated in dollars. The glue that binds the global financial system helps explain the cross-border fungibility of monetary policy.

Société General’s Albert Edwards has long been derided for criticizing the inherent unsustainability of the current generation of central bankers’ approach to monetary policy. So have I. But we’re not naïve as to QE’s ameliorating effects: “Much of the continued resilience in US markets last year was put down to huge global QE despite the US starting to tap its foot on the brake,” said Edwards. “Huge flows of QE came over from Europe in particular but also Japan. Bullish brokers, i.e. the vast majority, have been trying to reassure clients that the collapse in global QE back to close to zero does not represent a monetary tightening, but a return to neutral. Needless to say, quite a few of the savvier investors are not falling for this reassurance.”

Edwards may be on to something. The divide between the S&P 500 and the combined Smart Money Flows Index and Ed Yardeni’s Fundamental Stock Market Indicator is now at a cycle wide. Google both and thank me later.

Maybe it’s a case of not waiting for the haunted house to whisper to you to “Get Out,” Amityville Horror style. To wit, there is nothing new in Europe’s money supply growth slowing; it’s now slid to the lowest level since November 2014. In Japan, the growth rate of the Bank of Japan’s monetary base has slid to 7.8%, the lowest since late 2012.

As difficult as it may be to discern the slow liquidity drain, something is amiss in the shortest-term lending rate markets. The pace at which LIBOR was rising has subsided for the moment. But the deluge of rising Treasury supply could easily reignite the rate at which short rates are rising, especially if the Fed nods to its preferred inflation gauge hitting its (arbitrary) 2% inflation target.

The most recent Economist warned that the biggest risk is the Fed acting “abruptly to see off inflation.” In Jitterbugs, which highlighted the recent rise in short rates, the newspaper echoed the IMF’s concerns centered on the financial system’s vulnerability to a sudden shock. “Threats to the economy can lurk in obscure corners of the market. They can also be found in Washington DC.”

While it’s impossible to pinpoint what agent will spread the contagion, we can make some educated guesses. Credit risk has been underpriced in the markets for years. At first investors just looked the other way. But today they wince if they’re in the compromised position of having to put money to work.

Just last week, WeWork Co. sold bonds into the high yield market. Such was the demand for fresh paper that instead of the originally planned $500 million, the company was able to sell $702 million, apparently a lucky number. The same cannot be said for the buyers who have seen their bonds decline in value every day since.

But it’s beyond companies that generate buzz but have challenged business models and shaky cash flows. It is companies such as Steinhoffs, Toys “R” Us and now American Tire Distributors that investors should not have had priced to perfection. On April 30, a report revealed Goodyear planned to drop the tire distributor; its bonds that traded as high as $102 two weeks prior collapsed to 40 cents on the dollar.

Meanwhile, leveraged loan covenants, or better stated, the absence of them, are a shared joke among underwriters the same way toxic subprime mortgages were the last go around. And any frontier issuer that can substantiate a physical border can float a sovereign issue. These are accidents we know full well are waiting to happen.

As for the unknown, look no further than the vast universe of “investment grade” U.S. corporate bonds. This supposed safe haven is littered with tomorrow’s calamities, angels that will tumble from the heavens.

All of these products were born of central bankers with no self-control, individuals who’ve long since demonstrated that they are lacking in common sense. The fact is, they’ve gorged together and fed each other’s risky markets in concert. Now comes the time for the real discovery, the revelation of the feedback mechanisms that will infect each other’s markets and economies.

Could Mario Draghi blink? Could the Bank of Japan attempt to reup its QE? Could the Swiss buy more FAANG stocks? After all this time, you know the answers to all of these questions. But what if all of these counter-maneuvers don’t fend off the Fed? The Fed may well be first in, first out. But it also controls the controls, which was purposefully redundant.

Dollar flows and dollar-denominated debt are global phenomena. Furthermore, Jay Powell has stated that QT is not up for negotiation; it will continue to run in the background, come what may. Granted, this commitment may not be set in stone and would surely be revisited if Powell was convinced recession was imminent. But will it be too late by then? Will contagion spread from one central bank balance sheet and one financial market to the next? If history teaches us one lesson, it is that “too late” often happens suddenly.

