Here’s Why the Stakes Are Higher for the ECB’s QE Exit

Central bank's bond buying has far outstripped new issuance, making it a bigger event for the market, Deutsche Bank says

When it comes to quantitative easing, the European Central Bank may be trying to bite off more than it can chew. 

The ECB is now buying seven times more bonds than the euro-area governments are adding to the market, according to calculations by Deutsche Bank economist Torsten Slok. To put it into perspective, Bank of Japan's bond purchases currently outstrip new issuance by a factor of three. The demand coming from the Federal Reserve hasn't exceeded supply since around mid-2002.

Source: Deutsche Bank Research

In general, Deutsche Bank estimates that because of the central-bank activism roughly $8 trillion of global debt is trading at sub-zero rates. That's roughly 17 percent of all the world's outstanding bonds.

"This reveals how much additional 'firepower' each central bank brought to the market in an attempt to lower long rates and narrow credit spreads and boost stock markets," Slok says in his note. The "difference in QE magnitude across the G3 is an important reason why the ECB exit is likely to be a much bigger event for markets."

Source: Deutsche Bank Research

In the ECB's case, the asymmetry has been exacerbated by attempts from some of the euro-area largest economies to reduce their debts. Germany, which gets the biggest quota of monthly QE purchases among member states, has been running a budget surplus since 2014. In Netherlands, revenue also exceeded spending last year. Both can now issue debt with negative yields. Borrowing costs have also dropped for deficit-countries such as Italy, Portugal and Spain, allowing them to refinance debts at lower rates.

Graphic: When Will the ECB Pull Its Trillions From the Markets?

On Oct. 26, the ECB is going to lay out plans for its bond-buying in 2018. The program will reach 2.28 trillion euros ($2.7 trillion) by the end of 2017, and there may only be room for little more than 200 billion euros of purchases next year.  

At the same time, the central bank is likely to maintain the large size of its balance sheet through reinvestments of it maturing bond. That should go some way to cushioning the blow from its disappearing firepower.

India And Pakistan: Inching Toward Their Final War?

Both India and Pakistan have between 120 and 140 nuclear warheads, according to estimates provided by the  Arms Control Association. However a report produced in 2015 by the Carnegie Endowment for International Peace and the Stimson Center asserts that Pakistan may be outpacing India in terms of its nuclear stockpile, and may possess 350 nuclear warheads in the next five to ten years. A 2016 SIPRI report confirmed the assessment that Pakistan has more nuclear warheads than India.

However, what distinguishes the two neighbors' nuclear-weapons programs from each other is not so much the pace of production or the size of the stockpiles, but their radically different nuclear doctrines.

The major difference between the two countries' nuclear doctrines is that while India has renounced first use of nuclear weapons, Pakistan has refused to do so by reserving its right to use nuclear weapons in the face of India's conventional superiority.

So far, uncertainty regarding Pakistan's nuclear threshold is the principal factor preventing a major conflagration in South Asia. Pakistan's refusal to disavow first use of nuclear weapons, and its emphasis on amassing tactical nuclear weapons and short-range missiles as a corollary of its nuclear doctrine, can be explained in light of its conventional-force inferiority vis-à-vis India. It is in fact a mirror image of the American nuclear doctrine as applied to central Europe during the Cold War. The United States refused to disavow first use of nuclear weapons, and deployed tactical nuclear weapons in central Europe on a large scale, because of NATO's presumed inferiority in terms of conventional power vis-à-vis that deployed by the Warsaw Pact.

But for Pakistan, the uncertainty introduced by its nuclear doctrine has achieved another major objective as well. It has provided Pakistan with the shield behind which terrorist groups armed and trained by Islamabad, such as Lashkar-e-Taiba and Jaish-e-Muhammad, can engage in acts of terror that create mayhem not only in Indian-administered Kashmir but also in other parts of India. The fear of escalating a conflict with Pakistan to the nuclear level has prevented India from retaliating to these provocations with the massive use of its superior conventional force.

India desisted from retaliating against terrorist bases or Pakistani military installations even when a massive terrorist operation launched from Pakistan targeted India's financial capital, Mumbai, in November 2008. This attack lasted for more than sixty hours and left at least 174 people dead.

