Markets Edgy Over China, Italy Budget Staredown, Saudis, Brexit, Too Much Private Debt, Strained Valuations….

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The cliche is that the markets climb a wall of worry. But sometimes worry wins, and for good reasons.

After a sharp two day rally, Chinese stocks swooned, triggering global stock and stock futures market selloffs. Investors like to explain why markets do what they do, which is why many reportedly use psychics and astrologers. There are plenty of reasons for fund managers to think of lightening up on risky assets, such as nosebleed valuations across all major asset classes in a very long-in-tooth “recovery” while central banks are tightening (as in the US) or at least no longer engaging in monetary stimulus. And that’s before factoring in that private debt levels are high around the world and all sorts of authoritative bodies like the IMF and Bank of International Settlements have talking up crisis risk, which is out of character for them. So that would be enough to make money managers trigger happy, even before getting to the fact that it’s October.

The overnight news reports suggest that so the spectacle of so many serious-looking situations precipitated the selling. In China, even though the government launched a new stimulus program, asset holders fret that it won’t be enough to compensate for the damage that a US-China trade war could inflict. And recall that outsiders have ben concerned about a crisis for years in the face of massive investments in un or underproductive assets and more and more debt needed to produce an additional dollar of GDP growth. From the Financial Times:

China’s main equities indices went into sudden reverse on concern that government policies to boost its economy will be offset by the impact of its trade dispute with the US. Mainland China’s CSI 300 closed down 2.7 per cent, with declines for every sector on the market. It represented a sharp reversal from Monday’s rally of over 4 per cent….

“The geopolitical whipsaw just keeps on coming . . . and its getting harder and harder to keep track of all of the issues that are out there now,” said Brad Bechtel, managing director at Jefferies.

“Talk from Steven Mnuchin, the US Treasury secretary, that he might be open to changing the way the US evaluates currency manipulators is not helping the cause for China. The US keeps ratcheting up the pressure and China keeps responding any way it can. I don’t see this dynamic changing anytime soon.”

Analysis from Société Générale said that while Beijing’s efforts to boost confidence — which included speeches by top officials, tax cuts and funding for local governments — were “striking the right tone”, China’s falling current account balance meant more changes will be needed.

As of this hour, the DAX was down by 2% and US stock futures were off by roughy 1%.

Italy and the EU are in a staredown. As readers likely know, Italy wants to run a budget deficit of 2.4% of GDP next year and forecasts that the deficit level will fall because growth will improve. If anything, Italy’s proposed deficits are too small relative to the slack in its economy. Even though the EU has often let countries break budget rules and not put up a stink, its rationalization of why it is getting tough with Italy is that Italy has a high debt load, at ~ 130% of GDP. However, the fact that Italy has an upstart populist government and it won a fight with the EU over migrants (recall its refusal to let ships carrying immigrants land in Italy) probably plays into the EU playing hardball. As our Colonel Smithers noted in a recent comment, French and German civil servants and bankers at a recent conference were sympathetic with the Italian government’s stance on running a deficit. As he put it:

The German and French contingents agreed with their Italian counterparts that failure to cut Italy some slack would put the EU/Eurozone project at risk, but felt that the politicians and other elites benefitting from the current set-up would not countenance such heresy.

As so often happens, the wrong people are in the driver’s seat. From a different Financial Times report:

Italy’s populist government defied eurozone budget enforcers on Monday, refusing to curtail its plans for a sharp increase in public spending and insisting that breaking the EU’s fiscal rules would not threaten the currency union’s stability…

[Economics minister] Mr [Giovanni] Tria wrote that challenging Brussels’ request for changes to the budget “was a hard, but necessary decision in light of Italy’s delay in getting back to pre-crisis levels of GDP and the desperate economic conditions in which the most disadvantaged citizens find themselves”.

Rome’s refusal to budge marks the first time a member of the common currency has ignored a formal reprimand from Brussels since EU fiscal rules were overhauled at the height of the eurozone crisis.

It also sets Italy’s governing coalition on a collision course with the commission, which is expected on Tuesday to demand Rome resubmit its 2019 budget, an unprecedented move from eurozone authorities. If Italy fails to comply, it faces millions of euros in fines. The commission declined to comment other than to confirm it had received Italy’s response.

Investors have been watching the stand-off warily, with borrowing costs on Italian debt returning to near four-year highs on Monday after Mr Tria rejected EU entreaties. The benchmark 10-year bond had briefly rallied earlier in the day after a Moody’s downgrade stopped short of pushing the debt into “junk” status. But the bond pared those gains later in the day, hitting an intraday high of 3.53 per cent.

