Markets Insight

Summer Fed lull has investors ‘whistling past the graveyard’

August has a history of turning ugly, but there could be deeper trouble further ahead
Periods of calm across markets rarely last long and August has a history of turning decidedly ugly for investors.

The summer has been distinguished by very supportive central banks, with the Bank of England’s kitchen sink effort in the wake of the Brexit vote just the latest example of the “central bank put” pumping up asset prices.
With many central banks still looking to ease policy, one stands apart and holds the key to whether global equities can keep climbing, led by US share prices setting a record pace.
In the wake of last week’s robust employment data, the shadow of tighter US Federal Reserve policy and, by extension, that of a firmer dollar remains faint with little prospect of a sharper outline emerging over the coming weeks.
For now, complacency reigns, with the US bond market and many investors convinced the Fed will stick to the policy sidelines and keep interest rates low for a long time.

Two solid months of job gains in June and July falls into the camp of constituting the best of both worlds for markets. US equities are rising on the idea that second-half activity may gather pace and hopefully ignite earnings growth, while the bond market shrugs off a strong jobs print and continues to expect no action from the Fed.
Market expectations of a US interest rate tightening only rise above 50 per cent by March of 2017. The current two-year Treasury note yield of 0.72 per cent remains below last December’s level of 1 per cent, when the Fed finally began tightening policy.

Such a belief in the mantra of “lower for forever” against the backdrop of aggressive bond purchases by other central banks has compressed global bond yields and spurred a stampede into emerging market sovereign debt that sport higher fixed returns because they also reflect a greater degree of risk.
As measures of market volatility compress ever tighter and the search for yield embraces risqué areas of bond land, investors are largely viewing the world through the lens of secular stagnation.
The idea that the US economy will shift into a higher gear and trigger a reappraisal of the dollar with dangerous consequences for elevated EM prices, let alone US assets, notably expensive looking bond proxies — the shares of high dividend paying companies — appears a dim prospect to investors. One can’t blame them for whistling past the graveyard at this juncture, however.

Playing a role is the calendar, with the Fed not meeting until well into next month. As Lou Crandall at Wrightson Icap notes: “There is still plenty of time for events to undermine the case for a rate hike, as they have done repeatedly in recent quarters. It is much too early to say with confidence that the data will line up in favour of a rate hike on September 21.”

The annual gathering of central bankers at Jackson Hole in late August, with a speech from Janet Yellen, will probably offer little new information about the policy outlook.
Not until we see the tone of the August jobs data early next month, does the potential beckon for a stronger reaction from investors and the dollar. This is when things might become interesting. Based on employment and inflation considerations, a tightening of US policy from a meagre 0.25 to 0.5 per cent range is warranted.

Longview Economics makes the point that two forces — growing wages via a tightening jobs market and accelerating credit and money supply growth — support higher US service sector inflation.

“The risks to the consensus view are therefore skewed to the upside, with the growing likelihood that the Fed is forced, at some stage, to once again begin talking up the prospect of rate hikes,” says Chris Watling at Longview.

Such talk, however, raises the prospect of a stronger dollar, and as we have often heard, Fed officials do worry about financial market turmoil stemming from a rejuvenated reserve currency tightening financial conditions.

At some point and perhaps sooner than the market thinks, US policy officials need to break this impasse. The longer the Fed stays on the sidelines, the more distorted markets become, storing up a much more painful outcome for investors.

Are Negative Rates Backfiring? Here’s Some Early Evidence

Economists worry that people and businesses are saving more, instead of spending

By Georgi Kantchev, Christopher Whittall and Miho Inada

The European Central Bank cut interest rates below zero to encourage consumers and businesses to spend more. Photo: Martin Leissl/Bloomberg News 

KORSCHENBROICH, Germany—Two years ago, the European Central Bank cut interest rates below zero to encourage people such as Heike Hofmann, who sells fruits and vegetables in this small city, to spend more.

Policy makers in Europe and Japan have turned to negative rates for the same reason—to stimulate their lackluster economies. Yet the results have left some economists scratching their heads. Instead of opening their wallets, many consumers and businesses are squirreling away more money.

When Ms. Hofmann heard the ECB was knocking rates below zero in June 2014, she considered it “madness” and promptly cut her spending, set aside more money and bought gold. “I now need to save more than before to have enough to retire,” says Ms. Hofmann, 54 years old.

Heike Hofmann, who sells fruits and vegetables in Korschenbroich, Germany, reacted to negative rates by cutting her spending.

