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Morgan Stanley: Here Comes “The Three-Headed Policy Monster”

August 20, 2017 Tyler Durden 0

One month ago, Morgan Stanley’s chief cross-asset strategist looked at the current state of the market – “the S&P 500, Russell 2000 and NASDAQ have hit all-time highs. Volatility has plunged back down near all-time lows. Credit is tighter and yields have been stable” – and asked “what rattles this market. What breaks the egg?”

His answer was five-fold, including valuations, inflation, geopolitics and China, but the biggest concern was what is coming in just one month on the US legislative docket:

The debt ceiling worries us most, given that action may need to be taken within as little as seven weeks.

It was “seven weeks” four weeks ago, which means that the D(debt)-day for the US government – now expected ti hit in the first days of October – is ever closer, even as the domestic political situation in the U.S. gets progressively worse.

So where are we now?

Predictably, as Sheets writes in today’s latest weekly Sunday Start, “political risk is rising on our list of concerns, after a limited (negative) impact so far this year”, and while the MS strategist is concerned about the UK, he is increasingly more worried about the US: “In the US, it’s the need to pass a budget and increase America’s borrowing authority so the world’s largest economy can pay its bills. The stakes are high; without the ability to issue new debt, our economists expect that the US Treasury’s dwindling cash reserves could be exhausted by mid-October” meanwhile “in the US, Congress will return Labor Day to face what my colleague Michael Zezas calls a “three-headed policy monster”: Raising the debt ceiling, passing a budget and embarking on tax reform. None are easy, but we see the debt ceiling as the most immediate test.

What happens then:

The most likely outcome is that, after some tension, the debt ceiling gets raised. But we don’t think it will be easy, or smooth, and it may require some form of market pressure to get different sides to fall in line. I’ve spoken to investors who are comforted by FOMC transcripts from 2011 that discussed prioritisation of debt payments in order to avoid default. I am not. First, I worry that this reduces the urgency of what remains a serious issue. Second, this prioritisation would require delaying payments to programmes like Social Security and Medicare, with real human and economic cost. And third, while the mechanics of this prioritisation may work, it is untested in a live environment.

In other words, the fact that the Fed has a “backup plan” for the worst case scenario, is precisely why the worst case scenario is now much more likely to happen, something that judging by the growing kink in the T-Bill curve, the market increasingly agrees with, and why the first week of October could be a major shock for risk assets.

 

Furthermore, assuming a best-case outcome, one where a clean bill passes with no problems, there is an additional wrinkle according to MS:

“in the good scenario where the debt ceiling is increased, the Treasury will need to issue a lot of paper to claw back the cash balance that’s been drained during this process. Our US economists think that this could involve US$300-375 billion of T-Bill issuance in 4Q, a level with very limited historical precedent.

While there are various trade ideas associated with that observation, Sheets ends off with a somber, philosophical adieu:

The idea that America’s creditworthiness is beyond reproach is, without exaggeration, the cornerstone of the global fixed income market. We hope that politicians appreciate the seriousness of this issue and put politics aside to resolve it. History is watching.

And on that note, here is Morgan Stanley’s full report:

One-Sided Political Risk

 

We remain constructive. But political risk is rising on our list of concerns, after a limited (negative) impact so far this year. In both the US and UK this risk looks one-sided and negatively skewed over the next month, with the best case being that it may not matter. We’d stress that this is before considering any effect on confidence or policy after a growing number of CEOs and business leaders moved this week to publicly rebuke and distance themselves from the US administration.

 

In a few weeks’ time, politicians will come back from their summer holidays to face serious challenges. In the UK, there will be increased scrutiny of the progress (or lack of) in Brexit negotiations. In the US, it’s the need to pass a budget and increase America’s borrowing authority so the world’s largest economy can pay its bills. The stakes are high; without the ability to issue new debt, our economists expect that the US Treasury’s dwindling cash reserves could be exhausted by mid-October.

