See The Problem?

by: The Heisenberg


Summary
 
- Let's talk about what happened on Thursday.

- One market was blinded by obfuscation, but another market saw right through the charade.

- Allow me to synthesize everything for you.
 
 
Well, Thursday was fun.
 
The clear and present danger was Mario Draghi, who inadvertently set off a mini-tantrum in DM rates late last month with what he probably thought were innocent enough comments about the purportedly transitory nature of weak inflation.
 
Or maybe he didn't think the comments were innocent. Because the dramatic reaction in German yields didn't stop him (and his counterparts) from ratcheting up the hawkish rhetoric in the days that followed.
 
Fast forward three weeks and the stage was set for the ECB statement and subsequent Draghi presser to put still more upward pressure on yields, a scenario which, if recent shifts in correlations are any guide, would have been bad news for risk assets.
 
So what happened on Thursday morning? First of all, the ECB statement was dovish.
 
Specifically, it kept this sentence unchanged:
The Governing Council stands ready to increase the programme in terms of size and/or duration.
Folks were looking for the removal of the word "size" and when it stuck around, the knee-jerk in bund yields and the euro (FXE) telegraphed a dovish interpretation from markets.
 
Then, 45 minutes later, Draghi's prepared remarks at the press conference sent the single currency flying:
.
 
Were there hawkish bits you could cherry-pick? Yes. Were his comments overtly hawkish? Not at all.
 
So what you see in that chart effectively represents FX traders simply saying "we don't believe you anymore."
 
See the ECB is bumping up against some technical constraints with its dual QE programs, notably in PSPP. I won't put you to sleep with the details, but suffice to say it has to start scaling it back.

But while the FX market saw right through the dovish smoke screen, Draghi's presser was a clinic in obfuscation and doublespeak. And that saved us from another rates tantrum. Have a look at how hard a time the rates market had in figuring out exactly how to read Draghi:
.
 
Simply put: you should trust the FX market's interpretation on this one. The bottom line is that these policies have reached the end of the road. There's not much else central banks can do.
 
Of course, someone forgot to tell the BoJ that. Predictably, Kuroda doubled, tripled, and quadrupled down on the reality denial after the BoJ decision on Thursday (you should read his comments).
 
Japan is nowhere near its inflation target and honestly, it is never going to hit it. Have a look at how far behind it is versus the ECB and the Fed:
 
(Bloomberg)
 
 
Despite the fact that what it is doing is clearly not working, Kuroda is going to keep at it.
 
On that score, I wanted to bring something to your attention. There are still a few readers on this platform who are in the habit of pretending as though central banks aren't behind stock market returns. That's an especially strange thing to say with regard to the BoJ, because it quite literally owns 75% of the entire Japanese equity ETF market.
 
But just in case this point needed to be reinforced, here's what Akira Kiyota, the head of Japan’s stock exchange, told Bloomberg in an interview published this week:

[The BoJ's ETF buying] is not good in the long run. If you keep buying 6 trillion yen a year, that means constant distortion.
Yes, "constant distortion."
 
And in what is perhaps the most poignant example yet of central bank market dominance, consider that within 36 months, the BoJ will own the entire free-float of Fast Retailing (the operator of Uniqlo stores) which incidentally is the most heavily weighted company on the Nikkei:
 
(Bloomberg)
 
 
I would gently ask critics of the central bank "conspiracy theory" to riddle me this: "Does buying the entire free-float of a company count as 'cornering the market'"? Or do we still need "more evidence?"
 
You can see why the FX market is starting to ignore what these officials say - it simply isn't possible for this to continue in perpetuity.
 
Meanwhile, global equity (SPY) and bond markets continue to soar to new record highs and volatility continues to make new record lows. Look at this:
 
(Bloomberg)
 
See that white line? That's global stocks.
 
Ok, so that white line is the same as the light blue line in this chart:
 
AssetPurchases
(Citi)
 
 
The dark blue line is rolling central bank asset purchases and that giant leap off a cliff you see in the "forecast" section (shaded in red) is what's going to happen starting later this year.

See the problem for stocks?
 
Yeah. Me too.

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