As for history’s other lessons, it is unquestionably disturbing to listen to the drum-beating and witness the tragedy of leaders killing their own people. But we’ve clearly forgotten that it is economic conflict that precedes geopolitical upsets, not the other way around, hence the red herring of most perma-bulls’ contentions that geopolitics is the only thing that can derail markets.

If you doubt my logic, know that I had many great leaders who shaped my way of thinking. One of them, the late Dick Jenrette, co-founded the firm I called home on Wall Street many moons ago. He truly had an open-door policy. I was privileged to know him and even learned a thing or two about planning ahead from him. Planning should be at the forefront of every central bankers’ and politicians’ minds these days.

In late April, Jenrette passed away at the age of 89. This excerpt from his Wall Street Journal obituary is particularly fitting to the subject at hand: “His advice to crisis managers was to make a plan and ignore the critics. He often quoted a proverb: ‘The dog barks but the caravan moves on.’” No hyperbole. Pure observation. Refreshingly simple and elegant.

 

 


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DANIELLE DIMARTINO BOOTH, BUNSON BURNOUT.sm

Bunsen Burnout & Vexing Vulnerabilities — When Tell Tale Economic Signals Flash Falsities

A quick perusal of the financial press revealed a treasure trove of write-ups on PIMCO’s Richard Clarida, the recently named nominee to be Vice Chair of the Federal Reserve Board. Coverage of one Michelle Bowman, nominated the same day to serve as a governor on the Board was, however, scant.

Given the dearth of warm bodies on the Board of late, I thought it only fair to provide a bit of color on the woman who goes by the nickname “Miki.” Bowman is presently the State Bank Commissioner for Kansas and has been since January 2017. Her designated role on the Board would fill the regulator of community banks position created by Congress in 2014. Much of the coverage ends there.

Did you know, though, that Bowman is a fifth-generation banker and holds a law degree? Her family’s bank has been around for 135 years. She has also served in Washington at the Department of Homeland Security and FEMA in the George W. Bush administration. Prior to that, she was a congressional adviser to former Kansas Senator Bob Dole. That’s not to say she is unaware of how very global the banking system is. Bowman ran a government and public affairs consultancy in London for five years through 2009.

As reported by the Kansas City Business Journal, Bowman is a known known in the Senate. Senator Jerry Moran, a member of the Senate Banking, Housing and Urban Affairs Committee, said Bowman’s breadth of experience, “will bring a unique and important perspective to the Board.”

Her nomination is welcome news. The value of community banks in our country cannot be discounted – they are the tie that binds so much of our rural economy to the broader financial system. Innovation is not confined to the Silicon Valleys that sprinkle our nation, nor should it be. And yet, according to George Mason University, the number of banks with assets of $10 billion has declined 27% from 8,263 in 2000 to 5,961 in 2014. The situation is sure to have continued to degrade given inappropriately onerous regulations that have been enacted since then, even as large banks have grown by over a third.

So yes, I will be listening to her confirmation hearing and do look forward to the intellectual diversity and pragmatism she would bring to the Board. We need a strong community bank advocate. Let’s hope Miki Bowman fulfills that role with vigor.

Back on our Bloomberg monitors, the biggest banks and heftiest tech darlings have taken it on the chin of late. Maybe supreme dominance isn’t all it’s cut out to be. Or the stocky stocks could simply have gotten ahead of themselves against a backdrop of inflation that refuses to abate. Overvaluation and rising costs are certainly not ideal bedfellows.

As for what’s to come, there may not be a scheduled press conference following next week’s FOMC meeting, but I’m not convinced May 3rd will be the usual lame duck nonevent. Should we prepare for an unexpected announcement? Who knows? Maybe Powell has finished ruminating on whether press conferences should follow every FOMC meeting and is of the mind to announce that they will. Perhaps the May statement would be a fitting platform to roll out the news. Markets haven’t priced in a miniscule probability of a May rate hike for nothing. I’ll be all ears. You should be as well.

If nothing else, Powell, who founded the Industrials Group in his years at Carlyle, may be paying as close attention as we are to the earnings parade. Has he also noticed companies lamenting how quickly input and labor costs are rising? A shift to more hawkish inflation language would do the trick in validating that Powell & Co. are concerned inflation is more than a cyclical phenomenon. No doubt the inflation debate will continue to rage on with all eyes on the core PCE release Monday morning.

