The Xi Put

Tepper vs. Citibank

Being on the other side of a David Tepper trade is never a comfortable position. Yet, that is where Citibank and an army of other sell-side strategists find themselves when analyzing China’s stimulus this week. They must either believe the $2 trillion in measures is only a half-measure to overcome the problem or that the People’s Bank of China (PBoC) is creating a pool of credit that will never be tapped. According to Citibank, China’s problems stem from a vacuum of extremely low investor and consumer confidence weighed down by a mountain of loan losses from the property market’s collapse. The government is still reluctant to address the bad loan problem directly.

Furthermore, Beijing burdened its financial sector with yet another government directive. We discussed the currency swaps, bought on behalf of the government, that sit on the books of the six large state-owned banks to strengthen the Yuan. If the global economy slows and the U.S. Dollar rises, those bank stocks, which would fall in value just off recession concerns, will fall even faster from losses on the swaps. Currently, insurance companies, funds, and brokers can borrow money from the PBoC directly to buy equities. This added leverage will magnify the downside risk if stocks begin to fall.

Tepper loves the PBoC’s swap facility to support equities and believes the government is solving the demand problem. Because of that, he plans to exceed his normal 10-15% China exposure limits. He is going all in.

No question, this is a liquidity put, and the hope is higher stock prices will increase investor and consumer confidence. David Tepper is convinced this is the real thing, and he better be right. If things go south, the newly levered financial institutions could have solvency problems that could dwarf the property developer crisis. The bulls are thinking because the government is putting their institutions in harm’s way, they will ensure their success.

‍Empty Pockets

Can you ever bet against the U.S. Consumer? Even as employment demand has started to fade, August’s Retail Sales data grew at a solid annual 2.8% rate. That would have made sense if we were still enjoying last year’s 4% real income growth, but after inflation, payrolls are only increasing at 1.1% annually. The result is that people paid for things out of savings, pushing the Personal Savings Rate below 3%, half its 30-year average. Dipping below 3% is a rare event; the only sustained run with such low savings rates occurred between 2005-2007, when rising stock and housing prices made everyone feel wealthier, and consumers spent as though there would never be another downturn.

It is well known that consumers kept spending at an artificially high rate thanks to the enormous pandemic savings checks. That was the intention. Those savings have become a thing of the past, but apparently, no one has told the consumer. Many are spending well above their means. The consumer continues to draw upon base savings, which makes them vulnerable if they find themselves out of work. We can hope for a repeat of the 2005-2007 period, with record stock prices and appreciating homes, but at some point, personal balance sheets get stretched to their limit. At that point, spending falls below income growth. With real income growth so low, the economy does not have a cushion, and recession risks become serious.

From the Naysayer

Fed Governor Michelle Bowman was the first Federal Open Market Committee (FOMC) voter to vote against a rate decision since 2005. Her dissent, in favor of a more measured 25-basis point cut, was in keeping with her reputation of being the most conservative FOMC participant. She agreed that lower inflation and softer labor demanded starting the process toward a more neutral monetary policy. She just wanted to have done so more gradually.

Why would 25 basis points have been preferable? First, employment is still strong in her eyes, especially considering how few layoffs have occurred. Also, until spending comes down, she is hesitant to believe the labor market is soft (our second Point above explains why she may be wrong about that). Governor Bowman argues that it is difficult to hold a strong opinion about how weak the labor market really is because the jump in immigration has created distortions by sharply increasing the supply of workers.

Over the past few months, core PCE inflation has stayed stubbornly above a 2.5% annual inflation rate. That is a warning to her that the Fed’s 2% inflation target may never be hit. She is worried that the 50-basis point cut could unnecessarily spark demand that ensures inflation remains elevated. In short, Bowman is concerned that history will look back on the decision as once again making a “premature declaration of victory on our price stability mandate.”‍

What to Look for This Week

1. Tuesday, October 1 at 10:00 a.m. E.D.T. Job Openings and Labor Turnover Survey (JOLTS) for August. Many FOMC voters are watching the Quits Rate which has been falling steadily for over two years from 3% to 2%. It ticked up in July to 2.1% and the hope is that it holds above 2%, otherwise it will reveal unwanted weakness.

2. Thursday, October 3 at 7:15 a.m. E.D.T. Challenger Job Cuts are announced for September, and their monthly report is released. The Challenger Report for August stated that hiring fell to the lowest year-to-date level since the outplacement firm began collecting data in 2005 (so it included 2008). We will be looking for any signs of further decline.

3. The ADP September employment report is out at 8:15 a.m. E.D.T. Wednesday October 2 and Initial claims is out at 8:30 a.m. E.D.T. Thursday October 3 (the 4-week moving average has fallen since August 8), but the market will be waiting for the September Nonfarm Payroll report out Friday October 4 at 8:30 a.m. E.D.T. before forming an opinion on the labor market. We will be looking for any more downward revisions to prior months.