'Two Interest Rate Theorems' - 'Disinflationary effects of technology, aging demographics and excessive debt' - '..the bursting of China’s historic Bubble..'

'Two Interest Rate Theorems

To answer the question as to why and where we are going in the future (in terms of interest rates):
<ol><li>Federal debt accelerations ultimately lead to lower, not higher, interest rates.</li>
<li>Monetary decelerations eventually lead to lower, not higher, interest rates as originally theorized by Milton Friedman.'</li></ol>
- Mauldin Strategic Investment Conference 2019 (Part I – Dr. Lacy Hunt), May 17, 2019



'But over time, the neutral rate has been coming down and for a lot of the reasons Liz Ann Sonders was telling us yesterday:
<ul><li>Disinflationary effects of technology, aging demographics and excessive debt.</li></ul>

..

Let’s focus on the leading indicators:
<ul><li>Down 16 months in a row global OECD</li>
<li>Down 11 months in a row in the U.S.</li>
<li>Both at lowest levels since we were emerging gingerly from the Great Financial Crisis a decade ago…'</li></ul>
- Mauldin Strategic Investment Conference 2019 (Part II – David Rosenberg), May 24, 2019



'I have argued that the bursting of China’s historic Bubble presents a catalyst for the piercing of the global Bubble. And I posited as recently as last week that the breakdown in trade negotiations risks pushing China over the edge. I also suggested that acute Chinese fragility likely explains the extraordinary drop in global safe haven bond yields. While this is reasonable analysis, it is surely too simplistic.'

'When it comes to various risks, over years it became increasingly easy to simply “Ignore Them.” Central banks have repeatedly stepped up to backstop vulnerable risk markets. At the same time, the central bank “put” has ensured readily available inexpensive market insurance (i.e. put options). Why not write/sell flood insurance when the authorities control the weather? And with market protection so cheap, is it not rational to partake in rewarding risk-taking activities? Moreover, with QE having become the principal instrument in the central banking toolkit, prices for Treasury, Bund, JGB and other “safe haven” bonds are essentially guaranteed to rise in the event of heightened systemic risk. Superior to even cheap derivative protection, can’t lose holdings of safe haven bonds offer protection while also inflating in value.

As I’m fond of discussing, crises typically erupt in the money markets. It is when the perception of safety and liquidity is suddenly questioned that all hell breaks loose. And never before have risk markets so harbored the misperception of money-like attributes. This explains the “Then Panic” Dynamic.

I have argued that contemporary finance functions poorly in reverse. The market-based global financial apparatus seemingly performs wondrously so long as securities prices rise, the cost of market protection remains cheap and risk embracement holds sway. And it is as if the system has evolved to operate quite splendidly under moderate degrees of apprehension. Such a backdrop provides the Buy the Dip Crowd fruitful opportunities, while lavishing effortless profits upon the writers/sellers of market protection. To be sure, a hospitable marketplace of mild pullbacks and robust rallies further emboldens the prevailing view that markets always go up (so ignore risk!).

..

I have argued that the bursting of China’s historic Bubble presents a catalyst for the piercing of the global Bubble. And I posited as recently as last week that the breakdown in trade negotiations risks pushing China over the edge. I also suggested that acute Chinese fragility likely explains the extraordinary drop in global safe haven bond yields. While this is reasonable analysis, it is surely too simplistic.

Crisis unfolding in China has become a high probability catalyst for bursting the global Bubble. Yet it is structurally-impaired global financial and economic systems that explain virtual panic buying of safe haven bonds in the face of resilient risk markets. For decades now, risk markets have climbed the proverbial “wall of worry” – seemingly scaling new heights after overcoming one potential crisis after another (i.e. deep U.S. recession, European crisis, geopolitical flashpoints, Brexit, multiple China scares, “flash crashes,” the winding down of QE, etc.). It became rational for risk markets to welcome risk as an opportunity to capitalize on additional central bank and Beijing stimulus measures.

Safe haven bond markets view the backdrop altogether differently. Current market structure is unsustainable. Treasuries, bunds, JGBs, etc. are zeroed in on the risk markets’ proclivity for Ignore Them, Then Panic. The safe havens are now preparing for the Panic Phase, with the presumption that dysfunctional speculative dynamics and deep structural maladjustment ensure the next bout of “risk off” (de-risking/deleveraging) deteriorates into illiquidity and market dislocation.

The assumption is that central bankers will have no alternative than to cut rates and aggressively resort to even greater marketplace liquidity injections (QE). Considering the scope of speculative leverage permeating global markets, along with structural dependency to unending liquidity abundance, I don’t disagree with the safe haven perspective.

..

The huge 2019 risk market rally has only exacerbated underlying market and economic fragilities. Safe haven bonds concur with this view, while the ongoing collapse in global market yields works to support the speculative Bubble raging in the risk markets. Corporate Credit, in particular, has been underpinned by sinking sovereign bond yields. The backdrop has made it especially easy to Ignore Them – myriad risks including collapsed trade talks, rising U.S./China tensions, a fragile Chinese Bubble, waning global growth, vulnerable EM, susceptible European finance and economies, and the rapidly deteriorating geopolitical backdrop.

Healthy markets would adjust and correct to reflect heightened uncertainties and deteriorating prospects. Speculative markets instead promote excess and the ongoing accumulation of imbalances, maladjustment and impairment. There’s no operable release valve. Pressure builds and builds – risks accumulate in all the wrong places - Then Panic.

The flaw in contemporary finance – especially within market psychology over recent years – is to believe central bankers have nullified market, economic and Credit cycles. They have certainly averted a number of market crises over recent years, in the process dangerously extending cycles. Along the way risk market participants grew greatly overconfident in the capacity of central bankers to permanently forestall crisis. Moreover, they have turned completely blind to the historic crisis festering just below the surface of their delusional view of a “Permanently High Plateau” of global peace and prosperity.'

- Doug Noland, The Ignore Them, Then Panic Dynamic, May 25, 2019



Context

'This week marked the True Start to the U.S. vs. China Trade War.'

'..monetary knowledge .. of currency reform under difficult conditions you have to go to Carl Menger.'

'..things continue to follow the worst-case scenario .. It was another blunder for the global central bank community..'