Monkey with Money at Your Own Peril

Doug Nolan

With markets on the rather quiet side, I awoke Friday anticipating a more theoretical focus for this week’s CBB. But then May’s surprisingly dismal jobs report – 38,000 seasonally-adjusted jobs versus consensus expectations of 158,000 – threw the markets for a loop. Bond yields sank - at home and abroad. Currency markets went haywire, with the Japanese yen surging 2% versus the dollar. The U.S. dollar index ended Friday’s session down 1.75%, its biggest one-day decline since December.

June 3 – Bloomberg (Liz McCormick): “Bond traders have a message for the Federal Reserve: Don’t even think about raising interest rates this month. The world’s biggest debt market soared Friday, driving yields lower, after government data showed U.S. employers added the fewest workers in almost six years last month. For traders, the figures drove the final nail in the coffin as far as bets that the central bank would lift rates when it meets June 14-15. The probability of a June hike plunged to 4%, from about 22% before the report’s release. It was 30% a week ago…”
Two-year Treasury yields dropped 11 bps on Friday (“largest daily fall in 8 months”) – and were down 14 bps on the week (“largest weekly decline since October 2014”). Yet it wasn’t just Treasury yields on the decline. Friday trading saw German 10-year bund yields decline five bps to a record low 0.068%. Ten year U.K. gilt yields sank 16 bps this week to close at a record low 1.27%.

June 3 – Bloomberg (Jonathan Levin and Ye Xie): “Bond bears were licking their wounds after a weaker-than-forecast May jobs report sent Treasuries surging. Data released later Friday suggest the pain was widespread. Hedge funds and other speculative investors were net short Treasury two-year note futures in the week ended May 31 by the most since before the financial crisis, according to U.S. Commodity Futures Trading Commission data. Two-year notes surged Friday by the most since September…”
Global markets have not been cooperating with the leveraged sect. Just as market operators were becoming comfortably positioned for higher U.S. rates and a stronger dollar, the payroll data turned weak - and previous gains were revised lower. Basically, job creation has been on a steady downtrend for the past six months. Perceptions had of late swung in the direction that a general firming of U.S. economic data (and relatively stable global markets) provided a window for the Fed to bump rates a bit higher. The markets rather abruptly Friday morning shifted to the view that the Fed might have once again missed it’s timing for a rate rise. One and done.

So the yen currency short – a seemingly enticing trade with Japan in disarray and the Fed about to hike rates – suddenly turned into a wretched bear trap. The yen surged 3.4% this week, charging back to near 18-month highs. The commodity currencies, ostensibly tantalizing shorts with the dollar rally gaining momentum, rather abruptly ripped traders’ faces off. For the week, the South African rand surged 4.0% and the New Zealand dollar rose 3.8%. The Australian dollar rallied 2.6% this week. And speaking of “rip your face off” rallies, gold stocks (HUI) surged 13.9% this week. Again, with the dollar rallying and bullion under pressure, the gold equities short trade was attracting attention again. So many speculative macro trades bludgeoned this week.

Global financial stocks have turned hyper volatile. U.S. Banks (BKX) dropped 2.25% during Friday’s session, and the Broker/Dealers (XBD) fell 2.20%. It was quite a reversal from last week, when the banks gained 3.2% and the broker/dealers surged 4.5%. Yet the really big moves were, ominously enough, in Europe.

Europe’s STOXX 600 Banks Index sank 5.4% this week (down 2.17% Friday), increasing 2016 losses to 19.6%. Italian bank stocks were clobbered 8.4% (down 2.84% Friday), ending the week just off of early April’s three-year lows. Italy’s banks closed the week down 39% y-t-d. The Italian stock market (MIB) was down 3.8% this week, increasing y-t-d losses to 18.3%. Spanish stocks (IBEX) dropped 3.4%, increasing 2016 declines to 7.8%. Germany’s DAX fell 1.9% this week and France’s CAC 40 dropped 2.1%. European equities are quickly giving back what had been an unimpressive rally.

European bond markets have been confirming that all is not well. It was a week of record low German bund yields and widening periphery spreads. Portuguese 10-year bond spreads widened 20 bps this week, with Greek spreads 13 bps wider. Spanish and Italian 10-year spreads were five wider.

Analysts have been quick to note U.S. equity market resiliency. The S&P500 ended the week almost exactly unchanged, outperforming most developed markets. Below the surface there is ample volatility. While the financials were under heavy selling press, the Utilities jumped 2.4%. 

The small cap rally continued, with the Russell 2000 gaining 1.2%. The squeeze in the biotechs persevered, with the BTK up 2.7% this week. The bottom line is that market dynamics continue to be extraordinarily challenging.

It’s now been more than seven years since I first warned of a new “global government finance Bubble.” I had no idea that by 2016 the Fed’s balance sheet would have inflated to almost $4.5 TN. The thought that the BOJ and ECB would each be expanding their balance sheets by about $1.0 TN annually never came to mind. I did not at the time contemplate that the ETF and hedge fund industries would both balloon to $3.0 TN. I would have argued against the possibility for negative interest-rates and $10.0 TN of negative-yielding global debt securities. I expected a Bubble in China, but a $35 TN Chinese banking system and $8.0 TN of so-called “shadow banking” were inconceivable back in 2009. And clearly I expected this “Granddaddy of all Bubbles” to have succumbed before now.