 

Simple, one might say. For the UK, negotiations are still in their early stages. For the US, leaders from both parties have stated that they’re committed to raising the debt ceiling. Yet, both of these scenarios face the challenge of ‘campaigning versus governing’. We think this can matter for markets.

 

Let’s start with the UK. The idea of ‘Brexit’ was always loosely defined during the referendum campaign. But now that it’s official policy, a choice needs to be made between ‘soft’ versions that still encourage trade and ‘hard’ versions that curtail immigration sharply. Picking one will invariably disappoint some supporters, while those originally opposed to Brexit will likely remain so.

 

There is little margin for error: the government’s majority is slim, and our economists think the effective deadline for reaching a deal may be as early as October 2018 (considering the time needed for ratification by various EU member states). Having been bullish on GBP earlier this year, our FX strategists would now be sellers, expecting increased press attention on these challenges to impact sentiment. They like being short GBPSEK and GBPEUR.

 

In the US, Congress will return Labor Day to face what my colleague Michael Zezas calls a “three-headed policy monster”: Raising the debt ceiling, passing a budget and embarking on tax reform. None are easy, but we see the debt ceiling as the most immediate test.

 

You may not have realised it, but the US Treasury hit its borrowing limit in March, is unable to issue new net debt, and has been operating by running down its cash balance. Our economists estimate that those reserves will be exhausted by mid-October. Since one doesn’t want to cut this too close, this ‘debt ceiling’ needs to be raised by the end of September.

 

That won’t be easy. A subset of Republicans in the House want to make additional borrowing conditional on spending cuts (an issue they’ve campaigned on). That could be a non-starter for the Senate, where bipartisan support will be needed to reach the 60 votes that this increase needs. The fractious nature of the health care debate likely hasn’t helped the level of trust between the Houses of Congress and the parties within them. And the ability of the White House to whip key votes could be impaired by low approval ratings and the continued fallout from comments related to last weekend’s tragic events in Charlottesville, VA.

 

The most likely outcome is that, after some tension, the debt ceiling gets raised. But we don’t think it will be easy, or smooth, and it may require some form of market pressure to get different sides to fall in line. I’ve spoken to investors who are comforted by FOMC transcripts from 2011 that discussed prioritisation of debt payments in order to avoid default. I am not. First, I worry that this reduces the urgency of what remains a serious issue. Second, this prioritisation would require delaying payments to programmes like Social Security and Medicare, with real human and economic cost. And third, while the mechanics of this prioritisation may work, it is untested in a live environment.

 

There’s one more wrinkle: in the good scenario where the debt ceiling is increased, the Treasury will need to issue a lot of paper to claw back the cash balance that’s been drained during this process. Our US economists think that this could involve US$300-375 billion of T-Bill issuance in 4Q, a level with very limited historical precedent.

 

For investors, our interest rate strategists think that this should make it attractive to position for narrower 2-year swap spreads. If the debt ceiling is resolved, this flood of issuance could lead 2-year notes to underperform the swap. If it isn’t, the same result may be possible if investors temporarily avoid short-dated Treasury securities.

 

The idea that America’s creditworthiness is beyond reproach is, without exaggeration, the cornerstone of the global fixed income market. We hope that politicians appreciate the seriousness of this issue and put politics aside to resolve it. History is watching.

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Republican Senator Warns “Violence Is Coming” If ‘Identity Politics’ Continues

August 20, 2017 Tyler Durden 0

Authored by Mac Slavo via SHTFplan.com,
Republican Senator Ben Sasse from Nebraska feels like there’s most likely more violence coming in the near future.

