Market is trading side-ways not helped by the very low volumes both on cash and options (40%/45% below the average). The S&P has made 10 new all-time highs this month, the most since the 14th of January 2018.

Trump signed the Hong Kong Human Rights and Democracy Act bill. He had no other choice though, as both the House and the Senate approved it with a large majority, a rare example of bipartisan co-operation. Indeed, China threatened retaliation without entering into details, which might derail existing trade war negotiation. According to this pro-democracy bill, the US should examine annually Hong Kong’s status and impose sanctions on anyone who has suppressed human rights.

Macro data doesn’t matter but it is still surprising to note that US consumer confidence had a dip in November despite record high equities, low unemployment and a recent big jump in house prices. We have highlighted the recent relative underperformance in US consumer stocks due to some profit warnings. The drop on US confidence is due to the labor side with the highest number in a year of those saying that job conditions are bad.

We had instead strong data on durable and capital goods, the former up 60bps vs -90bps consensus while the latter up 1.2% vs -20bps consensus. On both a headline and core basis, orders and shipments comfortably bit expectations by a wide margin, which is a pleasant surprise. Interestingly, the demand for U.S. business equipment unexpectedly increased in October by the most since the start of the year.

Also, US Q3 GDP was revised even higher at 2.1% vs 1.9% consensus vs 1.9% prior estimates. In focus, the beat is coming from Q3 business inventory investment which added 0.17% to the GDP change. Although personal income, pending home sales and Chicago PMI were weaker than expectation in October, still these results are pretty encouraging.

This morning Japanese retail sales down 14.4%  vs -10% consensus while Q3 Swiss GDP unexpectedly accelerates to 0.4% vs 0.2% consensus.

We have already mentioned the poor data in China with Industrial Enterprises total profit falling 9.9% YoY in October but the chart underneath helps to better understand the picture where we have seen annual declines in profits for 4 of the last 5 months. If we consider the classical seasonality, this should have been a period of acceleration, not recording the lowest for an October on record. No wonder why the PBOC is reactive lately, the last time Chinese industrial profits were falling this quickly, the CNY was devalued.

Volatility is continuing to drop every day with the VIX (volatility on S&P) now at 11.60. This means that we are at 13th percentile over 10 years of observations. In terms of positioning, Hedge Funds are now the shortest ever as the chart underneath is showing. One could be forgiven for asking if there is still some rationale behind those trades and if there is a rising risk of a contrarian shock.

In Europe, there is plenty of potential volatile events over the next weeks:

  • Spain is still attempting to form a coalition of the left with uncertain consequences (and Spanish banks have started to price some risks)
  • UK will have yet another decisive vote in the coming 2 weeks.
  • Italian situation is starting to look precarious with regional elections in January.

Given the US elections next year, it will probably be one of the major questions driving investment outcomes for 2020.

On another largely followed topic, it seems that there might be a Japanese bank behind the extraordinary measures taken by the Fed during the Fed Repo crisis.

Let’s briefly recap the latest moves of Powell: 17 September, Fed starts to inject $53Bln, then $75Bln per day in the short-term funding market, after the Repo rate skyrocketed up to 10%; 24 October, Fed increases daily liquidity from $75Bln to $120Bln, provides 14-day repo and starts to purchase $60Bln T-Bills per month; 25 November, although the Fed injects daily liquidity and increases repo-operations, liquidity problems still arise.

What are these talks about a Japanese bank behind this liquidity crisis? Norinchukin Bank, the Japanese agricultural lender that has become the world’s largest holder of collateralized-loan obligations, with a $150Bln exposure to CLOs in September, was in a desperate need of $ liquidity during the crisis. In order to get its financing, the bank had to take expensive rates up to 10%, mainly provided by few Money Market funds that are abusing of their oligopolistic positions.

As discussed in our previous updates, as long as the Fed doesn’t change US bank balance sheet regulation, the US short-term funding industry will need to deal with chronic liquidity dry-up.

The worrying situation is that despite the important efforts by the Fed, the LIBOR / OIS spread has continued to widen as shown on the chart. The LIBOR-OIS spread consists of LIBOR, which represents the interest rate at which banks may borrow unsecured funds within the interbank market, and the Overnight Index Swap Rate (OIS). The OIS is the fair, fixed coupon for an interest rate swap in which the floating leg is linked to the Fed Funds Effective Rate.

LIBOR-OIS spread is referenced when gaging cash scarcity among banks, as well as bank credit risk. With year’s end approaching, the liquidity should naturally dry up and is quite important to note that two days ago the Fed had 49bn$ of additional demand vs their daily offer of 25bn$ and yesterday the repo raised to 88bn$, highest in a month.

Also worth to note that in the collateralized loan obligations (CLO) market, in October, prices on double-B tumbled to the lowest in more than three years. Loans financed over the past few years during extremely loose lending standards are beginning to season and reveal fundamental cracks. This deteriorating trend should continue in the next quarters. As soon as loan default picks up, Double-B CLO tranches should come under strong pressure.