The higher bond yields mean bigger interest costs and thus a larger budget deficit. Back to the story:

Moody’s reduced Italy’s rating by one notch to a level above speculative status, or “junk”, after trading hours on Friday. The agency also restored its outlook to stable, from negative.

Some investors had feared that Moody’s could cut Italy’s rating by more than one notch, or leave its outlook as negative — a signal that the eurozone’s third-largest economy was on track to slip into junk status.

Financial Times reader Larchmont pointed out:

This is a political row. The projected deficit isn’t eye popping, several other members are in the same ballpark and debt levels generally have remained obstinately high. Bottom line the EU is appalled at having a “populist” government in Rome, especially as they may be the key votes for Juncker’s replacement…The budget must have seemed the perfect opportunity to even the score. Having made it an issue, the EU is now faced with backing down or a show down with all the instability that could bring just when it has its hands full with Trump, Brexit, V4, China, EP elections, Fed tightening etc.

Another cause for pause is Saudi Arabia. Mohammed bin Salman’s many outside the pale actions, such as rounding up and imprisoning 400 Saudi royals, including the well-connected Al Walid, the one-time rescuer of Citibank, in order to shake them down, and the detention of Lebanon’s prime minister Saad Hariri did get press reports, but shockingly little in the way of outrage or pushback. Why the brutal murder of Jamal Khashoggi has become the cause for pushing for the ouster of Mohammed bin Salman is an open question, although killing him in the embassy in Turkey does allow Turkey to fan the fire, which it is doing with great relish. From DW:

Turkish President Recep Tayyip Erdogan told lawmakers on Tuesday that Turkey had “strong evidence” the murder of Saudi dissident journalist Jamal Khashoggi was planned in advance by Saudi officials, contradicting Saudi accounts that the journalist died accidentally in a “fistfight” in the Saudi consulate in Istanbul….

What did Erdogan say?

– Turkey has strong evidence that Saudi officials planned Khashoggi’s murder days in advance.
– Saudi team visited forest in Istanbul and Yalova before Khashoggi’s disappearance on October 2.
– Consulate security cameras were removed.
– A day before the murder, a number of forensics, intelligence specialists arrived in Istanbul
– A Saudi team of 15 entered the consulate on the day of Khashoggi’s murder.
– Eighteen people arrested in Saudi Arabia in relation to the murder matches those identified by the Turkish intelligence.
– Khasoggi was killed in a violent, savage murder.
– He had no doubt to question the integrity of the Saudi King.
– The issue of diplomatic immunity under the Vienna Convention would be discussed in regards to the case.
– The suspects should be tried in Istanbul and not in Saudi Arabia.

Only Turkey knows: Turkish Foreign Minister Mevlut Cavusoglu said hours before the speech that Turkey had not shared any information about the case with other countries. He added however that Ankara would be willing to cooperate with an international probe. Saudi Foreign Minister Adel al-Jubeir told reporters that such a killing must “never happen again” and promised a thorough investigation into Kashoggi’s death.

The wee problem is that MbS would be very difficult to dislodge. He did a very fast and effective job of seizing control of the internal security forces and imprisoning or marginalizing rivals. Historically, Saudi Arabia has had its kings rule with the informal consent of factions within the royal family, with family councils having a lot of input. MbS shut down the councils and has succeeded in making himself much more of an autocrat than past kings. And it isn’t as if the US has a great track record with backing Middle Eastern “moderates” trying to oust national leaders.

And then we have Brexit. In Parliament on Monday, Theresa May stuck to her guns on trying to get an extension to the transition period, even though the DUP plus every faction in her own party is opposed, and the Shadow Chancellor trash talked it too. Oh, and the members of the EU Council didn’t discuss it either in their dinner after May’s talk, at least according to Donald Tusk. So May looks to be firing up a steam engine when none of the cars of the train are attached to it.

So there’s a lot to rattle the nerves. But since we are in an overly dynamic situation, who knows what happens next.

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  1. notabanker

    Don’t forget to throw in a few cat 5 hurricanes on 3 continents to get the party really going.

  2. PlutoniumKun

    Its just as well its a sunny day out.

    I’m not one to go around shouting ‘the end is nigh’ or to whine on about ‘the times we are in’. We are where we are. But at the risk of overindulging avian metaphors there are a lot of ducks lining up right now in a row, just waiting for a black swan to knock one over. The potential for an almighty economic/political earthquake within the next 6 months must be sky high.