Following last weekend’s deadly clash between neo-Nazi groups, and left-wing counter…

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Video Emerges Showing Clashes Between Indian, Chinese Soldiers

August 20, 2017 Tyler Durden 0

Late last week, we reported that in the first documented clash between Chinese and Indian soldiers who have been piling up across the border between the two nations over the latest territorial dispute, “Indian and Chinese soldiers were involved in an a…

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EURUSD Retains Bull Bias Despite Price Hesitation

August 20, 2017 MQL5: Traders' Blogs 0

EURUSD: The pair continues to hold on to its upside pressure though seeing price hesitation the past week. Resistance comes in at 1.1800 level with a cut through here opening the door for more upside towards the 1.1900 level. Further up, resistance lie…

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Mnuchin Rejects Call From Yale Classmates To Resign, Defends Trump

August 20, 2017 Tyler Durden 0

In a long statement issued by the Treasury Secretary, Steven Mnuchin rejected and pushed back against an urging from his former classmates at Yale University that he resign from Donald Trump’s cabinet, while defending the president’s response to last weekend’s deadly protests in Charlottesville, Virginia.

The statement was in response to a letter posted online on Friday by about 300 of Mnuchin’s classmates from the Yale University undergraduate class of 1985, asking Mnuchin to resign in protest of Trump’s comments. “It is your moral obligation,” they said. “We know you are better than this, and we are counting on you to do the right thing.”

Mnuchin, realizing that with Bannon gone, Trump’s future policies are now a “clean slate” for the Wall Street/MIC complex to rewrite as it sees fit with no internal opposition, disagreed.

“I am writing in response to my Yale Classmates and many other comments I have received urging me to “speak out.” I believe that your letter and these comments raise several Important issues and misconceptions that I am prepared to address”, Mnuchin begins, adding that “some of these issues are far more complicated than we are led to believe by the mass media,’ the former Goldman employee and hedge fund manager said, paraphrasing the Dude’s legendary “lotta ins, lotta outs, lotta what-have-you’s.

“As someone who Is Jewish, I believe I understand the long history of violence and hatred against the Jews (and other minorities) and circumstances that give rise to these sentiments and actions. While I find it hard to believe I should have to defend myself on this,
or the president, I feel compelled to let you know that the president
in no way, shape or form believes that neo-Nazi and other hate groups
who endorse violence are equivalent to groups that demonstrate in
peaceful and lawful ways.

In his statement Saturday, Mnuchin suggested that Trump’s political opponents, including Republican rivals in last year’s primary campaign, were unfairly seizing on the Charlottesville uproar to “distract the administration” from policy issues. Just like Bannon, Mnuchin’s ties with Trump go back to the summer of 2016, when he first started as Trump’s campaign finance chairman before being named as Treasury secretary; according to the WSJ he has a close personal relationship with the president.

Mnuchin also referenced a broader national dialogue about the legacy of slavery and how historical figures should be remembered.

“Some of these issues are far more complicated than we are led to believe by the mass media, and if it were so simple, such actions would have been taken by other presidents, governors and mayors, long before President Trump was elected by the American people,” Mnuchin wrote.

Meanwhile, seeking to distance himself from the “nationalist” angle of his administration in the aftermath of Bannon’s firing, Trump extended an olive branch to Saturday’s demonstrators, saying that protests can be cathartic as thousands swarmed into downtown Boston on Saturday to speak out against white nationalists.

“Our great country has been divided for decades. Sometimes you need protest in order to heal, & we will heal, & be stronger than ever before!” the president said in a pair of tweets. “I want to applaud the many protesters in Boston who are speaking out against bigotry and hate. Our country will soon come together as one!”

And yet, just one hour before lauding Saturday’s protesters, Trump, who’s spending the weekend at his Bedminster, New Jersey, golf resort, was less sympathetic. “Looks like many anti-police agitators in Boston. Police are looking tough and smart!” He praised the effort of law enforcement officers and Boston Mayor Marty Walsh.

Mnuchin isn’t the only ex-Goldmanite who is staying: last week the market turmoiled on speculation that Trump’s top economic adviser and former Goldman COO Gary Cohn, was upset by Trump’s remarks and thinking about quitting. Cohn will remain in his position, a White House official said on Thursday.