However, it seems that the logic of this deterrence is fast eroding. Attacks such as the one in Mumbai, and subsequent assaults on Indian military installations in Kashmir and elsewhere, have also provided justification for India's hard-line Hindu nationalists to heighten anti-Pakistan rhetoric, and putting pressure on the Indian government to intensify its military response. In the past few months, Indian retaliatory attacks have targeted not only terrorist bases but also Pakistani military facilities, causing significant casualties among Pakistani forces.

The escalation in the last two years in terror attacks, especially by Jaish-e-Muhammad, with the obvious connivance of the Pakistan army, on Indian military targets in Kashmir and surrounding Indian states has made the situation very perilous. In the past several months, terrorist groups operating from Pakistan have undertaken several such major attacks, causing significant loss of life among Indian security forces.

A major terrorist attack on the Uri camp in Jammu and Kashmir in September 2016, which left seventeen military personnel dead, motivated the Indian government to reassess its strategy for responding to such attacks. On September 29, 2016, India launched its first publicly acknowledged "surgical strike" against terrorist bases in Pakistan. Although there had been speculation that India had conducted such strikes earlier as well, this was the first admission by New Delhi that it was ready to launch major retaliatory attacks against targets in Pakistan and Pakistan-occupied Kashmir.

In the latest incident, in February 2018, Jaish terrorists attacked an Indian military camp in Jammu; five army personnel and four militants were killed. In retaliation, the Indian army destroyed a Pakistani army post with the help of rocket launchers, killing, according to Indian sources, twenty-two Pakistani personnel. This tit-for-tat exchange is reaching dangerous proportions.

So far, the Pakistani military has downplayed Indian incursions and retaliatory attacks and refused to recognize their seriousness, because it does not want to appear weak in the eyes of the Pakistani public, which is then likely to clamor for revenge. However, the Pakistani military cannot continue to downplay Indian attacks, especially in light of the increasing fatalities. There is the danger that at some point, either by miscalculation or by design, an Indian surgical strike in Pakistani territory will push the Pakistani military—which controls the nuclear weapons—to retaliate in force.

If a full-scale war erupts, at some point Pakistan, unable to counter superior Indian conventional forces, could resort to battlefield nuclear weapons, as its doctrine proclaims. While India subscribes to a no-first-use doctrine, it has made it abundantly clear that it will massively retaliate against any use of battlefield nuclear weapons by Pakistan without making a distinction between tactical and strategic nuclear weapons. This strategy, as enunciated in a statement issued by the government of India on January 4, 2003, is designed to inflict unacceptable damage on the enemy.

Former Indian national security advisor Shivshankar Menon elaborated this strategy in his memoirs:

"India would hardly risk giving Pakistan the chance to carry out a massive nuclear strike after the Indian response to Pakistan using tactical nuclear weapons. In other words, Pakistani tactical nuclear weapon use would effectively free India to undertake a comprehensive first strike against Pakistan."

This is a very scary scenario. Pakistan's overreliance on its nuclear deterrence, especially its refusal to subscribe to the no-first-use doctrine, when combined with its reckless support for terrorist groups attacking Indian military and civilian targets, could unintentionally usher in a nuclear winter - and spell doom not only for South Asia, but for a much wider area surrounding the subcontinent.

US National Debt Hits $21 Trillion

For 8 years, we took every opportunity to point out that under Barack Obama's administration, US debt was rising at a alarmingly rapid rate, having nearly doubled, surging by $9.3 trillion  during Obama's 8 years. It now appears that the trajectory of US debt under the Trump administration will be no different, and in fact based on Trump's ambitious fiscal spending visions, may rise even faster than it did under Obama.

We note this because as of close of Friday, the US Treasury reported that total US debt has risen above $21 trillion for the first time; or $21,031,067,004,766.25 to be precise.

Putting this in context, total US debt has now risen by over $1 trillion in Trump's first year... and the real spending hasn't even begun yet.

What is amusing is that Trump - who has a tweet for every occasion - and who no longer even pretends to care about the unsustainability of US spending was extremely proud as recently as a year ago by how little debt has increased during his term.

Donald J. Trump

✔

@realDonaldTrump

The media has not reported that the National Debt in my first month went down by $12 billion vs a $200 billion increase in Obama first mo.

We doubt today's milestone will be celebrated on Trump's twitter account.