I didn’t argue for a likely hyperinflation scenario. What was clear in my mind was that once the inflation of Central bank and sovereign Credit commenced it was going to be extremely difficult to control. Monkey with Money at Your Own Peril. I’ve always believed that using central bank Credit to inflate securities markets was both a trap and a monumental mistake. 


After the disastrous consequences of employing mortgage Credit for system reflation purposes, there was little possibility that inflating the securities markets would end any better. Yet after a few months of relative global market calm, the backdrop again has the appearance of sustainability. I’ll continue to chronicle why I believe it’s late in the game.

It’s become increasingly obvious that Japan’s QE and negative rate endeavor is floundering. A similar prognosis for ECB reflationary measures is at this point only somewhat less evident. Historic bond Bubbles proliferate. Meanwhile confidence in economic fundamentals, the course of policymaking and general banking system soundness wavers. There is little to indicate that either the BOJ or ECB will be capable of extricating themselves from flawed policies.

With the Federal Reserve having concluded QE, many present the U.S. as evidence that exit strategies are achievable and easily managed. It’s definitely not that straightforward. I would contend that ending QE was only possible because of the massive “money” printing operations being orchestrated in Tokyo and Frankfurt. I believe enormous amounts of finance have made their way into U.S. securities markets and the real economy, either directly or indirectly related to BOJ and ECB policymaking. Combined with historic Chinese “Terminal Phase” Credit excess, there was more than ample Credit and liquidity to propel the “global government finance Bubble” finale.

Yet there are today serious issues with BOJ and ECB policy measures as well as the Chinese Credit boom. I would argue that BOJ and ECB reflationary policies maintained the appearance of success only so long as the yen and euro were being devalued. For one, currency devaluation worked somewhat to mitigate domestic deflationary pressures. And, importantly, aggressive BOJ and ECB (QE and interest-rate) policies created extraordinary speculative opportunities for shorting the yen and euro. “Carry trades” and myriad leveraged strategies proliferated to profit from unusually conspicuous policy-orchestrated devaluations, in the process boosting securities market liquidity throughout global markets.

I tend to view yen and euro devaluations as part of last gasps in both policy experimentation and leveraged speculation. For a couple years, devaluation provided extraordinary speculative opportunities, in the process helping to mask the general deteriorating backdrop for leveraged speculation. Now, the yen is near 18-month highs against the dollar and the euro not far from one-year highs. Currency markets generally have turned volatile and uncertain. Slam dunk trades are a thing of the past. The backdrop is no longer conducive to leverage.

Integral to my bursting global Bubble thesis, I believe a monumental de-risking/de-leveraging cycle has commenced. This fledgling “risk off” backdrop helps to explain why BOJ and ECB QE measures have had such muted impact on global risk markets. At the same time, ongoing liquidity operations continue to bolster market sentiment in the face of a disconcerting fundamental global backdrop. Clearly, relative stability in China in concert with BOJ and ECB policy measures has been key to containing “risk off” over recent months.

China, commodities and EM have been the global markets’ weak links. The view has been that dollar weakness helps to ameliorate these fragilities. At the same time, there is the issue of how much speculative finance flowed into the U.S. in pursuit of king dollar returns. One more Crowded Trade to unravel? And there’s another issue worth pondering: confidence in QE has waned considerably over recent months. There’s increasing talk of “helicopter money” and central bank forgiveness of government debt obligations. Both would create serious issues in terms of the true underlying value of central bank Credit. And who holds the vast majority of central bank Credit? The major global commercial banks have accumulated Trillions of central bank obligations, as assets backing deposit liabilities. Perhaps waning confidence in central banking helps explain why the big global bank stocks trade as if something very serious is unfolding. It would also explain the seemingly insatiable appetite for safe haven assets.

June 2 – Bloomberg (Tracy Alloway): “Which fixed-income asset class is growing fast, outperforms similar debt issues, and rarely defaults? Emerging market 'quasi-sovereign' bonds, of course! At some $600 billion, debt sold by state-supported companies in emerging markets ranging from China to Oman has surpassed the amount of emerging market government debt outstanding, according to… Bank of America Merrill Lynch. Such quasi-sovereign debt issuance has helped propel the stunning growth of the overall bond market, with EM issuance accounting for 47% of the growth in global debt between 2007-14, compared to 22% in the previous seven years, according to S&P Global Ratings. But the surge in 'quasi' bonds is making some feel, well, queasy. ‘Quasi-sovereigns are effectively a 'contingent liability' for a country,’ write the BofAML analysts, led by Kay Hope. They note that quasi-sovereign issuance now makes up half of the $1.6 - 1.8 trillion euro- and dollar-denominated corporate bond market for emerging markets…”
May 31 – Wall Street Journal (Timothy J. Martin): “What it means to be a successful investor in 2016 can be summed up in four words: bigger gambles, lower returns. Thanks to rock-bottom interest rates in the U.S., negative rates in other parts of the world, and lackluster growth, investors are becoming increasingly creative—and embracing increasing risk—to bolster their performances. To even come close these days to what is considered a reasonably strong return of 7.5%, pension funds and other large endowments are reaching ever further into riskier investments: adding big dollops of global stocks, real estate and private-equity investments to the once-standard investment of high-grade bonds. Two decades ago, it was possible to make that kind of return just by buying and holding investment-grade bonds, according to new research.”
Again, Monkey with Money at Your Own Peril.

0 comentarios:

Publicar un comentario en la entrada