Thesis Corroboration
Doug Nolan
It was an eventful week worthy of some dissection.
Markets for the most part corroborated the “higher for longer” and rising global yields thesis.
Ample volatility supports the heightened currency instability thesis, with the yen, renminbi, and EM currencies all in the crosshairs this week.
The equities speculative melt-up appears increasingly vulnerable.
After closing the previous week at 11.93, the VIX (equities volatility) Index approached 15 (one-month high) during both Thursday and Friday sessions.
Late-cycle blow-offs feed off bearish positioning, ensuring there’s always a thin line between a downside reversal and (yet) another rejuvenating short squeeze.
The ridiculously over-loved tech sector is indicating vulnerability.
But in the spirit of markets inflicting the most pain on the largest number of people, perhaps Mr. Market will deviously spark a destabilizing rotation before succumbing to a long-overdue selloff.
Tuesday’s two- and five-year and Wednesday’s 7-year auctions were all met with tepid demand.
From Bloomberg (Will Hoffman and Ira Jersey):
“The final auction cycle of May marks one of the worst coupon auction cycles in recent memory.
All three issues tailed market expectations, with a cumulative tail of 3.6 bps surpassed only by February 2021 and September 2023’s 2-, 5-, and 7-year auction cycle.”
Two-year yields traded as high as 5.0% Wednesday, with 10-year yields at 4.63%.
Markets made it through Friday’s monthly PCE release without a negative inflation surprise.
Still, Tuesday’s bearish trading action appeared important.
Endless supply coupled with elevated inflation risk weighs on market sentiment – at home and abroad.
Italian yields traded to 4.02% in late Wednesday trading, up a notable 20 bps from Monday's lows.
For the week, Italian yields jumped nine bps, the largest increase since the global “risk off” week of April 19th – with yields near highs back to December.
Greek yields rose eight bps to the highest close since November 28th.
UK yields jumped 12 bps in Wednesday trading, to the high (4.40%) since November 13th. Rising 10 bps, German (2.70%) and French (3.17%) 10-year yields both traded to highs back to November.
Wednesday was also a rough day for EM currencies.
The Chilean peso dropped 1.6%, the Hungarian forint 1.5%, the Polish zloty 1.1%, the Mexican peso 1.1%, and the Russian ruble 1.1%.
The Nasdaq100 declined 0.7% Wednesday in bearish trading action, as the Semiconductors slumped 1.9% (losses included Advanced Micro Devices 3.8%, Microchip Technologies 3.3%, and Intel 3.0%).
May 30 – Bloomberg (Gowri Gurumurthy):
“US junk bonds had their worst day since late April in both return and yield terms on Wednesday, as a continuing Treasuries selloff due to weak government auctions pressured equities.
BB yields rose 8 bps to a four-week high of 6.78% while losing 0.26%.
CCC yields approached 12.5% after jumping 16 bps, the most in two weeks.”
Wednesday was also notable for Japanese 10-year bond yields jumping 5.5 bps to 1.08% - and then trading up to 1.10% in early Thursday trading – the high back to July 2011.
The yen declined Wednesday to 157.71 to the dollar, the weakest reading since the May 1st intervention.
May 31 – Financial Times (Kana Inagaki):
“Japan spent a record ¥9.8tn ($62bn) from late April to May to boost the yen, but the currency has resumed its slide towards 34-year lows even as expectations build for interest rate rises, highlighting the struggle Tokyo faces to stabilise its exchange rate.
With currency interventions having only a fleeting effect on the yen, analysts say the Bank of Japan faces a ‘huge dilemma’ as it comes under pressure to raise rates at a faster pace when the economy remains weak due to sluggish consumption.”
The yen has ominously little to show for the month’s chunky $62 billion worth of Japanese currency intervention.
For now, Japan has ample international reserves to continue its market battling.
I’ll assume things only get more challenging for the Ministry of Finance, with the next market test requiring even chunkier responses.
On multiple levels, Thursday was “interesting”.
For starters, it was a big squeeze day, with the Goldman Sachs most short index surging 5.9%.
The small cap Russell 2000 gained 1%, while the NDX was down 1.1%.
It was the largest daily NDX/RTY performance divergence since the April 19th tech selloff.
Thursday’s market dynamics offered a timely reminder of how quickly speculative dynamics could turn against popular hedge fund strategies (i.e., long/short).
May 30 – Associated Press (Michael R. Sisak, Jennifer Peltz, Eric Tucker, Michelle L. Price and Jill Colvin):
“Donald Trump became the first former American president to be convicted of felony crimes Thursday, as a New York jury found him guilty of all 34 charges in a scheme to illegally influence the 2016 election through a hush money payment to a porn actor who said the two had sex.
Trump sat stone-faced while the verdict was read as cheering from the street below could be heard in the hallway on the courthouse’s 15th floor where the decision was revealed after more than nine hours of deliberations.”
Friday volatility was notable.
The Nasdaq100 was down 1.9% at intraday Friday lows – only to rally 1.9% in afternoon trading to end the session unchanged.
The S&P500 opened 0.4% higher, then retreated 1.2% to intraday lows - only to rally 1.7% (almost 1% in the session’s final 20 minutes) to close the session 0.8% higher.
The Banks rallied 1.6% off lows to finish the session up 1.8%.
The Utilities rallied 2.4% to end Friday trading 2.6% higher.
The Nasdaq100 dropped 1.4% this week.
Microsoft fell 3.5%, Applied Materials 2.6%, Amazon 2.4%, Meta Platforms 2.4%, and Micron 3.5%.
The Nvidia melt-up was resilient through Thursday morning, with the stock trading to an all-time high $1,158 ($2.85 TN market cap).
