Authorities Were Allowed to Fix Things In 2008. Sadly, Not This Time

Authorities Were Allowed to Fix Things In 2008. Sadly, Not This Time
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At the start of this year’s second half, the economy was supposedly primed for a rebound. Whatever had happened to end the year before and begin this one, and nobody has bothered to explain, water under the bridge. These “transitory” factors and cross currents would abate and then the real strength of the US economy would show through.

Forget about everyone else’s troubles overseas, they said. The unemployment rate went a little lower therefore still keeping Economists and policymakers to their story predicated on a strong labor market. Sure, there were “unexpected” problems in Germany as well as those suddenly popping elsewhere, but so long as US businesses keep on hiring none of that overseas turmoil would matter.

This is becoming more than a story about economics (small “e”). Indeed, it’s rarely been about economics given the politics which understandably entered the mix around the time of Bear Stearns. In our current case, merely an extension of that former case, these difficulties and uncertainties aren’t new.

What is new is how once Presidents and Fed Chairs worked together at least on obfuscation, nowadays they are near enemies. Private disagreements on policy have become public spats of a much deeper nature. I don’t think the term frenemies can apply.

Earlier this week, the widely watched ISM Manufacturing PMI dropped sharply. It had already been calculated below the 50 level dividing contraction from expansion. For the month of September 2019, the gauge stands at 47.8.

Not only was it below 50, it was the lowest since 2009. There can no longer be much doubt. Manufacturers have hit a very real slump, one that more and more looks like a contraction.

In response, the President tweeted his further disdain for the monetary policies he continues to claim is the cause. His tweet said, in part, “As I predicted, Jay Powell and the Federal Reserve have allowed the Dollar to get so strong, especially relative to ALL other currencies, that our manufacturers are being negatively affected.” For Trump, it was rate hikes that raised the dollar, therefore the manufacturing recession belongs to Jay Powell.

On the other side, Federal Reserve Chairman Jay Powell has been less confrontational than the President but no less resolute pointing his finger right back at the White House. At every opportunity, the nation’s chief central banker refers to “trade tensions” as the main thrust of these economic cross currents. It’s not my fault, he says indirectly to the Executive, I’m now trying to clean up the mess you made.

For those taking Powell’s side (including unlikely allies who are simply anti-Trump) that was the message sent inside of this week’s ISM Manufacturing series. Dragging down the headline, the component for new export orders dropped sharply, too, and hitting a level of just 41.0. Commenting on the numbers, Timothy Fiore, ISM’s chair of its Business Survey Committee, said:

“Global trade remains the most significant issue as demonstrated by the contraction in new export orders that began in July 2019. Overall, sentiment this month remains cautious regarding near-term growth.”

Sounds like “trade wars.” Except, the whole central focus of current protectionism is the US imposing tariffs on Chinese goods and China retaliating only where it can. The United States exports hardly any goods to China. More agricultural products than anything else, if there is a roadblock in terms of trade due to trade wars it would be coming in the other way – fewer US imports of Chinese goods hammering Chinese manufacturers.

With all global trade falling off causing US manufacturers very real harm, how can that be related to US levies on China? It can’t. Not even the non-specific appendage “trade tensions” can account for these wrong way trends. In the absence of an actual explanation for what is happening, since everyone just repeats the phrase over and over, “trade wars” it is.

Which makes the politics even more inconvenient for the President coming right upon the dawn of Election Season. Therefore, the pressure ramps up even higher on him to deflect the blame in some other direction. Jay Powell plays the perfect patsy; clueless, stumbling, and hardly the type who exudes competent leadership or inspires confidence in public.

And for him, the ISM had more bad news a few days later. In addition to the labor market story, one of the bedrock assertions for the second half rebound has been what was interpreted as limited spillover effects from the transitory manufacturing stumble. Manufacturing, you will constantly hear, is only 12% of GDP or some such.

Therefore, if the ISM index for that part of the economy is in contraction that’s not good but it’s not really all that bad for the overall economy, either.  Services, that’s what will ultimately matter especially since that’s where all the hiring and employment strength is purportedly coming from.

But on Thursday, the ISM reported that its Non-manufacturing PMI had tumbled to just 52.6 last month. Since 2009, it has only been lower on two occasions.