Heike Hofmann, who sells fruits and vegetables in Korschenbroich, Germany, reacted to negative rates by cutting her spending. Photo: Georgi Kantchev/The Wall Street Journal

Recent economic data show consumers are saving more in Germany and Japan, and in Denmark, Switzerland and Sweden, three non-eurozone countries with negative rates, savings are at their highest since 1995, the year the Organization for Economic Cooperation and Development started collecting data on those countries. Companies in Europe, the Middle East, Africa and Japan also are holding on to more cash.

Economists point to a variety of other possible factors confounding central-bank policy: Low inflation has left consumers with more money to sock away; aging populations are naturally more inclined to save; central banks themselves may have failed to properly explain their actions.

But there is a growing suspicion that part of problem may be negative rates themselves. Some economists and bankers contend that negative rates communicate fear over the growth outlook and the central bank’s ability to manage it.

“People only borrow and spend more when they are confident about the future,” says Andrew Sheets, chief cross-asset strategist at Morgan Stanley. “But by going negative, into uncharted territory, the policy actually undermines confidence.”

Going negative was a big bet by central banks faced with a sluggish recovery from the financial crisis. Whether negative rates succeed or flop has huge implications for the global economy. Japan and Europe are already doing large volumes of bond buying to spur their economies, and their central bankers have little left in their tool kits.

The U.S. Federal Reserve’s next move is likely to raise rates, but Chairwoman Janet Yellen has said negative rates could find a place in the Fed’s armory in any future crisis.

The Bank of England, shaken by June’s surprise vote to leave the European Union, cut interest rates to their lowest in its 322-year history last week but said it was reluctant to go negative.

BOE Gov. Mark Carney said he is “not a fan” of a policy that has negative consequences for savers and the financial system. European banks say their profitability has been hit hard by low rates.

Some central bankers say it is too early to judge negative rates. “The effect won’t be seen all at once, but it will gradually become clear,” said Bank of Japan Gov. Haruhiko Kuroda in a June news conference.

Benoît Coeuré, a member of the ECB’s executive board, in a July speech, said measures including negative interest rates, “are proving to be effective in lifting inflation toward its medium-term objective and reducing the overall level of risk in the economy.”

Low interest rates should encourage consumers and businesses to spend by depressing returns on savings and safe assets such as government bonds. Such spending should create demand for goods, help lift sagging inflation and boost economic growth.

Negative rates aren’t fundamentally different, in their day-to-day effects, for most people. Negative rates mean large commercial banks have to pay to park their money at central banks, which encourages them to lend it out instead. Banks spread those costs in various ways. For the individual or most corporate customers, the effect is to push interest rates paid on deposits, while still positive, even closer to zero.

Negative rates aren’t just aimed at spurring spending. Europe and Japan need weaker currencies to help exports and boost low inflation, and negative rates can help bring that about.

Some economists now believe negative rates can have an unintended psychological effect by communicating fear over the growth outlook and the central bank’s ability to manage it.

“The signal to the consumer is that something is wrong—it’s a crisis measure,” says Carl Hammer, chief currency strategist at Swedish bank SEB.

Lasse Bohman, a 63-year old newsstand worker from Stockholm, said the concept of negative interest rates is “weird” and makes him want to save more for retirement rather than spend. “I am just going to keep on putting money in the bank,” he says, or “put it under the mattress at home.”

In Germany, Europe’s largest economy and a nation known for thrift, savings as a percentage of disposable household income rose to 9.7% in 2015, according to preliminary data from the OECD. That is the highest rate since 2010, and the OECD expects the savings rate to rise further this year, to 10.4%.

Many Germans worry that negative rates pose a threat to their rainy-day funds. Four in 10 Germans cite the ECB’s monetary policy and low interest rates as their biggest concern when it comes to savings, according to a survey by the German Savings Banks Association last October.

In December, Ms. Hofmann, the Korschenbroich fruit vendor, used her Christmas bonus to buy two 10-gram bars of gold. She has since bought more and has put it, and every euro she can set aside, into a safe at home, saying she doesn’t trust banks. “Every time I check my savings account, it makes me want to cry,” she says.

In the broader eurozone, where saving isn’t as ingrained in the psyche as in Germany, the household savings rate has edged lower since negative interest rates were introduced in 2014.

The OECD forecasts the household-saving rate will increase this year in Japan, which introduced negative rates in February. Cash and deposits held by Japanese households were up 1.3% in the first quarter from the same period a year ago, according to the Bank of Japan.