For my take on where we are in the cycle and how inflation plays into the dynamic, please enjoy this week’s installment, Bunsen Burnout & Vexing Vulnerabilities: When Tell Tale Economic Signals Flash Falsities.

Consider this my third and final appeal to recognize the legacy of Bloomberg Senior Economist Rich Yamarone, who passed away suddenly at the age of 55 last fall. As my friend and colleague David Rosenberg, a close friend of Rich’s for 16 years reminded us in his own entreaty, “contributions are the bedrock of scholarship.” Please join David and me in giving to the Richard A. Yamarone Memorial Scholarship in Economics at Brooklyn College. I too have humble beginnings in academia, but that has only served to fortify my loyalty to the institutions that schooled me in the fine art of thinking for myself. Please follow the link below if you are so inclined and to those of you who have answered my call, a huge debt of gratitude.

https://secure.etransfer.com/EFT/BlockCode/donation1.cfm?d2org=BCF&d2tool=donate

NOTE: Donors should enter “Richard A. Yamarone Memorial Scholarship” in the comments box provided to ensure that their gift will be allocated to the Yamarone Scholarship. 

 

Hoping you take a moment to listen in, and wishing you well,

 

Danielle

 

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DiMartinoBooth, PUBLIC PENSION TROLLEYsm.

Public Pensions & the Trolley Problem — The Impossibly Immoral Choices the Future Holds

Forget about the snowy spring weather you’re trying to avoid up north. It’s tornado season down south, that special time of the year you tune in to the local news for a quick check of the weather before heading out to battle the masses on the highways and byways.

As coincidence would have it, a story covered on that same local news station stopped me dead in my tracks. Kaitlyn Smith, a resident of a Dallas suburb, was off to visit her 90-year old grandfather. After parking our front, Smith noticed something was decidedly missing from his open side yard, as in the concrete slab was there but the 100-plus pound air conditioning unit had been ripped off its foundation, while her grandfather was at home.

It would appear that the word is out that the CRB Commodity Index has soared to the highest since October 2015 though it’s doubtful most thieves have Bloomberg terminals within reach. Nonetheless, the shocking story reminisced of the heady days of the last housing boom when vacated houses would be harvested for scrap metal of any kind.

The contributor du jour is nickel which is up by more than 10% on concerns that Russian sanctions put Norilsk Nickel in their crosshairs. Add this to the list of metals from aluminum to copper to steel. And of course, we’ve seen a surge in oil prices which is bound to bring joy to households nationwide, or not. Look for a spurt of anxiety the next time a confidence survey is released. Pump prices bleed through to inflation expectations faster than any other factor, and with good reason as it often means no family meal out that weekend.

For the moment, investors remain in a celebratory mode. Earnings season thus far has been a cause celebre as banks parade out one beat after another. And why shouldn’t they given the return of trading volumes care of the volatility renaissance and tax cuts that went straight to the bottom line? As an added bonus, banks’ raw materials are brainpower, not metals. They already pay their highly-skilled workers very well, so there’s no need to worry about that same wage inflation that’s biting the industrial sector in the backside torching margins.

As for what’s to come, perhaps we should key off of trucking giant J.B. Hunt. With a hat tip to Peter Boockvar for catching this, read the following earnings excerpt very carefully. “JBT revenue decreased 1% from the same quarter in 2017. Revenue excluding fuel surcharge decreased approximately 3% primarily from a 15% decrease in load count partially offset by an increase in revenue per load. Revenue per load excluding fuel surcharge increased 14% primarily from a 10% increase in rates per loaded mile and a 3% increase in length of haul compared to the same period last year.” Did you catch it? Load count fell 15% over last year but the top line was salvaged thanks to a rate increase.

I’m not sure what you call a decline in activity offset by higher prices, but it does have a name in the dismal science of economics and it isn’t one many like to harken. Is this dreaded fate what the yield curve is so desperately trying to communicate? If that’s the case, the message is falling on deaf ears. Volatility has been tamed anew and stocks are all the rage as if February never happened.