With the “globalists” having won decisively the war for Trump’s Inner circle of influence, the markets are eagerly awaiting to see what if any change in tone, rhetoric and policies will be unveiled by the president. With the debt ceiling deadline looming, Trump has little time in which to make a decision what his upcoming pivot will look like.

Mnuchin’s full letter is below.

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UAE backs counter-revolutions: Qatar’s envoy to Turkey

August 20, 2017 Middle East Monitor 0

Qatar’s ambassador to Turkey has accused the United Arab Emirates (UAE) of supporting “counter-revolutions in the Arab world for restoring dictatorships”. In a statement issued on Saturday evening, Ambassador Salem Al-Shafi said: “The UAE and a number of allies have paid around $40 billion to consolidate the military coup in Egypt alone,” in reference to the ouster of Mohamed Morsi, the country’s first freely elected president, in 2013. “We say that these countries have not learnt the lesson well,” he added. Blaming Qatar, using bright terms such as counterterrorism and attacking the moderates with a view to winning the West will not help protect them from the people. Al-Shafi denied accusations against Qatar of backing Islamists and extremists in the Middle […]

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Here Is The WSJ Article That Jeff Gundlach Has Been Raging Against

August 20, 2017 Tyler Durden 0

Well, the “fake news” article that Jeff Gundlach has been quietly – and not so quietly – raging against for weeks on Twitter, is finally out.

Readers will recall that DoubleLine’s Jeff Gundlach has been engaging in an odd subtweeting campaign on Twitter over the past week with what until recentl had been an unnamed media outlet that is allegedly being used by a similarly unnamed Doubleline competitor to accuse Gundlach’s fund of doing poorly and is suffering outflows, something the “bond king” has said is a “false narrative”…

Then last week, Gundlach finally revealed that the “fake news” publication with the imminent hit piece in question was the WSJ:

Mutual Fund Wire just put out looong “top influencers” list. Have to laugh competitor in cahoots with WSJ upcoming fake news didn’t make it!

— Jeffrey Gundlach (@TruthGundlach) August 17, 2017

WSJ desperate to populate “anonymous source” DBL hit piece. Now calling new employees. Even called spouse of one last night. Sad but true.

— Jeffrey Gundlach (@TruthGundlach) August 17, 2017

Meanwhile, Gundlach had done everything in his power to take preemptive damage control and publicize that DoubleLine is in no way in peril, or in need of funding. In a recent interview with Bloomberg’s Erik Shatzker, Gundlach said that he is content with the size of his fund, which he does not want growing too large, and may soon turn new money away:

“Gundlach is taking a similarly conservative approach to building his eight-year-old firm. While some competitors embrace the mantra “size matters,” he believes there’s a limit to how much DoubleLine can manage well and says the firm may stop marketing altogether once assets reach $150 billion, up from about $110 billion today.

 

‘I’ve actually been turning money away in our institutional business,’ Gundlach said. ‘I don’t want to manage $500 billion. I don’t really want to manage $200 billion.’… “I don’t want one $150 billion fund, I want 10 $15 billion funds. A diversified business,” Gundlach said in the interview. “We lose business because our fees are too high and I say, ‘Fine, that’s a way of regulating growth.’”

 

“Bill Gross once managed a single fund with $293 billion in assets, the Pimco Total Return Fund. By comparison, Gundlach, who co-founded DoubleLine in 2009, said he’s debated whether to close the $54 billion DoubleLine Total Return Bond Fund, the firm’s largest, to new money.”

The statement echoed what Gundlach said in a tweet from August 2: DoubleLine Facts: All time high AUM, revenue, headcount. Returns good-to great across funds. CEO never berates employees. Boycott fake news!”

