Rondonomics

The flattening yield curve has sounded alarm bells in the bond market, raising fears of an increased possibility of recession in the near future. These fears are largely unfounded. When investors speak of a flattening yield curve they are referring to the tightening spread between short term and long term interest rates. Typically the spread between the 2 year treasury rate and the 10 year treasury rate (2s10s spread). A flattening yield curve may eventually become an inverted yield curve, implying the yield on short term rates will be greater than long term rates. This is a problem because it signifies the end of the short term debt cycle, a concept used by Bridgewater's Ray Dalio. The short term debt cycle involves the relationship between the growth rate of money and credit (or spending) versus the growth of the quantity of goods and services produced (capacity). Most spending is driven by increases in credit. For the private sector to generate credit growth, both borrowers and ...

In honor of the upcoming 19th National Congress of the Communist Party of China, I will highlight some of the significant hurdles the Communist Party faces that often go under appreciated in the western media. Like in many states - the largest risks to government rule are not external threats, but festering internal divisions. The challenges range from the financial system to geography and regional inequality. What is largely missed in the endless discussion over the global financial crisis and its aftermath, is that it was Chinese credit expansion that fueled the global economic recovery. In the face of a cratering global financial system, and the devastation to aggregate demand that would ensue, China unleashed fiscal stimulus - especially in its housing sector. Commodities prices and emerging markets soared in the years after the crisis, providing ballast for the world. In the exuberance, many industrial sectors became plagued with overcapacity, a problem China and the world must ...

"If something cannot go on forever, it will stop" - Herbert Stein Ten years ago this August, the French bank BNP Paribas froze three funds exposed to US subprime mortgages, an event many consider to be the beginning of the financial crisis. In "celebration" of the 10 year anniversary, I wanted to share some concerning observations from global fixed income markets: Since the beginning of the year, the yield curve has flattened  The 2s10s treasury spread went from 125 bps to 87 bps today The Fed dot plot implies 1 more 25 bp rate hike in 2017, and 3 more 25 bp rate hikes in 2018  That makes 100 bps over the next 16 months, the long end better go up.... Flattening yield curves usually precede recessions Global Debt is a 325% of GDP Corporate Debt levels are 30% higher today than in 2008 Corporate Debt to GDP is at its highest point in history NACM (National Association of Credit Management) have cited deteriorating credit conditions since 2014 The IMF re...

As the US recedes from the global stage as guarantor of world order, individual nations must fill the security vacuum and increase their own defense spending as various forces challenge global security in the years to come. After WWII, the forces of technology and globalization unleashed profound changes on global governance and economies. The Great Recession, income inequality, and erosion of trust in key institutions have poured fuel on the fires of nationalism and populism. Costly and ineffective wars in Iraq and Afghanistan have diminished American willingness and ability to project power abroad. These factors and events have hollowed out alliances that maintained peace among great powers during the post WWII era. To quote a report published by the Eurasia Group in September 2016:  "The end of governments' monopoly over politics isn't the only factor making the world messier. The very alliances that underpinned international relations in the post-World War II e...

The Fed recently eluded to the "normalization of its balance sheet" or quantitative tightening. The Fed has communicated this tightening will commence "relatively soon" potentially while short term interest rates are still in the hiking phase. I find this perplexing. The Fed's dual mandate is employment and inflation. Employment likely cannot go much lower, but the lack of significant wage pressures give comfort that the labor market is not overheating. Inflation is barely approaching the 2% target, and with the exception of a few years in the mid 2000s, has been at 2% or below since the early 1990s. Technology and globalization have smoothed out inter-regional economic links and muted inflation's effects in developed markets. If anything, growth expectations in the US have come down since the beginning of the year. One could even argue there is little justification for interest rate hikes in general (although this is not my opinion). The Fed has proven adep...

"The Germans make everything difficult, both for themselves and everyone else" - Goethe  The German economic machine has many admirers. They seem to operate in a beautiful fusion of capitalism and socialism resulting in a cohesive and productive society. Their European counterparts run unsustainable budget deficits, while Germany registers a capital surplus (greater than even China's). The southern periphery struggles with a rigid labor system; Germany's dynamism and highly touted apprenticeship programs churn out productive workers. Unemployment in Germany is under 4%, while in Greece it is over 23%. In the United States, the problem is not so much the lack of jobs but the lack of worker skills to fill open jobs. Many look to German training programs as a future model. In an age of blustering politicians who accomplish little, Angela Merkel is commended for holding the fabric of Europe together while taking tactical risks. She has navigated bailing out insolvent Eu...