The same cannot be said of our nation’s teachers who are increasingly hot-tempered as the spring budget-writing season gets underway. Massive Medicaid and pension underfunding seem to have taken a toll on school funding and many teachers have had it up to here, compelled to protest their unfortunate circumstances, especially any threats to their pensions. Does anyone at all see a bit of irony in their outrage? For more on this, please enjoy this week’s, Public Pensions & the Trolley Problem: The Impossibly Immoral Choices the Future Holds.

Before bidding you adieu for the week, I would like to reiterate my call to action from last week. Last November, Rich Yamarone passed away suddenly at the age of 55, much, much too young. Rich had become as an institution in and of himself as senior economist at Bloomberg. Everyone he called friend he loved and made laugh, and we were all better for knowing him. My dear friend Josh Frankel has blessed Rich’s memory by spearheading the creation of the Richard A. Yamarone Memorial Scholarship in Economics at Brooklyn College. In the past week, Peter Boockvar, Philippa Dunne, David Rosenberg and Barry Ritholtz have joined me in calling upon their listeners and readers to give as generously as they can to this honorable endeavor. Please join us in contributing via the link below.

https://secure.etransfer.com/EFT/BlockCode/donation1.cfm?d2org=BCF&d2tool=donate

NOTE:  Donors should enter “Richard A. Yamarone Memorial Scholarship” in the comments box provided to ensure that their gift will be allocated to the Yamarone Scholarship. 
Hoping you don’t have to duck into a storm shelter, of any kind, and wishing you well,

Danielle
 

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DiMartino Booth, Money Strong, Fed Up, NY Fed, MIGRATION OF MEDALLIONS.MOVE

The Migration of the Medallions — Leadership, Leniency and Leaks at the NY Fed

Inflation is up, and the yield curve is flattening? What gives? In bond market nomenclature, much of which is indecipherable by the design of craft fixed income traders, what we are witnessing today is a bull flattening. Long maturity Treasury yields are falling at a faster pace than short rate Treasury yields are decreasing.

The short rates rising reflects the March core CPI, which excludes those two essentials of food and energy, hitting 2.1%, the highest in 13 months. At 2.4%, the headline CPI is also at a 13-month high. It would seem consumer prices are finally beginning to echo what we’ve known on the input side, that is producer prices rising at the fastest pace in nearly six years, not months.

As for the pressure on the long end of the curve, words such as “missiles” and “strike” when combined tend to make markets a bit edgy. The clear winners are investors who have been waiting for such a development to hammer home the validity of their owning oil. Refer back to that headline CPI, however, as relentlessly rising gasoline prices will do little to assuage drivers and policymakers.

Is this Syria business the real deal? The crafty analysts at Political Alpha, one of the Street’s preeminent political intelligence outfits, certainly seem to think so. “The main issue under debate is that last year’s strike didn’t deter Assad from using chemical weapons. The conclusion is that a bigger strike is necessary.” That emphasis is theirs, not mine.

So, the Administration is serious even as the GOP’s leadership ranks continue to disperse. Nervousness is thus justified.

In the other corner of the market ring is the happy crew, those who are elated at Chinese President Xi’s sweet nothings. The risk, as has been the case since Xi took office, is that Xi’s words are closer to being nothing at all.

According to the China Beige Book, trade tensions aren’t going anywhere. “Markets have rallied several times over the past few weeks on the idea that Presidents Trump and Xi can quickly come to a trade deal. The logic: ‘It makes too much sense not to.’ We disagree, possibly over the short term and certainly over the long term. Media and business hysteria over the tariff list aside, going after China is perceived as still popular by the White House and both sides of the congressional aisle.” Again, the emphasis is theirs.

The market’s relative euphoria could just be a simple, technical matter of short covering as those betting on a negative outcome get squeezed by happy headlines.

Of exceedingly more importance is the upcoming earnings season. Traders are betting on companies continuing their streak of under-promising and over-delivering on the bottom line. Banks may be the exception and get things off to a swimming start but be careful from that point on.