Then, as we reported two weeks ago, we suggested that the reason for the recent din over DoubleLine – or rather Total Return Bond Fund – AUM is that Gundlach was anticipating the latest Morningstar fund flow data, reported by Reuters, according to which investors pulled another $200 million from Jeffrey. Gundlach’s flagship Total Return Bond Fund in July, extending the outflow streak that began in November to nine consecutive months. So far this year, the fund has posted outflows of $3.6 billion, leaving it with $53.6 billion in AUM as of the end of

As Reuters wrote, “the withdrawals are notable given that other bond funds are swimming in new cash from investors and at a time when the DoubleLine fund’s performance has been strong.

Some $203 billion flowed into bond funds in the first half of 2017, and bond funds overall have not recorded a single week of outflows all year, according to the Investment Company Institute, a trade group.

The outflows are odd in the context of TRF’s YTD outperformance: “DoubleLine Total Return Bond Fund’s lower-cost institutional shares were up 3.2 percent this year through Tuesday, beating its benchmark, according to data from Thomson Reuters’ Lipper research unit.” Preempting the news, Gundlach in a tweet early Wednesday said that DoubleLine is a top-ranked fund company by net cash inflows this year through July.

Sure enough, while TRF is seeing outflows, the broader DoubleLine continues to take in cash: overall, the firm pulled $253 million into its mutual funds and ETFs during July and $2.5 billion this year, ranking 24th of 405 fund families, according to Morningstar data. A recent interview with Reuters may explain this discrepancy: Gundlach said DoubleLine was “trying to focus on our strategy: growing our other funds.” He was referring to the SPDR DoubleLine Total Return Tactical ETF, DoubleLine Core Fixed Income Fund, DoubleLine Shiller Enhanced CAPE, DoubleLine Low Duration Bond Fund, DoubleLine Infrastructure Income Fund and DoubleLine Flexible Income Fund. Those six funds have attracted $5.8 billion this year, according to Morningstar.

“We are marketing our other funds and not DBLTX,” Gundlach said. “We are accomplishing exactly what we planned.”

As we concluded two weeks ago, “it remains to be seen if there is anything more structural within DoubleLine to explain the outflows, or the explanation for Gundlach’s recent odd tweeting behavior.

* * *

And with all that in mind, fast forward to today when the long-awaited moment in which the much-(pre)publicized WSJ article is finally out. In it, the WSJ’s Greg Zuckerman picks up on what we, Reuters and Morningstar previously noted, namely the 9 consecutive months of outflows from DoubleLine’s flagship bond fund:

Jeffrey Gundlach built one of the most successful new bond funds ever, amassing $61.7 billion of assets at the DoubleLine Total Return Bond Fund over just six years. But during the past year something else happened: Some customers began to leave. Assets under management at the fund dropped 13% from their peak last September to $53.6 billion as of July 31. 

 

Investors have pulled $8.5 billion from the fund in that period, Morningstar Inc. says, while funds in the same category took in net inflows of 7.2%. The fund has had outflows in each of the past nine months.

Naturally, the WSJ was delighted to take advantage of the massive publicity Gundlach’s own tweeting had generated for the coming piece in recent weeks:

As performance has slipped and the fund has shrunk, Mr. Gundlach, 57 years old, has turned combative, taking on the media and continuing to taunt a rival. Meanwhile, some within the firm are bracing for what could be a more challenging environment.

And here are the “dots” of information that one can finally connect based on Gundlach’s aggressive subtweeting since the start of August:

Late last year and earlier this year, some at DoubleLine Capital’s offices in downtown Los Angeles say, they were told bonuses might drop in 2017, according to people close to the matter. The firm says the guidance was aimed at creating a “pragmatic assessment” of 2017 after a big year in 2016.

 

Mr. Gundlach’s fund’s performance has been solid. But some investors say they are leaving because the fund has cooled from its previously white-hot pace.

