You Can’t Make This Up

Via Kevin Muir of “The Macro Tourist” fame

Lots of well-meaning pundits are pounding the table on the fact that although the Federal Reserve is raising rates, financial conditions are easing, muting the rate rises effects.

Well, these financial prognosticators might have good intentions, but the reality is that this is nothing new. I don’t deserve any credit for this next observation – it was brought to my attention by Bloomberg reporter Luke Kawa. Over the past three hiking cycles, financial conditions have either gone sideways, or more commonly, actually eased.

I guess you might argue that during this cycle, financial conditions are easing at a greater pace than previous campaigns, but the phenomenon is hardly unique. Financial conditions will only worsen once the Fed goes too far. By the time we see the bottom indicator falling, a recession will already be in the cards.

So when you read an article citing that financial conditions are not tightening as the Fed raises rates, click the next story button. Financial conditions will not fall until the economic cycle is about to roll over. Sure, we might get some squiggles up and down, but if the Fed was successful in tightening financial conditions as much as strategists desire, then we would be staring at the start of the next recession.

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Norway – tapping out at the bottom?

A couple of days ago, Norway’s sovereign wealth fund made headlines when they announced they would sell their oil equities from their sovereign wealth fund. From Bloomberg:

The $1 trillion fund that Norway has amassed pumping oil and gas over the past two decades wants out of petroleum stocks.

“Our perspective here is to spread the risks for the state’s wealth,” Egil Matsen, the deputy central bank governor overseeing the fund, said in an interview in Oslo. “We can do that better by not adding oil-price risk.”

The plan would entail the fund, which controls about 1.5 percent of global stocks, dumping as much as $40 billion of shares in international giants such as Exxon Mobil Corp. and Royal Dutch Shell Plc. The Finance Ministry said it will study the proposal and decide what to do in “fall of 2018” at the earliest.

Norway has always held a special place in my heart. Their story of rags to riches from the discovery of oil off their coast in 1969 has given rise to so many great investing lessons (An Epic Trading Tale from Norway). And the way Norway has taken that windfall and wisely invested it, should be a model for all other resource-rich nations.

So, what to make of their recent announcement to divest themselves of the companies of the industries that brought them so much wealth?

Instead of some snarky remark that even those that got rich off of oil have given up on it, I will just comment that this move is prudent and maybe long overdue. What is the worst mistake individuals make in their self-directed retirement accounts? Buying shares of the company they work for. The last thing these individuals need is more exposure to the one company that provides their source of revenue. Throughout history, there have been gobs of sob stories of people who doubled up with their retirement savings by betting on their employer’s stock. Enron springs immediately to mind. It might work sometimes, but it’s not worth the risk.

If someone asked me for advice on what do with their retirement savings, the first thing I would suggest would be to lighten up their exposure to their main source of revenue. And the same goes with Norway. Why bother owning petroleum equities? If oil surprises everyone and the pace at which oil gets supplanted by alternative energy sources is slower than expected, then Norway’s finances will be better than expected. But if they are wrong, and oil is displaced more quickly, then owning crude oil equities will only exacerbate Norway’s problem.

So yeah, Norway selling off their petroleum equities is the prudent move. But I must admit, the contrarian in me wonders if there more to this story. I mean, why are they only figuring this out now? Maybe it’s a sign that even those that make a living selling petroleum are finally giving up on it.

Still absolutely no courage

Last week I wrote about how the US Federal Government has no courage to extend duration in their debt issuance. Well not only does Mnuchin not have the guts to write a big long duration pink ticket, but he is actually going the other way!

From WSJ:

The Treasury Department has unveiled a new strategy for managing federal debt that could ease pressures set to push up long-term interest rates and reduce a potential drag on the economy.

Under the plan unveiled earlier this month by Treasury, the department would increase the share of shorter-term debt issuance and reduce the share of longer debt issuance, ending a yearslong trend that favored long-term debt issuance.