In the U.S. and U.K., where interest rates are still positive but annualized growth rates in the year’s first quarter were slower than the eurozone or Japan, savings rates have been stable or trending lower.

Companies also are also holding on to funds, and some are forgoing cheap loans.

In Japan, cash and deposits held by nonfinancial corporations increased 8.4% in the first quarter from a year earlier, according to the Bank of Japan. That growth was the biggest since the 1990s.

Nonfinancial corporations in Europe, the Middle East and Africa had €921 billion in cash balances as of December 2015, according to a report from Moody’s Investors Service on the companies it rates, up about 5% from a year earlier. As a percentage of revenues, cash balances were 15% last year, versus 13% in 2014.

“This odd policy of negative interest rates hasn’t motivated us to invest more. On the contrary, it’s a signal that the economic situation isn’t improving,” says Hans-Gerd Wienands, chief financial officer of Messer Group, a German supplier of industrial gases.

The company has cut the amount it invests to 12.5% of revenue this year, from more than 20% in 2010, as it reduced debt.

In Japan, Tatsuro Takahashi, who sells barbecue pork from his food truck in Tokyo, said, “I’m not interested in borrowing money to expand my business, whether the rate is lower or not. It is riskier.”

Bank lending in Japan has expanded for 58 months in a row through July, but growth has slowed.

The Bank of Japan “failed to foresee people’s behavior,” said Noriko Hama, a professor of economics at Doshisha University in Kyoto, in the magazine Weekly Economist. “It’s simply rational for them to increase savings.”

Household spending in Japan jumped 1.2% in February, the month the BOJ introduced negative rates, but fell the following four months.

Some say other factors are contributing to increased savings. In Germany, for instance, low inflation stemming from cheaper oil and tepid growth means that people have more money to put away simply because the stuff they buy costs less.

ECB President Mario Draghi says that after accounting for inflation, the rate that savers earn today is higher than it was on average in the 1990s.

Peter Praet, the ECB’s chief economist, says the focus should also be on borrowers, who are more inclined to spend than savers, and are seeing a boost to their disposable income because ultralow rates reduce the cost of servicing debt.

Other central-bank executives concede negative rates may push some to save. Yves Mersch, a member of the ECB’s executive board, said in June that it is possible “households are hoarding even more” because they need to save more to build up the same amount of wealth over the same time span.

Household spending as percentage of gross domestic product has fallen slightly in Germany to 54% last year, from 55.4% in 2013, according to OECD data. It also has fallen in Sweden, and is relatively flat in Denmark and Switzerland.

Interest payments on savings accounts in the eurozone are at the lowest levels since 2000, according to ECB data. In the early 1990s, it took nine years for a German saver to double his or her capital as interest income piled up, according to Hans Joachim Reinke, chief executive of Frankfurt-based Union Investment. Now, savers like Ms. Hofmann would have to wait 500 years for that to happen.

Negative rates have also hit pension payouts, giving older savers another reason to squirrel away more cash.

Pension funds and pensioners typically invest in government bonds in a quest for reliable income. That income has never been smaller. About $12 trillion worth of bonds currently have negative yields, according to Bank of America Merrill Lynch European credit-strategy research, compared with almost none two years ago.

That is a problem for Henrik Olejasz Larsen, who as chief investment officer of Sampension manages pensions for Danish government employees. The return on assets that Sampension invests in has fallen as low as 0.2%, far from the 3.5% needed to maintain pension payouts at a level expected by their holders.

University of Michigan economist Miles Kimball believes rates should be lowered even deeper into negative territory. If people are getting scared by negative rates, he says, it is the fault of central banks’ inability to communicate effectively, not the policy itself.

“They should say that this is a normal tool of policy,” he says, “and then people wouldn’t freak out.”

—Charles Duxbury, Tom Fairless, Todd Buell and Takashi Nakamichi contributed to this article.

Mr. Market - The Great Pretender

dog baby world smart only

Oh yes, that seems to fit Mr Market’s mood these days.
Too cynical a description you say?

Maybe so, but finding the reality of market conditions is a challenge these days.

The past few weeks allowed some crazy two-way action in energy markets. Oil prices plummeted early in the month on oversupply conditions. Then, just as markets got hip to those conditions, they reversed direction sharply rallying fresh highs. Why was this? Apparently bulls were able to dust-off the reliable canard—suppliers were now going to reduce production. And so what was previously uncritical suddenly (sigh) became credible once again.

So weak sectors in markets became strong once again lifting them once again. And this allowed for more sector sectors renewed the trading places game once conditions to resume confusing markets.