And while some can argue - especially adherents of the socialist Magic Money Tree, or MMT, theory - that there is no reason why the exponential debt increase can't continue indefinitely...

... one can counter with the following chart from Goldman, which shows that if one assumes a blended interest rate of roughly 3.5% as the Fed does, and keeps America's debt/GDP ratio constant, in a few years the US will be in what Goldman dubbed "uncharted territory" and warned that "the continued growth of public debt raises eventual sustainability questions if left unchecked."

The bad news, however, is that debt/GDP will not be constant, as the CBO recently forecast in what was actually an overly optimistic prediction.

JPM's Kolanovic: If Trump "Destabilizes Markets" He "Opens A Path" To Impeachment

JPM's head quant, Marko Kolanovic, who from a chronic market skeptic has in recent months morphed into a raging bull, is out with a note in which he not only first mocks the bears...

Recently, financial press stories were dominated by fear. This is perhaps understandable given a long period of extremely low volatility before the recent turmoil. Negative stories also tend to attract more attention (clickbait). After running through various negative narratives – inflation, stagflation, hyper growth, rollover of growth, large deficits, tariffs to reduce trade deficits – the most recent bear narrative is trade wars (and particularly one with China).

... only to tease them by forecasting new all time highs...

We argue below that this risk is also very low, and if we take the 2015 turmoil as a template for flows from systematic and fundamental investors, markets are likely to reach all-time highs soon.

... even as his JPM cross-asset colleague John Normand warns that the time to sell  may be approaching, now that the odds of a recession inside 3 years are over 70%.

Or, as Kolanovic would see when looking at the Rorschach test above, just the right conditions for all time highs.

More interesting is the JPM quant's assertion that Trump will - or should - avoid launching a trade war at all costs, not least of all because he wants to avoid impeachment, which would be far more likely if Trump "destabilizes global markets" impairing the administration's 'market scorecard' and likely leading to an election loss. And, as Marko adds, "lost elections open a path to impeachment, and other complications."

Which is clearly a sensible thing to say for any bank employee, whose bonus would be similarly "complicated" if Trump "destabilizes global markets." As for the "revelation" that a market crash could Trump the midterms - and potentially his liberty - well, that's been the plan since November 8, 2016.

Here's Marko:

A significant trade war started by this administration would destabilize global equity markets. Should this happen ahead of the November election, it would impair the administration's 'market scorecard' and likely lead to an election loss. Lost elections open a path to impeachment, and other complications. The game is also non-zero sum, as one can both use tough rhetoric and at the same time do little disruptive action (e.g., players as we defined them can 'have their cake and eat it'). Setting up a diagram (similar to the well-known 'prisoners' dilemma') points clearly that there will be strong rhetoric, but weak or no action that would destabilize equities.

One could argue that a similar analysis can be applied to the risk of the Fed committing policy errors (see figure below, asymmetry in the case of the Fed would be causing a recession, and the public pinning the blame to specific individual central bankers responsible for the decision).

So after telling to the president that he should avoid a market crash if he knows what's best for him, Kolanovic then goes back to prodding the bears, explaing that since there have been no further shockwaves from the record February VIX spike (which by the way Kolanovic said would not happen), what comes next for the market are fresh all time highs. To wit:

Unless there is a recession, all of these flows tend to reverse within 1-2 months. For instance, short-term momentum turns positive ~1 month after the initial shock, short-term options expire within a 1-month cycle (gamma rolls off), and realized volatility starts declining prompting volatility sensitive investors to buy. This all happened in 2015 and is happening again now. A very simplified price analogy is shown in the figure [below], and suggests the market should reach all-time highs relatively soon.

Which, ironically differs substantially with what Kolanovic wrote at the end of January when he said that "In terms of timing market downside risk, we would be more concerned about the period after the Q1 earnings season, when fiscal reforms are likely to be priced in and central banks make further progress on the normalization of monetary policy."

That would be right now.

Finally, the quant has one last card up his sleeve: if you don't believe him, then believe JPM's forecast of over $800 billion in stock buybacks:

There is also a substantial difference between Feb 2018 and Aug 2015. Right now, both macro (synchronized global growth) and corporate fundamentals (tax reform and record earnings) are much better than in 2015. This adds demand for equities and strengthens fundamental reversion flows. For instance, compare current fundamentals to 2015, when we had a US earnings recession, EM crisis, China crisis, Energy, and High Yield concerns. This year, we expect $800bn of buybacks vs. ~$600bn in 2015. The difference ($200bn) on its own, equates to all the value of all recent systematic strategies' selling. And while systematic strategies will buy back most of what they sold, buybacks will not reverse.