Total issuance of government debt will still rise in coming years with growing federal budget deficits. As that supply increases, it is likely to weigh on bond prices, pushing up yields, which rise as prices fall. And Treasury yields influence other household and business borrowing costs throughout the economy, such as on mortgages and corporate bonds.

The Treasury’s new approach will shift some of that upward pressure on yields to shorter-term debt and away from longer-term debt.

This is absolutely the stupidest thing I have ever heard. Wait, I take that back. Posing for this tone-deaf picture is probably the stupidest thing ever.

I mean, really? You don’t think that might be misconstrued? I almost wonder if the Secret Service in charge of protecting Mnuchin egg him on.

“You know what would look really great? A picture of you and the Missus holding up a sheet of US dollar bills?”

“You think so?”

“For sure sir. It will make you look regal. Here let me snap the picture for you…”

Anyways, back to Mnuchin’s brain dead Treasury issuance policies. He must be listening to Lacy Hunt and all the other deflationistas, willing to roll it at the front end, convinced that inflation will never return. This group believes locking in funding is a waste of money. But with interest rates at multi-generational lows, not locking in seems like pure gambling that the trend will continue forever.

I don’t want to appear as to too much of a pro-Canada cheerleader, as trust me, we have more than our share of absolute mind-numbingly stupid politicians, but at least someone in the Canadian treasury is thinking. From Bloomberg:

Canada took advantage of its flattening yield curve by selling ultra-long bonds for the second time in three months on Thursday.

The country auctioned C$500 million ($392 million) of 2.75 percent bonds due in December 2064 at an allocation yield of 2.25 percent. The offering by the Bank of Canada, which sells bonds on behalf of the federal government, followed a sale of C$750 million of the same securities on Aug. 29 at a 2.22 percent yield.

You sell when you can, not when you have to. And right now the bond market is begging for governments to sell.

Actually, it’s not just governments, it’s any issuer.

How about this? From MarketsInsider:

Veolia (Paris:VIE) has issued a 500 million 3-year EUR bond (maturity November 2020) with a negative yield of -0.026 %, which is a first for a BBB issuer. The transaction was very positively welcomed by the investors, which led to an oversubscription ratio over 4. Thanks to this strong demand, Veolia managed to issue the bond with a spread against swap rate of 5 basis points, which is the tightest spread ever achieved for a 3-year fixed-rate EUR Corporate bond.

And if that isn’t bat-shit crazy enough for you, take a gander at this story. From Bloomberg:

Orsted A/S, the Danish company built on oil and gas extraction, will issue its first green bonds as it moves toward completing a transition to renewable energy.

Orsted, which sold its oil division earlier this year, plans to offer a hybrid note due in 3017 (it’s a 1,000-year bond) and a senior unsecured bond maturing in 2029, the company said in a statement Thursday. Both will be so-called green bonds, which means proceeds must be used to fund projects with positive environmental benefits.

“We have already seen seven perpetual green bonds issued to date, all of which sold in the last two years,” said Dan Shurey, an analyst at Bloomberg New Energy Finance in New York. The sale shows that Orsted is “confident demand for green securities will be sustained.”

The bond market is eating up whatever crap is offered. This is the kind of market where, as an issuer, the only question to ask is “how much do you want and how long will you lend?” To which the only answer is “SOLD.”

Yet, instead, the US government is rolling everything at the front of the curve because they envision this benign bond friendly environment continuing forever. I think it might go down as the Trump administration’s greatest error. And yeah, I said it. That’s what a monster mistake I believe this policy to be.

Finally, while we are on the subject of bond issuance. One of my buddies reported back from a dinner he had with some private equity bigwigs. It included a junior banker in his late 20’s who my pal quizzed for some details. Here’s what he emailed me:

I asked him about covenants, and he said “Oh, I heard about those when I was studying, but I’ve never seen any since I’ve been in the business, all the deals today are what I think you call “Cov-lite”.

You can’t make this shit up!