But from Thursday’s intraday high to Friday’s trading low, the stock retreated $88, or 7% - only to rally $26 to end the week 3.0% higher.
It didn’t take long for Chinese stock market enthusiasm to dissipate.
The CSI300’s 0.6% weekly decline pushed the index back to lows since April. The growth oriented ChiNext Index closed out May with a 2.9% loss, giving back all the early-month advance.
May 28 – Bloomberg:
“China’s onshore yuan dropped to the weakest level since November as signs mount that policymakers are slowly letting the currency decline against a resilient dollar.
The yuan fell to as low as 7.2487 per dollar as the People’s Bank of China gradually cut its daily reference rate for the managed currency to a level unseen in four months…
The PBOC has been facing a constant battle to find the optimal pace of yuan weakness that’s conducive for growth, without triggering market panic or capital outflows.
For most of the year, the central bank has kept the currency steady but pressures have been building due to worsening capital outflows and lackluster domestic growth.”
Analysts have been encouraged that Beijing finally recognized the serious risks associated with China’s apartment Bubble collapse.
It’s not an unreasonable market assumption that the colossal scope of the real estate debacle will require massive ongoing stimulus measures.
May 21 – Financial Times (Thomas Hale and Joe Leahy):
“With the announcement of a Rmb300bn ($41bn) fund to support government purchases of unsold housing, the Chinese government last week appeared to finally unleash major firepower to tackle a three-year slowdown in the country’s real estate market.
But while the new measures may mark a turning point in a crisis that has weighed heavily on China’s economy, analysts and economists said the hundreds of billions of renminbi was nowhere near enough.
‘This is a drop in the ocean given the scale of unsold stock,’ said Harry Murphy Cruise, an economist at Moody’s Analytics…”
A “drop in the ocean” indeed, though markets assume Beijing is prepared to open the floodgates as needed.
The currency creates a predicament.
Xi’s global ambitions require a “powerful currency.”
But a monumental reflation would push an already fragile renminbi off the ledge.
I suppose Beijing will attempt to thread the needle: major but contained Credit-induced reflation, while orchestrating a measured currency devaluation.
I just believe the scope of the collapsing real estate Bubble is beyond manageable.
May 30 – Bloomberg:
“Chinese policymakers have identified reducing a glut of housing inventory as the key to ending the nation’s unprecedented property slump.
It’s easy to see why.
The country has the equivalent of 60 million unsold apartments, which will take more than four years to sell without government aid, according to Bloomberg Economics.
The oversupply is dragging down prices at the fastest rate in a decade, giving people less reason to buy a home…
Even in China’s four tier-1 cities, where the market is relatively resilient, it will take an estimated 27 months to sell the supply of new homes as of April, according to China Real Estate Information Corp.”
The above Bloomberg article was published with a chart of “Months to Sell New Home Inventory:” Beijing 48.9 months, Wuhan 42, Fuzhou 41.1, Shenzhen 36.2, Nanjing 33.1, Changchun 31.7, Qingdao 31.3 months...
Yan Yuejin, director of E-house China Research & Development Institute, was quoted:
“There is a fundamental change in homebuyers’ confidence over the biggest cities in the long term.
While low-tier cities have higher outstanding housing stock, the major inventory issue lies in bigger ones.”
“As of April, about 80% of China’s cities had an inventory absorption pace that was worse than a ‘warning line’ of 18 months…”
“Residences completed by developers but unsold expanded to 391 million square meters nationwide as of April, the highest since 2017...
Including properties that are almost finished and approved for presale, the stock is much larger at about 1.8 billion square meters, JPMorgan… estimates.”
“China’s support package announced on May 17 is estimated to translate into 500 billion yuan of credit to help government-backed firms buy housing stock from developers…
Reducing the inventory to a more optimal level through government-backed acquisitions would require 5 trillion yuan, according to JPMorgan analyst Karl Chan.”
May 17 – Wall Street Journal (Jacky Wong):
“There are enough unsold homes in China to house every family in California and New York combined… Goldman Sachs estimates that there was around $4 trillion of residential inventory on a cost basis at the end of last year, including land and projects under construction.
Around 45% of that are homes that are either completed or ready for presales.
The bank said the property developers need approximately $400 to $600 billion of funding to go back to normal operations.”
I’ve been chronicling the great Chinese apartment Bubble for years now.
It has followed the typical pattern.
The Bubble inflates for so many years that Bubble Analysis is completely discredited.
At the height of exuberance, the doomsayers and their bearish analysis were viewed as nothing more than ridiculous extremism.
And I'm increasingly confident that the bursting China Bubble will follow the typical course I’ve witnessed in three decades of analyzing Bubbles: things will prove worse than even the most bearish analysis.
Most research and articles highlight the massive developer inventory of new and under construction apartment units.
The above Financial Times article touched upon what will be a decisive issue:
“And Goldman Sachs estimated that, in addition to the unsold housing stock, there were 90mn-100mn units of ‘shadow supply’ in China that were often bought as investment properties and had not been lived in.”
The pieces are all there for a problematic global de-risking/deleveraging episode.
Do things come together in the Autumn, as they often do?
Or will crisis dynamics catch everyone by surprise this summer?
We’ll closely monitor the “periphery,” where there was some action this week.
The EM ETF (EEM) dropped 2.9%, the largest weekly loss since last August.
This pushed the two-week downdraft to 4.6%.
I’ve already mentioned weakness in Italian, Greek and European bonds.
Japanese yields are on the move, while yen and renminbi stability seem to hang by a thread.
It’s difficult to see instability held in check through such a long, hot, and blustery summer.
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