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Trade Deal – Buy the Rumor, Sell the Fact

December 16, 2019

Last Week This Morning

  • 10 Year Treasury started at 1.84%, spiked to 1.95% on news of a trade deal, then dropped back down to 1.82%, also on news of a trade deal…
    • German bund unch at -0.29%
    • Japan 10yr up 0.07% to -0.02%
  • 2 Year Treasury basically unchanged at 1.60%
  • LIBOR at 1.74% and SOFR at 1.53%
    • LIBOR tends to climb a bit at year end and then retrace in January
  • Phase 1 of a trade deal with China is apparently a done deal
  • NAFTA USMCA somehow got passed in Congress (I forgot the two parties could work together)
  • CPI at 2.1%
  • PPI at 1.3%, well below expectations of 1.7%
  • G7 sovereign 10 year yields average 0.79%
  • Brexit may finally be happening



With year-end liquidity concerns heating up in the repo market, there was more than usual anticipation about the NY Fed’s weekly repo announcement.  If the market can experience a seizure on a random day in September, how badly can it freeze when markets are notoriously ill-liquid to begin with?

On Friday, the Fed announced a massive round of repo to preempt these issues (just don’t call it QE).  Not only will it continue the daily $50B liquidity injection, it will add $150B (total of $225B) through the beginning of January to avoid year-end funding issues.  Then it will maintain at least $120B daily through mid-January.  But it will also conduct 9 special repos totaling $140B.  All told, that translates into $365B in repo funding through mid-January.   Here’s the Fed’s balance sheet.

Source: Bloomberg Finance, LP

Just because these Fed holdings of Treasurys have overnight maturities instead of 10 year maturities doesn’t mean it isn’t QE…


FOMC – Asymmetric Bar For Next Move

As expected, the Fed held rates steady and signaled a strong commitment to maintaining current levels through year end 2020.

While an economic downturn could call for cuts, there will be a very high bar for hikes.  This is particularly notable for anyone that believes the Fed might begin another tightening cycle in 2020 now that we have a truce with China.  If you think Friday’s news might cause the Fed to take back some of its recent cuts, think again.

Powell said the bar to hike is inflation that is “persistent and significant.”  He also noted that the Committee has learned that the unemployment rate can remain at “quite low levels for an extended period of time without unwanted upward pressure of inflation.”

Inflation (or inflation expectations) will be the primary driver of any rate hike.  Strong economic news alone will not necessarily drive up rate hike projections if it doesn’t also imply inflation.

In other words, it will take a lot more positive news to lead to a hike than it will take in negative news to cut.  Asymmetric bars.

For now, Powell seems very comfortable with the Fed’s current stance and believes it has accomplished a soft landing.


Phase 1 – Deal or Truce?

Markets spiked on Thursday on news of a trade deal with China, and then reversed course on Friday on news of…you guessed it…a trade deal with China.   This was a classic situation of buy the rumor (Thursday), sell the fact (Friday).

Details are still forthcoming, which is not exactly creating market stability.  Here’s what we think we know so far.

US Concessions

  • Cancels yesterday’s deadline for tariffs on the $160B of consumer goods like laptops (that’s why stocks like Apple spiked)
  • Reduction in tariff rate from 15% to 7.5% on the $120B of Chinese goods that went into effect in September on clothing goods

US Gets

  • Formal promise from China that it won’t require US firms to surrender technology in exchange for accessing their markets (because they’ll just keep stealing it anyway)
  • US banks and credit card companies can move into Chinese market without having to partner with a Chinese firm
  • China promise to buy an additional $200B in agricultural goods over the next two years (which it needed anyway)
  • $16B in specific farm goods next year (but not nearly enough to offset the losses incurred over the last 18 months)
  • China holds off on the retaliatory tariffs on more than 3,000 US goods that was set to take place yesterday

Remains the Same

  • Existing tariffs remain on $360B worth of Chinese goods

What Didn’t Happen

  • Currency manipulation agreements
  • China won’t reduce subsidies for its own steel manufacturers
  • Trade deficit won’t shrink
  • Huawei was not removed from the naughty list

If you can’t tell, I am mostly unimpressed by this truce to a self-inflicted wound.  Trade deficits are not inherently bad – if products are cheaper made elsewhere, consumers benefit from lower costs.  The best reason to go after China was instead the intellectual theft of US technology.  Any progress on that front is good news, but was economic cost really worth the Chinese “promise” to stop stealing?

Before the trade war was started in July 2018, China was buying $25B per year in agricultural goods.  The totals from 2018 were below $10B, and this year will likely be even lower. That means even if China doubles or triples its purchases in 2020, it will still fall short of the levels seen prior to when this whole mess began.

Don’t forget that the government has provided a bailout to farmers in the amount of $28B to help offset losses from the trade war.  By way of comparison, the initial TARP bailout of the auto industry was for $17.4B.  Farm bankruptcies are up 25% since the start of the trade war, and the suicide rate among farmers exceeds that of veterans.  I hope it was worth it.

You want proof the market isn’t that impressed with the agricultural aspects of this deal truce?  Check out the Bloomberg Agricultural Index.  It ticked up slightly last week, but by no means was it a spike.  And we are lightyears away from the levels seen prior to July 2018 when the first round of tariffs were formally announced.

Source: Bloomberg Finance, LP

This is a truce, not a deal.  The probability of a Phase 2 being completed before the election next year feels like a near impossibility.  Why would China agree to anything with a potential lame-duck president?  Any deal would likely include huge concessions by Trump just to help with reelection because China can take a wait and see approach.

Most importantly, China views some of the more significant unresolved issues as an attack on sovereignty.  China’s goal for “Made in China 2025” to become the world’s leader in high-tech manufacturing is not up for negotiation.  Any attempts to negotiate points that would adversely affect that objective are non-starters.

Trump will claim this as a win, but it’s mostly a political talking point.  He’ll use it for the 2020 election run and then move on to the next thing.  When was the last time you heard about the caravan of immigrants?  Oh, right before the mid-term elections?  Probably a coincidence…

China avoided another round of concrete tariffs in exchange for “promises” to buy more and to not steal US intellectual property.  Pinky swear.  What a deal.

China’s “promise” carries about as much weight as Urban Meyer committing to a recruit that he will be there for their entire career.  It was just seven months ago that China reneged on all of its “promises” from the first “deal” we struck with them.

Markets spiked on Thursday as rumors of the Phase 1 were complete.

Markets reversed on Friday as actual details started to emerge.

Buy the rumor, sell the fact.

Let me be clear – any progress is good.  This is the type of development that could help avoid a recession in 2020.  Just don’t call it a victory.

From a rate perspective, it’s the type of agreement that gives 10 Year Treasury yields room to move higher, without being the actual catalyst for a move higher.


This Week

Quite the week ahead, with manufacturing, consumer confidence, and most importantly, inflation data.  Powell and others will also use their upcoming speeches as a last opportunity of the year to clarify the FOMC’s general position.

As usual, headlines about China will also contribute to market movements.  Sooner or later the market may tire of jumping every time Trump tweets about another “victory” if it isn’t accompanied by a Chinese signature on a document with actual details.

Click to Open: The Pensford Letter PDF