THE DAILY EDGE: 18 SEPTEMBER 2019: Fed Up, FedEx

Fed Intervenes to Pull Down Rates For first time since 2008 the central bank injects funds into money markets after a sudden shortage of cash

The pressures relate to shortages of funds banks face resulting from an increase in federal borrowing and the central bank’s decision to shrink the size of its securities holdings in recent years. It reduced these holdings by not buying new ones when they matured, effectively taking money out of the financial system. (…)

The New York Fed moved Tuesday morning to inject $53 billion into the banking system through transactions known as repurchase agreements, or repos. The bank said Tuesday afternoon it would inject up to $75 billion more on Wednesday morning, but many in the market were looking beyond that decision. “The market will be waiting to see if the Fed makes this a more permanent part of the playbook,” said Beth Hammack, the Goldman Sachs Group Inc. treasurer. (…)

Rising rates in overnight lending markets “are clearly not desirable because they impede the transmission of monetary policy decisions to the rest of the economy,” said Roberto Perli, an analyst at Cornerstone Macro. (…)

There wasn’t evidence Tuesday of credit-market dislocations or other transactions that have followed past periods of distress. Instead, the pressures that sent the fed-funds rate higher were related to monetary and regulatory changes that created shortages of funds for banks. (…)

The Fed stopped shrinking its asset holdings last month, but because other Fed liabilities such as currency in circulation and the Treasury’s general financing account are rising, reserves are likely to grind lower in the weeks and months ahead.

In addition, brokers who buy and sell Treasurys have more securities on their balance sheets due to increased government-bond sales to finance rising government deficits.

Then on Monday, corporate tax payments were due to the Treasury, and Treasury debt auctions settled, leading to large transfers of cash from the banking system.

Meanwhile, postcrisis financial regulations have made short-term money markets less nimble. This didn’t matter as much when the banking industry was awash in reserves and could absorb the kind of swings witnessed this week. These days, “the market doesn’t respond to temporary deposit flows as efficiently or fluidly,” said Lou Crandall, chief economist at financial-research firm Wrightson ICAP. (…)

Unexpected bids seeking cash entered the market at a time traders said was uncomfortably close to the 3 p.m. deadline for settling trades.

Scott Skyrm, a repo trader at Curvature Securities LLC, said he had seen cash trade in the repo rate as high as 9.25% Tuesday. “It’s just crazy that rates could go so high so easily,” he said. (…)

“It seems like there’s something underlying out there that we don’t know about,” he said. (…)

“If you all are selling corporate bonds one day, and you want JPMorgan to take on—finance $1 billion—I can’t, because it’ll just immediately affect these ratios,” said JPMorgan Chase Chief Executive James Dimon at a banking conference this month. “It won’t hurt you very much in good times. Watch out when times get bad and people are getting stressed a little bit.” (…)

• This does not appear to be a precursor of broader financial market stress: We do not believe that this pressure on repo rates is a precursor to financial stress as we saw in 2008. Whereas in 2008, we saw market participants stepping away from investing in secured financing facilities due to diminishing confidence in the system, this increase in rates appears to be due to market technical and regulatory factors. (Goldman Sachs)

• Nasty Number Four: Repo Chaos, TAF Makes A Comeback, and EFF Shows Us How Inept Officials Really Are

(…) You can’t lose control of a money market rate. You just can’t. The Fed did that in 2008 and it didn’t work out so well. While it may not mean much to the layperson on the street, this stuff matters a great deal where it counts the most. Already under suspicion, a clear escalation in the liquidity situation can only lead to even bigger problems than we’ve already witnessed this year. (…)

The big liquidity problem is not EFF and federal funds. Again, all federal funds tells us is that there must be an absence of dealers to arbitrage what should be easy, easy profit. If they aren’t taking advantage in fed funds, they must be restrained and strained where it does count. (…)

I’ve written all year how it seems like the bond market has been spooked about something. The bond market is dealer banks (more than specifically primary dealers). They have become more and more shy about liquidity functions (which, we can now see since it was ended six weeks ago, had nothing to do with QT).

Not federal funds. Not calendar bottlenecks. Repo. Collateral bottlenecks.

An overnight repo operation is the Fed basically saying, we don’t know what else to do. In that way, maybe, yes, TAF II.

In case you missed this yesterday:

• LIQUIDITY VS VOLATILITY

Richard Bernstein (RBAdvisors.com) is a smart strategist:

(…) The primary factor influencing financial market volatility is liquidity. (…) investors often simply can’t buy at the market low because they don’t have the liquidity to do so. Chart 1 shows the relationship between the effects of Federal Reserve policy (depicted here as the slope of the yield curve) and equity market volatility. Although not a perfect relationship, there has historically been a strong link between liquidity and equity market implied volatility. The effects of monetary policy on financial market volatility can have significant lags because the Fed can’t force financial institutions to start or to stop lending. (…)

The gradual tightening of monetary policy has yet to work through the financial sector, but the inverted yield curve is suggesting that volatility could be on the rise. This is not simply a US event. Chart 2 shows the proportion of global yield curves that are flat and inverted (i.e., 10-year to 2-year spread less than or equal to 100 bp). The sharp rise in this indicator suggests that global liquidity has been drying up, which implies that global financial markets are likely to become more volatile. (…)

Saudis Say Oil Output to Recover Within Weeks Saudi Arabia will soon restore most of its oil output and return to normal production levels in weeks, the country’s energy ministry said.

