All Things in Moderation

Stocks are lower in the US on overseas weakness. Bonds and MBS are up

Mortgage Applications rose 0.1% last week as purchases fell 3.5% and refis rose 3.1%.

Job openings fell in June, according to the JOLTS job openings report. The quits rate was steady at 1.9% and hires was steady as well. The quits rate is an important labor market indicator to the Fed.

Chinese weakness has been driving the sell-off in stocks and the rally in bonds. Does it have staying power? Can it affect the Fed’s thinking with interest rates? IMO, the answers are yes and no. The Chinese real estate bubble is deflating – the only question is whether it will be a disorderly mess or whether the government can let the air out slowly. Given the amount of state control over the economy they may be able to engineer a soft landing, but no one else has been able to do it  – Japan came close, however they took their debt to GDP ratio to 2.2x and have had to endure 25 years of no growth (and counting) to do it.

The punch line however is that China’s economy will slow, and that will depress commodity prices and increase deflationary pressure worldwide. This probably is Treasury bullish at the margin, but it isn’t going to be the driver of Treasury prices – the US recovery and the Fed are. If anything, turmoil in China is going to be a secondary effect. I still think the Fed hikes rates 25 basis points in September and then waits to see what happens. If the economy accelerates, maybe they hike another 25 in December. If the economy flatlines, maybe they wait. Note the Fed has historically been reticent to make big changes in an election year, for fear of being accused of being political.

Everyone knows that Dodd-Frank’s limits on market-making has affected liquidity in asset markets. Stocks are already susceptible to air pockets as tight spreads and low commissions have made the market-making business unprofitable. However we are seeing it in other markets as well – gold, currencies, etc.. Citi makes an interesting observation: performance-chasing by professional investors is also exaggerating market moves. They call this a “fundamental change” in the markets. I wonder how much of it is due to ZIRP. If professional investors cannot make a return in buy and hold strategies because interest rates are too low, they have to chase performance. I suspect as rates go up, this dynamic will reverse as professional investors return to classic buy and hold strategies that work. That said, the market-making aspect is a new normal that we need to get used to.

For all the sturm and drang about volatility, the VIX (a measure of fear in the market) is remarkably sanguine at 16.

Hillary Clinton gave her server and a thumb drive to the FBI last night under subpoena. Supposedly the IG found top secret messages on her server, so this could (or at least should) potentially be serious, if Obama decides to make it serious. Supposedly the admin was the one who initially leaked the story to the press, so they may treat it seriously. As a former Naval Officer who handled classified material, I know if I had taken home top secret material, I would have been thrown in jail. Also, regardless of what the Obama Administration decides to do, someone has everything that is on that server. If it is someone’s interest to not have Hillary as president, it will get leaked to the press.