Jefferies shares views on Xi's China policies, Trump; says US stock & money markets pricing in 2 different outcomes

Jefferies' Christopher Wood in his latest GREED & fear note said the markets in the US are priced for two entirely different outcomes. The stock market, it said, is priced for an idealised soft landing while the money markets are priced for a degree of monetary easing, which only seems likely in the event of a recession.

Wood said the Fed funds futures are now discounting 144 basis points (bps) of rate cuts this year, though down from 168 bps anticipated last Friday and 158 bps at the end of last year. In the case of US stock market, the Nasdaq 100 is now trading at 24.4 times one-year forward earnings and the Russell 2000 is trading at 22.6 times, compared with 19.6 times for the S&P500, it said.

"GREED & fear’s base case remains that a downturn is coming as signalled by the collapse in US M2 growth. That argument was summarised concisely in a letter published in the Wall Street Journal on Tuesday by GREED & fear’s old friends Steve Hanke and John Greenwood. Meanwhile, a further reminder that the Fed is willing and able to turn on a dime, following Jerome Powell’s pivot at the December FOMC meeting, came from Federal Reserve Bank of Dallas President Lorie Logan in a recent speech," it said.

Logan said there was a case to slow balance sheet reduction as a result of the steep decline in the amount of funds held in the Fed’s

reverse repo facility. Jefferies said a decline has indeed been dramatic as money market funds have taken funds out of the reverse repo facility to buy higher yielding Treasury bills.

"This is another sign that the Fed will end quantitative tightening and resume quant easing at the first sign of trouble. The same message was sent in the release earlier this month of the minutes of the 12-13 December FOMC meeting. A section of the minutes detailed how participants had discussed the shift of money market funds out of the reverse repo facility and that it would be appropriate to begin to discuss “the technical factors that would guide a decision to slow the pace of runoff," it said.

Jefferies said if the Fed is likely to end balance sheet contraction sooner rather than later, there is one Fed facility which is due to be wound up by March 11.

"GREED & fear refers to the Bank Term Funding Program (BTFP) set up last March in the wake of the Silicon Valley Bank failure where liquidity challenged banks were able to borrow from the Fed helped by the fact that the Fed decided to value the collateral, such as Treasury bonds, at par not at market value in a notable departure from traditional prudential central banking principles. In a classic example of the law of unintended consequences, a Wall Street Journal article last week reported how the borrowing in this facility has increased of late not because of growing stresses but because a profitable arbitrage has opened up for healthy banks to earn free money.

Trump victory

Jefferies said that the recent  Trump’s victory by a 30-point margin is indeed historic and is the latest evidence, if it was needed, that the more indictments are levelled against him the more support for him grows. A Detroit News poll last week found that Trump was leading Biden in Michigan, a key battleground state, by eight percentage points.

"In this respect, the major problem for the 45th American president is that the election is not being held now. But if a downturn does hit the US in coming months, causing a stock market sell-off with it, it would set up the stock market for a rally in anticipation of pro-growth Trumpian policies," Jefferies said. 

China market, Xi

Jefferies said there are concerns about intensifying deflationary momentum in China with the release of the latest data, be it the continuing decline in credit growth or the continuing announcements of negative PPI. From a market standpoint the concerns are also reflected in the Chinese ten-year government bond yield which recently reached its lowest level since April 2020, it said.

"All of the above raises the all-important question of what might trigger a more aggressive response from the central government aside from the by now established pattern of ongoing incremental easing. One issue here, in GREED & fear’s view, is the absence of clear leadership in economic policy following the retirement last March of former Vice Premier Liu He and the former head of the China Banking and Insurance Regulatory Commission (CBIRC), Guo Shuqing. Those two were the key drivers of the deleveraging policy in President Xi Jinping’s first ten years in power," Jefferies said.

Jefferies said the lack of such experienced leadership is reflected in the lack of a consistent policy response to the property downturn. One moment the government is signalling that it will not bail out the most leveraged private developers. The next moment there is talk of a “whitelist” which could include some of the most leveraged developers, as previously discussed here.

"This is not conducive to generating confidence in a country where for years the technocrats were, rightly, celebrated for their economic management skills. Still, if there is a seeming lack of decisive economic policy making, in terms of clear signals being sent, that in turn raises the issue of what will cause President Xi to become more focused on the economy," it said.

 

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