Kolanovic is referring to this chart...

... which incidentally will never materialize if i) rates jump making debt-funded buybacks impossible and ii) if there is a trade war.

None of this matters to Marko, however, who is about as bullish as we have ever seen him:

This is all supportive of the market reaching new highs relatively soon (e.g., with the onset of Q1 earnings season), and is consistent with our previous fundamental and quantitative research.

And so we wait to find out: will Kolanovic be right with his new all-time-high prediction, or will it be Gartman's turn to finally have a last laugh after his "watershed call" that the market has now topped.

Drums Along The Potomac

The amateur psychologist in me suspects that the more the USA heaps Russia with censorious opprobrium and punishments, the closer this floundering polity actually is to completely losing its shit. Friday morning's front-page headline in The New York Times appears to have been written by Pee Wee Herman:

I can just hear Vlad Putin blowing a raspberry out of the Kremlin: "Nyah, nyah, nyah… I know you are, but what am I…?" We're also informed today by that august journal that U.S. Accuses Russia in Cyberattacks on Power Plants. (Oh, wait a second, they changed the headline at 8:02 to Russia Wormed Its Way Into Access at Power Plants, U.S. Says.)

Hmmmm… well, the amateur detective in me suspects that A) this is exactly the kind of bullshit that US intel excels at making up; plus B) the public was actually told last year that our intel has the ability to place any kind of cyber-footprint and time-stamp it wants on digital information, so that C) this assertion can be neither proved nor disproved.

The amateur international relations analyst in me sees in these shenanigans a desperate search for a casus belli, an excuse to go to war. But that only brings me back to amateur psychology: the US apparently wants to commit suicide. Wouldn't war be a great idea a week after Russia announced it had new hypersonic missiles that the US can't defend itself against?  Hmmmm. Maybe the Russians made that shit up. And maybe they didn't. Perhaps we'd like to test that, say, by bombing a bunch of Russian military personnel in Syria, just to see what happens.

There is also the matter of the poisoning in Salisbury, UK, of the Russian Sergei Skripal and his daughter Yulia with a suspected nerve toxin, Novichok, first developed by the old Soviet military. The two remain in critical condition. A nasty bit of business. Skripal was a Russian-to-British double agent who was exchanged some years back in one of the infrequent swaps of captured intel "assets" by the so-called great powers. British Prime Minister Theresa May had a whack attack over the Skripal hit, reeling out new sanctions and booting a boat-load of Russian diplomats off-island.

Forgive me for seeming callous, but it's a little hard, in the first place, to give a fuck one way or the other about the poor Skripals. Being a double agent carries some serious occupational hazards. This is generally understood among observers older than age six. Mr. Skripal came to an unhappy fate, and his daughter is apparently what we like to call collateral damage — of the sort, say, when one of our drones in a foreign land blows up a wedding party by some targeting error. Whoops! Our bad. One lesson here is that people with ambitions in the intel sector should consider sticking with one side or the other.

Interestingly, and secondarily, the accusation itself is unaccompanied by evidence. The Brits will not release samples of this Novichok for analysis. But are we also to believe that the Brits (or one of their close allies, say) could not concoct a bit of this poison themselves in a lab? After all, when you're in the world of double-agentry, you're in a hall of mirrors, and who, really, is to be trusted? Least of all in a matter such as this, would you start banging war drums.

But that, alas, is where things rest for the moment. War drums beating and war cries wafting across America's spacious skies. The hysteria is palpable and we are making ourselves ridiculous — if not getting ready to blow up the world. Oh, I might also add that it is impossible to believe that there is not some room in the giant NSA facilities full of computer jocks trying sedulously to worm their way into every computer system in every foreign land the world over. The question you'd have to ask is: why would we not be doing that?

The amateur theologian in me thinks: when the Shining City is at hand, will someone please hitch Rachel Maddow to the back bumper of a Toyota Landcruiser and drag her over six miles of broken lightbulbs? Of course, I can't say that because it would by misogynistic.