Worse for Powell, the Non-manufacturing Employment Index contained some alarming internal data. The index itself dropped to just 50.4, the lowest since 2009. The responses indicated a definite change more recently in employment patterns. Whereas in June 2019 28% of respondents told the ISM’s surveyors they were hiring more workers, only 21% said they were in September.

On the other side, just 11% had said in June they were cutting back on the number of employees. By September, that number jumps to 19% (while 60% reported no change). At the margins, there are already significant signs of labor market deterioration alongside this growing downturn.

What does trade wars have to do with US service providers beginning to think about or even beginning to reduce their headcounts of employees?

It’s not just the ISM’s sentiment surveys which indicate a material change in the employment environment. The BLS’s payroll reports have already suggested as much dating back to the end of last year.

The Establishment Survey’s 6-month average monthly change had been as high as +236k in July 2018 (which, to begin with, actually isn’t very good in historical context). As late as the month of January 2019, the average was still +234k.

Beginning in the month of February, the payroll reports have more frequently disappointed (even for the times) while also exhibiting a total absence of “good” months. Since January, only once has the monthly change been better than +200k and only twice above +160k. The 6-month average as of August (this was written before the September payroll report was released) is just 150k.

The last time it was this low Ben Bernanke’s Fed was panicked into QE3.

At best, the government’s numbers say the labor market is hugely uncertain. At worst, employers may already be making adjustments, the kinds of cost-saving measures typically associated with recession.

Not trade wars, not strictly manufacturing. Services and the whole US economy which would not ever be driven so far off course by tariffs on Chinese goods or a max federal funds rate of not even 2.5%. These are not the kinds of factors which would move the dollar higher and produce the heavy downward economic pressures being exhibited here as well as all over the rest of the world.

It is a global downturn and the dollar is right at the center of it – again.

I wrote back in late June how the second half rebound during these times is nothing but a mythical, unicorn-like concept. It just doesn’t exist. There are no transitory factors; there’s just that one factor.

Before the middle of September, there seemed to be more of an unspoken and nonspecific quality about it. Why does the dollar go up? Back in June I had recalled how the second half rebound in 2015 had been spoiled by “overseas turmoil” due to the rising dollar and how the second half rebound in 2008 had been, too.

In the middle of what would later be called the Great “Recession” most policymakers had come to believe they had avoided even a mild one altogether. One big reason was Bear Stearns. As bad as some market indications got, the worst that came out of it seemed to be only one near-death experience policymakers had, they believed, skillfully handled with aplomb.

Bernanke and his group had patted each other on the back for their orderly winding down of a “troubled” firm. What made it troubled? Something about mortgages, they said. What I wrote in June was:

“As it turned out, an orderly failure led to the same horrible results anyway. By focusing on housing and the perceived credit risks associated with subprime mortgages in particular, there was never enough consideration about ‘suddenly losing access to short-term financing markets.’”

That’s the thing about what some call “counterparty risk.” Another way of saying it is, contagion. Perceived risks about a specific firm or maybe an asset class becomes systemic risks as the entire market structure(s) must rethink and reprocess prior assumptions about them. The Global Financial Crisis wasn’t really about subprime mortgages, it was about a system coming to terms with how those things could have ever come about.

What was wrong about the global monetary framework that saw nothing wrong in proliferating those kinds of assets. If it saw and rewarded such stupidity, what did that say about the whole system? Minor, inconvenient questions about things like repo collateral which before had been minor and inconvenient abruptly transformed into insurmountable obstacles.

Suddenly losing access to short-term financing markets. Liquidity risk.

When the once-willing participants in this global monetary system faced up to these questions, for the first time, the whole global economy ground to a halt. That was the Great “Recession.” Not subprime mortgages.

But that’s the past and the present is the present. What would any of this have to do with September 2019?

After all, the Fed printed trillions of dollars in new money therefore there could never be another liquidity event again. Fed officials have said so, repeatedly. Janet Yellen spent the bulk of her tenure talking about how the financial system, thanks to policymakers’ combined genius efforts, has been made resilient!