As my great friend, Dr. Gates warns, persistence cannot be discounted. To wit, input costs have been rising at a most persistent rate. Headline PPI final demand grew at a 0.3% rate in March – it’s been higher for six of the last eight months, a streak not seen since the eight months ended July 2011. Perhaps more tellingly, the measure favored by the Federal Reserve, that is core PCE, has risen in five of the last six months. The last time we’ve seen such persistence: the six months ended March 2008.

Fed Chair Jay Powell and his recently anointed second in command, John Williams, have their work cut out for them. Come June, Williams will rise to the position of Vice Chair of the FOMC, permanent vote and all, in his capacity as New York Fed President. Williams comes to the position with deep experience on the economics front but precious little as the financial markets go. In a perfect world, the duo will have everything from the economy to financial stability to regulation of the banking system covered.

The hope is that Williams’ work ethic and capacity to learn will offset the formidable challenge his new position presents. For more on this, please enjoy this week’s installment, The Migration of the Medallions: Leadership, Leniency & Leaks at the NY Fed.

Before signing off, I would like to share with you a noble endeavor undertaken by my good friend, Josh Frankel. Last November, Rich Yamarone passed away suddenly at the age of 55, much, much too young. Rich had become an institution in and of himself as senior economist at Bloomberg. Everyone he called friend he loved and made laugh, and we were all better for knowing him. Josh has blessed Rich’s memory by spearheading the creation of the Richard A. Yamarone Memorial Scholarship in Economics at Brooklyn College. Please join me in contributing via the link below.

Richard A. Yamarone Memorial Scholarship in Economics at Brooklyn College

NOTE:  Donors should enter “Richard A. Yamarone Memorial Scholarship” in the comments box provided to ensure that their gift will be allocated to the Yamarone Scholarship. 

Hoping someone has blessed your life as Rich blessed mine, and wishing you well,

Danielle
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DiMartino Booth, Money Strong

When K.I.S.S. Fails – Private Equity on the Razor’s Edge

Don’t you wish every day was Turnaround Tuesday? That’s the clever term coined by a buddy of mine at Citi who sadly cannot be named and take proper credit. But it is a great term to describe the pattern that’s emerged in this year’s first quarter, a three-month span most market players were relieved to see written into the history books.

As for what’s to come, the scent of spring is decidedly in the air. Car sales hit it out of the park in March thanks in no small part to a cordial calendar which provided 20% more Saturdays than 2017 did. Incentives that would make a Mad Man blush and rising interest rates did their fair share as well.

To commemorate the season’s good tidings, General Motors’ executives have, for the sake of our collective auditory intake, dialed back the volume on the noise by reducing the frequency with which they report sales to a quarterly basis, down from what had been a monthly pace since the 90s. To think how swimmingly that worked out for retailers. How very thoughtful indeed.

At the opposite end of the spectrum, it’s become deathly quiet in Tokyo’s bond trading pits. According to the Wall Street Journal, a brand spanking new 10-year issued March 13th didn’t trade…at all, the seventh such instance in 24 years of record keeping.

A well-kept secret closer to home is that the Federal Reserve wasn’t necessarily keen to taper its QE purchases back in 2014. No, the move was a bit more forced on the doves as market functionality was jeopardized because the Fed was buying such a huge slug of Treasury and MBS issuance.

Could the same hindrances be at work in Japan? Or has Kuroda seen the light and acknowledged that QE is as futile an endeavor as any ever undertaken by a central bank? My money is on the former.

Every month, the University of Michigan queries households on what they’re hearing in the news, good or bad. According to Dr. Gates, my eagle-eyed economist friend, something rather unusual happened in March. Upper-income households perceptions of the news swung 50 points from positive to negative.

How unusual, you ask? It is after all, just bluster and talk, not a full-blown trade war. Right? Let’s just say the biggest spenders in an economy that runs on spending aren’t convinced this will blow over. What’s particularly telling is the other three instances in history where such a huge swing has been recorded. That would be November 1987, which needs no explanation; July 2002, when accounting scandals wracked markets; and August 2011, when a no confidence vote on Uncle Sam jolted investors. File that where you like.