The inevitable death of brick & mortar retail has been in the news for years. Even if you don't watch TV, take a drive through any suburb and the misery is unavoidable. You will see malls that used to have big box anchor tenants and empty parking lots. If you drive closer, you might mistake the big empty cement buildings for the headquarters of a dictator who rules in some future dystopia. Everyone knows Amazon is the company that is transcending business in every sector it's tentacles touch. When I come home to my apartment at night, I am surprised when I DON'T see a package from Amazon Prime waiting for one of my fellow tenants. They could have ordered that package 24 hours ago, what kind of crazy person would take time out of their day to go to a store and buy clothes? Moody's recently released a report highlighting the pressures ex-Amazon retailers are facing, citing "intense competition, erratic management, and limited financial flexibility." Tradit...

Amid the seemingly endless barrage of negative or embarrassing news stories during the Trump administration, a ray of hope may be shining from the Middle East. The Iraqi city of Mosul has been liberated by a coalition whose only commonality may be it's determination to eradicate the scourge of ISIS from the geopolitical landscape. ISIS leader Abu Bakr Al-Bagdadi, has reportedly been killed, his jihadist soldiers sent scurrying from their city strongholds and into the hinterlands. To some, victory or something close to it, appears to be in short order regarding the United States versus Islamic Jihadism. A closer look beyond the surface reveals cracks and failures of logic. The narrative of joint US and Iraqi forces teaming together to push back ISIS ignores the multipolar realities of the military effort to recapture ISIS controlled lands. Iranian backed Shia militias and Kurdish forces have played an instrumental part of recapturing land in both Iraq and Syria. This creates ser...

The election of Donald Trump as President of the United States on November 9th, 2016 was a shock wave for the political landscape as well as financial markets. Stock prices, bond yields, and inflation expectations soared. Even if you believed as I do, that these market moves were already underway on the back of Chinese reflationary efforts, the acceleration of the moves was striking. A businessman president and a Republican congress looked set to pass massive tax cuts, slash burdensome regulations, and deliver badly needed infrastructure spending. These collective actions would release "animal spirits" and a CapEx revival. Financials, Industrials, and small-caps outperformed and the 10 year US treasury was on it's way back to 3%. US Small Business Optimism exploded, and for a few short months it appeared that reflation, CapEx, and tax cuts could return the American economy to its former glory. Maybe after a few years, 3 - 4% growth would again be possible. Whatever you th...

"It was the best of times, it was the worst of times" - Charles Dickens Over the past few years, income inequality within developed nations has come to the forefront of contemporary political and social debate. While the problems of inequality between individuals and groups of people have been frequently discussed, the increasing inequality between companies has not. Nowhere is the stark contrast of fortunes better exemplified than the US credit market. The US economy has registered years of economic growth, credit index cash levels look flush, interest coverage ratios are manageable, and global investors insatiable demand for yield has provided adequate financing. Despite the natural resource driven spread widening, US credit index spreads have marched back to ultra-tight levels. Besides the lack of relative value, is macro level credit data hiding weakness? The devil is always in the details... 1. US credit index cash levels are deceiving - the top 5% of companies h...

During the past few years, as investors have searched for yield, private equity provided attractive returns in exchange for illiquidity risk. Regulations stifling Sales & Trading at big banks, combined with passive investing outperforming active has driven talented young financiers into the private equity field in search of riches. Despite the recent financial deregulation push from the Trump administration – during the 2016 election it seemed both candidates agreed on getting  rid   of  the “carried interest loophole” – the holy grail for private equity investors. Is this a threat to the private equity industry?   The current carried interest tax rate is the same as the capital gains tax rate of 20% (was 15% throughout the 2000s as part of the George W. Bush tax cuts and was increased by 5% in 2013 as part of a broader deal to raise the US debt ceiling) Theory for carried interest:  Same as theory for a lower tax on capital gains: In ex...

Allegations abound that Brazil’s president, Michael Temer, has been caught on tape encouraging the payment of “hush money” to Eduardo Cunha. The former congressman is currently serving a 15 year jail sentence for his role in the Petrobas scandal. Prospects for much needed fiscal reforms have been thrown into a cloud of uncertainty. The BRL and Brazilian rates sold off sharply while Brazilian equities plummeted. Predicting the legal implications of Brazil’s latest political scandal may be impossible. Investors have been given yet another reason to wash their hands of the once great star of the EM complex. They see a country roiled by corruption, anemic growth, unsustainable public debt, and a rigid labor market. Yet below surface level, there are reasons to be optimistic of the nation’s future. Corrupt politicians being brought to justice is a testament to the strength of rule of law. Inflation is finally below the central bank’s target of 4.5% and wage growth is picking...