Suddenly losing access to short-term financing markets? Not in this era of hyperactive monetary policy and bloated central bank balance sheets. If anything, they say, there’s too much money (and too many US Treasuries). It’s even got a name; it’s called the doctrine of “abundant reserves.”

However, even before what happened in repo markets in the middle of September, US central bankers had already been reconsidering their take of the liquidity environment.  Long before the fed funds rate broke out of its range, the FOMC voted to end so-called quantitative tightening way, way ahead of schedule. It was a tacit admission that something wasn’t right, monetarily speaking.

Indeed, that had been the case long before officials ever conceived it might be. I’ve been constantly writing about these things since early on in 2018, more so in the aftermath of May 29, 2018. Broad market liquidity indications that keep going in the wrong direction. Curves that have been upended and distorted, inverted for a very, very long time before all this broke out into the public consciousness.

While the labor reports were reportedly sky-high last year, the liquidity reports were becoming uniformly negative. In between, the labor reports have become more like the liquidity reports.

That’s the rising dollar on both ends of it.

What still sticks out about the funding market shakeup last month isn’t that there was one. Any surprise over it in the public eye is merely an indication of the financial media’s continued deference to policymakers and their biased opinions. No, the real noteworthy part was what was indicated, potentially, by the exploding ranges during those particular days. The content of the mess, so to speak.

Take federal funds, for example. The range on Tuesday, September 17, was as high as 4% (99th percentile). What that means is firms were bidding for federal funds, the sparest of spare liquidity, and were being charged as much as 4% (25% of all transactions took place between 2.5% and 4%). In the repo market, the ranges were much worse, especially as the repo rate got into the double digits on that same day.

In other words, more than a slight whiff of counterparty risk. Firms stuck on the wrong end of these funding dynamics had to have been frantically working the phones for any source they could find, and paying whatever costs were demanded in return no matter how ridiculous. No doubt that was the impetus behind the Fed’s sclerotic, haphazard response of overnight repo operations – officials knew they had to do something but really had no idea how to respond effectively.

Over the course of that week, these firms had to face the very real prospects for, say it with me, suddenly losing access to short-term financing markets. Nobody actually lost access, but for the first time in a very long time it was an immediate possibility.

Here’s the real kicker; that mid-September repo rumble wasn’t an actual credit event. It was nothing more than a seasonal low point for liquidity, an otherwise predictable and manageable bottleneck on the calendar. A dress rehearsal for if, maybe when, the real thing shows up.

Now, this doesn’t mean we are repeating 2008. What it does mean is that the global system is in an abnormally weakened state, and therefore the risks are much greater than has been communicated. Not at all resilient, Ms. Yellen. And further, this part’s like 2008, central bankers have no idea what they are doing. They don’t know what’s wrong and they wouldn’t even begin to know how to fix it. The repo operations haven’t had much effect; the seasonal bottleneck simply passed.

The effects, however, they will continue to pressure the global economy. Liquidity providers who are obviously already shy, and may now be thinking about counterparty risks, as well, are likely to become even more shy. Behavior is being altered as agents on both sides of the dollar rethink their perceptions after digesting what should have been a non-event.

Global dollar availability, really this global dollar shortage, it will have its biggest negative impacts upon global trade – just like what’s indicated in the ISM as well as in trade and economic accounts all around the world. And they will continue to spillover via the dollar into everything else. Services included.

The second half rebound is dead, and we are only halfway through the second half. It never had a chance, as the repo market loudly proclaimed a few weeks ago. While serious negatives continue to proliferate all throughout the dollar system, authorities fight instead over who should be blamed for them; with none of them holding any real insight into how it came to be this way or what to do about it.

At least they agree on one thing: there is definitely something wrong.

And this isn’t just an American controversy; it has spread to quite a few jurisdictions around the world alongside this “unexpected” downturn. India, Turkey, and Argentina are just the most extreme examples.

What’s next isn’t avoiding that downturn, it’s trying to figure out how the politics will work on the other side of it (without yet knowing its depth and duration). That’s the real difference between 2008 and now. Back then, even though they screwed everything up, the global public was willing to set all that aside and give authorities the chance to put things right. There was perhaps an unusual amount of patience back then.

Those days are long gone. 

Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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