    1. JTMcPhee

      I’m surprised none of the financialists has put forth a “Vulnerability Index,” something like a combination of VIX and the Doomsday Clock from the Atomic Scientists. Surely there must be an AI widget someplace that identifies, categorizes, assigns a moment-to-moment risk of collapse-initiation to all those ducks that are lining up like dominoes, just waiting for a little butterfly wing to beat the mortal tune, puff ever so gently on the just-right domino, and start them falling. I bet that GoldSucks and Big Insurance and Reinsurance and Global Supranational Corporations and Great Game types must at least have, or have nightmares or dreams (depending on their perversity index) about, such an index. Even as they go about setting up more dominoes, and tipping more of them ever closer to their angle of repose

      1. fajensen

        Well, one can even in my totally boing retail banks brokerage account readily trade “Bear / Bull” certificates with up to delta cubed (the price of the certificate changes as the cube of the change in the underlying) on most indexes and many stock. Since there is a daily fee for holding these papers, the timing in predicting the events is important.

        Some infovore’ish algorithm must be running the pricing of these things.

        I am planning to get a couple of “Bear” ones on the DAXX for Brexit, the question is when. Volatility seems to be going up and up which is an ominous sign that things are coming apart behind the seams, but, one doesn’t want to pay fees for months either.

      2. Oregoncharles

        That “AI widget” would be a very dangerous piece of software. You certainly wouldn’t want the results public, as there’s the little problem of self-fulfilling prophecy (and losing your advantage).

        That said, fajensen seems to be saying that something like it exists at his brokerage – if I understood the post.

        It’s also questionable how much the “AI” would add – most of us have a widget like that running in our heads. Yves just wrote about it. Hers is pretty finely tuned.

        Might be a good time to stock up on staples and buy a generator that will keep your refrigeration (and in our case, the well) running.

        Funny how this coincides with an election in two weeks. Oregon ballots are already out. Our election is pretty boring, except locally, so I’ll probably vote early. My chief dilemma is whether to vote for the Dem for Governor; she’s sort of OK, but a Democrat.

  3. JTMcPhee

    And on Saudi Arabia, there is this post from Sic Semper Tyrannis, the deck by Col. Pat Lang, Ret. on the internals of Saudi Arabia and how possibly vulnerable MbS might be to “regime change.”

    Very good background, if he is right on how the Sauds get to run the oil concession. Because MbS and his faction buy all those US weapons, sales of which I read are a principal reason for the long boom in the stock markets, you can bet the “regime change” experts in our sneaky-Pete operations are looking at the possibilities and features and benefits of either dumping MbS, or aiding his purges and looting, thus sharing intel and maybe doing the dirty with him. All in a good day’s work, of course, then go home, have a nice dinner, kiss the kids and tuck them in all safe and sound…

    As another commenter noted yesterday, the MIC uses huge amounts of petroleum to do that undefined enterprise called “WAR,” and so has to start and extend wars that protect the source of all that petroleum that is used to fuel the wars that keep the MIC afloat on a sea of MMT money. In nursing lingo, one would refer to that behavior as “circling the drain.” Too bad the mopes of the world will also drain out with the bathtub toys like the Littoral Combat Ships and F-35s, and the bloody products of global “Special Operations” and CENTCOM and the CIA…

  4. PlutoniumKun

    Just looking at the business news now, and it seems worldwide there are big drops.

    But there is good news!:

    Defence group Lockheed Martin may have bucked the gloom, by posting strong results and hiking its sales forecast for the rest of the year.

    Increased demand for its F-35 fighter plane helped to drive Lockheed’s net sales up to $14.3bn in the last quarter, up from $12.3bn a year earlier.

    Earnings per share jumped to $5.14, up from $3.32 12 months ago.

    Lockheed Martin chairman, president and chief executive Marillyn Hewson says:

    Our team achieved another quarter of strong growth leading us to improve our expectations for our full-year financial results.”

  5. vidimi

    there is no way MBS could have pulled off his lightning quick power grab without help from his american friends who knew where all the levers of power were. this is a very awkward situation for his backers.

    also, the saudis (and i mean MBS) hired a body double to walk around istanbul in khashoggi’s clothes after the murder and MBS himself reportedly had a call with him in the consulate which the turks intercepted. i imagine that was MBS taunting the victim before having him dismembered.

    not all the PR in the world can rescue this young head chopper from this mess he created.

    1. The Rev Kev

      But what if he was a ‘moderate’ head-chopper like you found used in Syria? Then that makes him one of ours.

    2. fajensen

      Maybe you are right. I think that competent Saudi royalty generally becomes very skilled in the art of power grabs and successful internecine feuding at a very young age.

      So, If american advisers were actual players in Saudi king-making, they would make full use their unique cultural understanding (a.k.a. as None Whatsoever) to turn everything into a stinking pile of manure that is bound to hit the fan at some inconvenient moment :p

      Well, guess what we seem to have?