Speaking of friends, I would be remiss to not share the infinite wisdom of my good friend Peter Boockvar. He recently made the observation that we no longer live from one economic or business cycle to the next, but we rather ride one credit cycle after another according to the ebbs and flows of monetary policy. If you can’t appreciate the distinction, consider that in the pre-Greenspan world, the Fed’s hiking and easing campaigns made saving cash more or less appealing. Since 1987, however, the virtue of saving has been annihilated altogether, by design. Kind of gets under your skin.

Along those same lines, has all of this private equity fund raising begun to irritate you? “Pigs get fat, hogs get slaughtered” anyone? For more on what’s driving the fee-fest, please enjoy this week’s installment, When K.I.S.S. Fails: Private Equity on the Razor’s Edge.

Hoping you’re not still circling foggy La Guardia in the sky and wishing you well,

Danielle

PS. Please enjoy my latest Bloomberg column which highlights where the smart money is these days (Spoiler alert: it’s not in the stock market) in Powell Shows Markets Won’t Be Rattled by Volatility.

 

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The Bounty Hunter and the Fugitive Collateral — The Flight Risk in the Corporate Bond Market

‘Tis the season for bunnies, baskets and bill auctions. Wait – one of those did not belong. And yet, April will herald Treasury bill auctions that put optimists’ posits to the test. Is the spike in short rates a technical glitch that will right itself or is there an underlying issue?

At least we can all agree that borrowers of the $200-plus trillion in leveraged loans, interest rate swaps and mortgages linked to Libor worldwide sure do hope the technical glitch gets fixed and in a hurry. 2018 may be a young year but Treasury bill supply over the past five weeks has already exceeded the 2017 total by over two times. It should thus come as no surprise that demand for Treasury bills is at the lowest in nearly a decade. The first few trading days of April will bring bill auctions that should tell us a bit more about investors’ moods.

Speaking of the last decade, the yield curve is at its flattest in over ten years. After putting up quite a fight, the flight to safety trade finally kicked in during trading yesterday and carried over into the overnight hours. At 2.75%, the 10-year Treasury yield has broken through a key resistance level, technically speaking (again).

If you were just to look at the data, it might stand to reason that long rates are coming down, both here and abroad. Metals prices are receding, which typically flags a tempering in economic activity. On that other hand, rig count in the United States is at a three-year high implying downside to crude prices. Is it a coincidence that the Dallas Manufacturing index tanked in March? More to the point, what’s with all this worrying about inflation?

Please hold is the best answer I can come up with. Follow those earnings reports because other sorts of nefarious price pressures are eating many companies alive. The question is will Jay Powell take note of what companies report? Well, he did start the Industrials Group back in his Carlyle days.

It won’t take long to alarm Powell given what survey data have been saying about transportation and input costs rising. General Mills — cereal maker — gave a preview in one of the first earnings reports to be released commenting that input costs had risen so far so fast it caused the company to turn in a disappointing profits report.

As more companies follow suit, Powell should be emboldened to push for more tightening on the Fed’s part — raising probability that it will be four and not three rate hikes in 2018. Inflation and slowing growth? How very distasteful.

Investment bankers aren’t waiting for any verdicts to come in. They tried their college best to rack up their annual bonuses in just the first three months of the year. If they can manage to crank out another $5 billion in M&A activity in the last few days of the month, March 2018 will go down as the second highest monthly tally for M&A in history.

On the other, other hand, this cycle might just be gearing up for one last push. The yield curve has managed to not invert for the longest period on record, so we’ve got that going for us. Or is that maybe a bad thing? Remind me please. What happens when rates stay too low for too long?

For more on that (rhetorical) question, please enjoy this week’s foray into the wide (and I mean wide) of “investment grade” credit. You’ll understand the air quotes after you read, The Bounty Hunter and the Fugitive Collateral: The Flight Risk in the Corporate Bond Market

 

Happy Easter or Spring Break or both if they apply in sync, and as always, wishing you well,

 

Danielle

 

PS.  Have you ever read something so good you had to share it? A few days ago my pal Richard Rosso tweeted out this gem of a quote that fits the times more than any I’ve recently read. Enjoy

Humans are prone to herd behavior – it is warmer and safer in the middle of the herd. We feel the pain of social exclusion in the same parts of the brain where we feel real physical pain. So being a contrarian is a bit like having your arm broken on a regular basis. — James Montier

 

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