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Unsinkable?


US Stocks started the day ballasted by D. Trump’s expected announcement of additional tariffs (of USD200bn) and never looked back, closing near the lows with the Nasdaq QQQ suffering a notable 1.9% loss as the S&P dropped -0.7%. Yesterday, the CBOE SKEW Index or so-called crash index a near all-time high (at 150), underscoring hedging demand, ahead of the news and somewhat associated mid-term elections risks. The dollar traded broadly weaker yesterday with EURUSD returning to the highs of last Thursday. While the weakest links of EM currencies dropped further (TYR shed 2%) other EM currencies such as MXN and RUB gained. Elsewhere in FX, EURSEK dropped as much as 1% to 10.41 after Riksbank Governor Stefan Ingves said he’s convinced inflation will be around 2% in coming years with the Bank’s Minutes revealing broad commitment to tightening soon. Precious metals (IAU SLV GDX) gained with Gold recouping the USD1200 mark as the dollar weakened. It was mainly in response to the dollar falling however with XAUEUR closing mostly unchanged, we have the impression that gold is trying to form a base from which it could rally. The 10-year anniversary of the Lehman bankruptcy offered an opportunity to revisit the causes of the great financial crisis. Bloomberg, Wall Street firms and the financial press all covered the topic and the WSJ probably offered the best perspectives on what happened and what could happen in the next financial crisis. Three WSJ observations stood out: (1) “In the past decade, total global debt (sovereign, corporate and household) has spiked 75%, including a doubling of sovereign debt, from $29trn to $60trn, according to a recent McKinsey report.” This report can be found here and is a well worth read because certain things do not matter until they start to matter but then when they do, they tend to be all that matters... Excessive debt credit and deleveraging ranged high in the worry list yesterday. Some official bodies have been warning relentlessly about the continuing debt build up witnessed since the great financial crisis but nobody has seriously started doing anything about it, or worried about it certainly not US equity investors as the Alligator’s jaws gaped wide open... The time to worry could be nearing as interest rates have started to creep higher, at least in the US where fiscal policy is also going to turn aggressively expansive, translating into higher government debt issuance at a time when international investors’ appetite for US debt has started to seriously wane, under the weight of Trump’s policy. Those being “tariffed” or “sanctioned” by Trump for a reason or another have started to look away (Russia, Iran, Turkey), others might reduce their dependence on the USD to conduct trade in another currency, hence reducing their own need to hoard dollars (and treasuries). Assuming Trump’s policy would start to work (for the moment they increase the US trade deficit because US consumers are rushing to buy foreign goods that might become subjected to heavy tariffs) and flatten out bilateral trade deficits, those countries will see their current account surplus with the US diminish which should automatically translate into less need to purchase treasuries in order to close the gap. All that at the time when the supply of Treasuries will increase substantially. If there is a US funding gap to close, the Fed might be obliged to step in (reversing QT and going back to QE) which could spell the end of the strong dollar as we know it today... (2) (second take away) “40% of U.S. companies are rated one notch above “junk” or lower, and the Bank for International Settlements estimates 10% of legacy companies in the developed world are “zombies,” meaning earnings before interest and taxes don’t cover interest expenses.” That could mean that the next crisis will be a corporate debt crisis that could also be made worse by the problems of illiquidity that have been discussed and laid out as a consequence of Dodd Franck and the existence of large pools of credit ETF’s that will offer no liquidity when the credit tide finally turns. (3) (third take away) “The U.S. owes $21.5 trillion of Treasury debt, the majority of which is scheduled to be refinanced in the next eight years, disregarding the additional $1 trillion required by the 2017 tax reform and an estimated $100 trillion of unfunded entitlement spending ahead. The Fed still owns $2.324 trillion it bought from banks as part of quantitative easing, which will need to be refinanced at maturity. Foreign sovereigns own $6.5 trillion, 40% of which is in the hands of China, Japan and Saudi Arabia. China and Japan are increasingly refinancing their own debt. As China continues its transition from exports to domestic consumption and buys its oil in its “petro yuan” straight from Saudi Arabia, while the U.S. buys less Saudi oil, Riyadh and Beijing have less appetite for U.S. Treasuries. Finally, the European Central Bank’s anticipated policy normalization suggests Europe too will be competing with the Fed for buyers in sovereign refinancing markets. Is it prudent to assume that private institutions will pick up the slack?” Asking the question is not answering it... This might comfort our view that the Fed will have to keep most of that debt and perhaps buy some more as long as the US policy remains what it is... Core European bonds were largely stable while Italian bonds outperformed strongly with the 10 y BTP/Bund spread dropping 14bps on hopes regarding the Italian budget negotiations. After the bell, the S&P dropped 10 points after the Trump administration confirmed it will slap a 10% tariff on USD200bn in Chinese goods next week, and 25% in 2019, adding it wants to give time to US businesses to look for alternative supply chains. Beijing is expected to retaliate with duties on USD60bn US goods ranging from LNG to aircraft and the US said the President is to pursue USD267bn more if China retaliates (which would cover all Chinese exports).

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