 

Total Return Bond Fund topped 90% of peer funds over the past three- and five-year periods. In 2017, though, it is besting 59% of competitors, with a 3.15% gain through Aug. 17, Morningstar says.

That said, in the the article’s weakest link, and rather bizarre argument, one is somehow expected to extrapolate from the behavior of a few investors (in this case a retired orthodontist), what billions in capital will do momentarily.

“Among those bailing are individual investors, who helped fuel the fund’s growth but can be quicker than institutions to pull their funds when performance lags. Barney Rothstein, a retired orthodontist in Tucson, Ariz., withdrew $250,000 from the fund over the past 18 months and shifted the money to individual bonds that carry similar yields but can be held to maturity, unlike a bond fund, potentially giving an investor more cushion if the market turns down.

 

“The extra return wasn’t there anymore,” he said.”

Well, Barney, the only “extra return” these days is if you buy tech stocks on leverage… or Ethereum and Bitcoin of course. Furthermore, it appears that the WSJ’s entire “outflows” thesis is based on the assumption that once a fund reaches a “normalized return”inflection point, investors will flee. We are hardly convinced, especially in a time when 90% of hedge funds can’t outperform the S&P:

Some investors in Pimco’s once-giant Total Return fund left it in 2013 and 2014 when the fund, led at the time by Bill Gross, stopped trouncing rivals. A spokeswoman for Mr. Gross’s current firm, Janus Henderson Investors, said he outperformed his benchmark during that period.

 

“This is part of having exceptional returns—at some point there will be less-than-exceptional returns,” said A. Michael Lipper, who advises investors in mutual funds. Mr. Gundlach, he said, “wouldn’t like the comparison, but the same thing happened to Bill Gross.”

 

Now investors like Castle Financial & Retirement Planning Associates Inc. in Hazlet, N.J., are shifting to Pimco from DoubleLine. “Performance has been waning,” said Al Procaccino II, president of the firm, which pulled money from the DoubleLine fund this year.

Doubleline’s response was well-telegraphed, the bond manager said it isn’t troubled by the outflows or the performance of the fund, which is nearly $45 billion larger than DoubleLine’s next biggest fund.

“Many well-known, actively managed bond funds that have been around long enough go through periods of net outflows, some far more dramatic than Mr. Gundlach’s fund has experienced,” a DoubleLine spokeswoman said. “There are only so many opportunities for actively managed funds. DoubleLine stopped marketing the fund two years ago, and the firm is pleased with where the asset level is.”

Of course, whether DoubleLine’s outflows are “controlled” will become obvious shortly: ultimately the single best predictor of future capital flows is today’s performance, and for now DoubleLine has nothing to worry about. Perhaps the only interesting aspect in the entire WSJ piece is the additional insight into why Gundlach’s twitter account has recently become rather more… colorful:

One former employee says Mr. Gundlach aims to stir debate and focus attention on his fund.

 

“Even if the inner Jeffrey is truly composed and collected, the outer Jeffrey is the actor—he’s a rational creation who understands how to rattle the cage,” says Claude Erb, a former portfolio manager at DoubleLine and TCW. “He’s seen client enthusiasm ebb and flow. When it’s waning, you have to redouble your efforts to get the message out.”

 

René Bruer, the co-chief executive at Smith Bruer Advisors, which manages $80 million, withdrew all of his clients’ money from the fund in 2015 partly because of concerns about its reliance on the outspoken manager. “He can create controversy. If that’s what floats his boat, great,” Mr. Bruer says. “But for my clients and for me, I can’t take much of that.”

Quoted by the WSJ, Jordan Edwards of Avier Wealth Advisors in Bellevue, Wash., which keeps about 10% of clients’ bond allocation in the fund, cited Mr. Gundlach’s investing skills and said, “I would prefer that he would not be as provocative as he is.” 

And yet, Jordan – and most other investors- will gladly keep their funds with Gundlach as long as he continued to outperform, which is why the whole point behind this article is rather lost on us.

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