      An assassination plot involving literally scores of people. People who are not only making a total mess of the job but also leaving a solid track all the way to who send them. The possibility of the consulate being bugged never even occurring to anyone, VIP-people even yakking on the phone during the act. Everyone involved are on cameras everywhere. It’s the planning of a 15-year old watching way too much TV.

      The particular grisly way of killing the victim will ensure that the press will be raking this over again and again, leaving no stone unturned in the case that something stomach-churning may be found underneath!

      Whats wrong with just whacking the guy in the street, using guns or a white van, like adult assassins do?

        1. Anarcissie

          It is possible that the execution of Khashoggi was done in the overt, revolting way it was to show that Prince Bonesaw could do it in the road and get away with it. He seems willing to take large risks to get what he wants. The US does not dare cut Saudi Arabia loose, since it would then either collapse or find another protector, one maybe hostile to the US. The moral degeneration of the American leadership class, hooked to such people, is almost complete. And thus the way is opening to the collapse alluded to above.

        2. fajensen

          Of course sending those special agents “Beavis” and “Butthead” to the armoury on their own was not that good an idea either.

    3. PlutoniumKun

      Actually, its more than likely the CIA wanted Muhammad bin Nayef as Salmans successor, not MbS. He has always been ‘their man’. Its possible of course that other parts of the blob had other ideas. However, it does seem that MbS and his croneys used his fathers growing senility to pull a fast one on MbN, it was very much an internal job, he didn’t need any outside friends to do it. Arguably of course if he was a US puppet he wouldn’t have been allowed to do so many stupid things in Qatar and Yemen.

    4. The Rev Kev

      Maybe MBS was channeling his inner Joseph Stalin. You know, when Stalin said:

      “Death solves all problems – no man, no problem.”

  6. begob

    Any views on the prospect of Italy and Greece demanding a little love at the Council of Ministers over their Brexit veto? Spain seems to be satisfied over Gibraltar, but the other two would be least affected by no-deal. Although tourism – hmmm.

    1. Yves Smith Post author

      They don’t have a veto. Go read Article 50. Only a “qualified majority” has to approve the Withdrawal Agreement. Qualified majority = vote of 55% of member states that have at least 65% of the population. Most votes in the European Council are taken on this basis.

      1. begob

        Yes, thanks. I was thinking really in terms of the domestic parliamentary votes – does that give leverage in the council against the commission?

  7. Andrew Watts

    I don’t think we’re anywhere near another financial crisis… yet. That will probably be dependent on how quickly the Fed raises interest rates in response to labor market conditions. If they aggressively raise interest rates over both the spring and into the summer I’ll start anticipating a crash as global liquidity dries up… again. It’ll be back to another round of debt deflation that was now only made worse by the collective policies of the central banks.

    Everything else is kinda small beans compared to the potential fallout from Brexit. It seems unlikely that the effects of a hard British exit from the EU wouldn’t do damage to the global economy. Italy is nowhere near the crisis-point yet imo. I don’t honestly know that Khashoggi has anything to do with this and I don’t know why anybody cares about it that isn’t a member of the club. It’s a big club and you’re not in it.

    …which is why many reportedly use psychics and astrologers.

    You say that like it’s a bad thing! One of my delightful memories in the intermediate aftermath of the financial crisis was watching Christine Lagarde go off about Numerology in public when she was head of the IMF.

    Most people had no idea what she was blathering about.

    1. Yves Smith Post author

      I don’t agree. A crashout is the start of the next financial crisis. It will take a while to get rolling, but you’ll see a UK banking crisis as a result of a sterling crisis + real economy damage, and eventually an EU banking crisis (they are on the verge of one anyhow) due to contagion + their own real economy damage (lesser than the UK will take but still not trivial).

  8. Oregoncharles

    “If Italy fails to comply, it faces millions of euros in fines.”

    Collected how?

    Again: populist politicians benefit politically from a head-to-head with an outside, essentially hostile authority. That dynamic leads directly to a crashout, unless someone blinks.

    Interestingly, BOTH Germany and France are facing political instability right now.

    1. Oregoncharles

      And this didn’t mention Hungary or Poland, both also in a confrontation with the EU – political, in their case, since neither is on the Euro.

    2. Yves Smith Post author

      The Bank of Italy will debit it from the government’s account. The Bank of Italy is much closer to the ECB than the government, particularly this one.

  9. Sound of the Suburbs

    Central banks spent ten year pumping up asset prices.

    The idea was that this would trickle down, but it didn’t.

    Markets now need to correct.

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