The kingdom has restored 50% of production lost in Saturday’s attacks as of Tuesday, newly appointed Energy Minister Prince Abdulaziz bin Salman said. He added that the kingdom is using reserves to supply oil to its customers at pre-attack levels and normal production of 9.8 million barrels a day will return by the end of September. Some Saudi officials said a return to normal will take longer. (…)

Some Saudi officials said restoration efforts will take even longer than the oil minister outlined Tuesday. “The damage is severe,” a Saudi official familiar with the matter said. (…)

One European oil executive who spoke to personal contacts at Aramco said he was told the repairs would take months. The executive said the repair efforts will require ordering made-to-measure equipment, which would need to be shipped from abroad and then tested.

U.S. Factories Bounced Back in August

Industrial production, a measure of factory, mining and utility output, rose a seasonally adjusted 0.6% in August from the prior month, the Federal Reserve said Tuesday, well above economists’ expectations for a 0.2% increase. (…)

Tuesday’s report runs counter to earlier signs of weakness in the industrial sector. Output at U.S. factories, which accounts for about 75% of the nation’s total industrial output, rose 0.5% last month from July. (…)

Factory output has increased an average of 0.2% a month over the past four months, after declining an average of 0.5% a month during the first four months of the year, the Fed said. Still, from a year earlier, industrial production rose by a tepid 0.4% in August, while manufacturing declined by 0.4%. (…)

Manufacturing output grew at a 2.7% annualized rate in the last 4 months after dropping 6.0% a.r. in the previous 4 months.

But both Markit and the ISM manufacturing PMI surveys pointed to a weak September:

The August PMI indicates that US manufacturers are enduring a torrid summer, with the main survey gauge down to its lowest since the depths of the financial crisis in 2009. Output and order book indices are both among the lowest seen for a decade, indicating that manufacturing is likely to have again acted as a significant drag on the economy in the third quarter, dampening GDP growth.

At current levels, the survey indicates that manufacturing production is falling at an annualised rate of approximately 3%.

Deteriorating exports are the key to the downturn, with new orders from foreign markets dropping at the fastest rate since 2009. Many companies blame slower global economic growth for weakened order books, but also point the finger at rising trade war tensions and tariffs. (Markit)

U.S. Home Builder Sentiment Continues to Increase

The Composite Housing Market Index from the National Association of Home Builders-Wells Fargo rose to 68 in September from 67 during August. It was the highest level since October of last year, but it remained below the expansion high of 74 reached in December of 2017. The NAHB figures are seasonally adjusted. During the last ten years, there has been a 65% correlation between the y/y change in the home builders index and the y/y change in new plus existing home sales.

The index of present sales conditions rose to 75 this month from 73 in August. The figure compares to a low of 61 nine months ago. The index of expected conditions in the next six months eased to 70 from 71 in August. The index has been trending sideways for six months. The index measuring traffic of prospective buyers held steady m/m at 50 in September. It remained the highest figure since October.

Regional readings were uniformly positive this month. For the Northeast, the index surged to the highest level since May. In the South, the index was at the highest level since August of last year. The index for the Midwest remained at the highest point since October 2018. The index for the West edged higher and was sharply above the December low. (…)

FedEx Fails to Deliver on Earnings. And That’s a Bad Sign for the Global Economy

FedEx shares tumbled roughly 10% after Tuesday’s market close after the company said revenues in its first fiscal quarter ended Aug. 31 slipped to $17.1 billion, while its net profit fell to $2.84 a share from $3.10 a share a year earlier. Analysts had forecast earnings of $3.15 a share, according to FactSet. (…)

“Our performance continues to be negatively impacted by a weakening global macro environment driven by increasing trade tensions and policy uncertainty,” said CEO Fred Smith. Even worse, FedEx slashed its full-year profit forecast to between $11 a share and $13 a share, down from Wall Street’s consensus forecast of $14.62 a share. (…)

Unlike UPS or the U.S. Postal Service, FedEx isn’t highly dependent on shipments to consumers, which make up about 20% of FedEx’s business. The rest relies further up the business food chain: Shipments from suppliers to manufacturers, for example. In other words, long before consumers even have a chance to buy those manufactured goods. What happens to FedEx augurs what could happen to the economy about 9-to-12 months down the road, Rogers says. (…)

CFO Alan Graf said the “vast majority” of the reduction in FedEx’s guidance was “associated with the macroeconomic conditions that we did not expect.” Smith added that the company is also taking steps to reduce capacity, including retiring several dozen aircraft.

Asked why FedEx didn’t start cutting capacity until long after the U.S.-China trade war began, Smith said, “Last fall, we were the first people to call this out. And I remember very vividly. I mean, we are the leading prognosticator of this.” Early this year, however, hope for an imminent trade deal led to a “tremendous amount of euphoria” before talks collapsed into new rounds of tariffs later on. That sent a chill to other economies, such as those in Europe, where FedEx is active.

And while FedEx is now reacting by cutting costs, Smith indicated that others remain in a sort of denial. “I watch the business press every day and I have to tell you, I think there’s a lot of whistling past the graveyard about the U.S. consumer and the U.S. economy versus what’s going on globally,” Smith said. (…)

While expectations were not high going into the quarter, the scope of the EPS reduction (y/y EPS now down 23% at the midpoint of the $11-$13 per share range) relative to the previous guide of down mid-single digits was quite disappointing. (GS)

This chart from Nordea/Macrobond illustrates the historical link between FDX and U.S. GDP:

This CPMS/Morningstar chart plots FDX EPS with the S&P 500 EPS:

India Bans E-Cigarettes Amid Global Concern Over Health Risks

Polls favor Biden but wagers vote Warren:

Source: @PredictIt (via The Daily Shot)