Retail sectors took it on the chin this week as earnings reports were dismal. To add to the mystery for investors small caps jumped higher as leadership rotated once again.

Not to be left out were talking heads from our friends at the Fed. They just can’t seem to shut up these days since they refuse to yield the conversation away from themselves. Yesterday it was Fed Gov. Bullard’s comments who allowed markets a late day boost and today it was Fed Gov. Dudley (Do-right) who grabbed the microphone to tell one and all things in the future were going to better. How much so? Well, he chastised traders to not to misunderstand the Fed’s guidance. Whatever that might mean. 

Below is the heat map from Finviz reflecting those ETF market sectors moving higher (green) and falling (red). Dependent on the day (green) may mean leveraged inverse or leveraged short (red).

8-18-2016 3-50-20 PM

Volume was ultra-light which isn’t even fitting tor a summer trading day. Breadth per the WSJ was positive.

8-18-2016 3-51-08 PM


Charts of the Day












    The NYMO is a market breadth indicator that is based on the difference between the number of advancing and declining issues on the NYSE. When readings are +60/-60 markets are extended short-term.


    The McClellan Summation Index is a long-term version of the McClellan Oscillator. It is a market breadth indicator, and interpretation is similar to that of the McClellan Oscillator, except that it is more suited to major trends. I believe readings of +1000/-1000 reveal markets as much extended.


    The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge". Our own interpretation has changed due to a variety of new factors including HFTs, new VIX linked ETPs and a multitude of new products to leverage trading and change or obscure prior VIX relevance.

The last two charts present a dangerous condition of high complacency and much overbought conditions.
This tells you all you need to know about how I feel about, and would approach investing in these markets.
Let’s see what happens.

China Goes Fishing in the East China Sea

China has recently been more brazen in provoking Japan.

By Jacob L. Shapiro

The latest round of Japanese and Chinese squabbling over disputed islands in the East China Sea has escalated in recent days. On Aug. 5, according to Japan’s Ministry of Foreign Affairs, as many as 230 Chinese fishing vessels and 13 coast guard ships sailed into the contiguous zones surrounding a group of islands, known as the Senkaku Islands in Japan and the Diaoyu Islands in China. Three of those ships reportedly had gun batteries, and two more Chinese government vessels allegedly got within 12 miles of the Senkakus/Diaoyus on Sunday evening.

There are two main things to note in this development. The first is that it represents a moderate intensification of tensions between Japan and China in the areas around these disputed islands where both countries’ territorial claims overlap. The second is that this escalation should not be blown out of proportion. China is not really spoiling for a fight, and Japan is not in a position to give it one.

Exclusive Economic Zone Claims of China and Japan

It is difficult to pinpoint a precise moment when tensions between China and Japan began to rise; this particular territorial dispute exerts a constant low-level pressure on both sides, even when relations are good. However, a few recent events stand out. On June 15, a Chinese Type 815 spy ship entered Japan’s territorial waters near the Sakishima Islands in Okinawa – the first time since 2004 that China had been so bold. Then, on Aug. 2, Japan issued its annual defense white paper, which criticized China for an overly aggressive posture in the East China Sea. China’s Defense and Foreign ministries responded in harsh terms to what they saw as unfair allegations and pledged to safeguard Chinese sovereignty with an “unshakeable” resolve.

Using fishing boats to encroach on Japan’s territorial waters isn’t necessarily a novel tactic, but the degree to which China put it to use this past weekend against Japan is notable. In the South China Sea, China often uses these fishing vessels – with or without coast guard escorts – to delegitimize other claimants like Malaysia or the Philippines. China has also done this around the Senkakus/Diaoyus before; in 2010, a Japanese coast guard vessel collided with a Chinese fishing vessel, which sparked nationalist protests in mainland China. However, 230 fishing ships and 13 coast guard vessels are a direct challenge, not a mistake or a few fishing boats looking for a big pay-day.

This is an effective strategy for China because it allows China to assert territorial claims without actually sparking violent conflict. In this case, Japan does not want to initiate conflict with China. For one thing, Japan cannot be certain that the U.S. will back it if Japan is seen as the aggressor. Japan also does not want to give China an excuse to become even more strident, nor does it want to set off nationalist sentiments in China in response to any offensive action it would take.

China then gets to pick the best kind of fight: one that won’t actually become a fight. It gives the impression that China is more powerful than it appears and makes Japan look weaker than it is. It allows China to play the role of provocateur and see just how far it can push its claims, while also leaving room to retreat if necessary. Even though China is the weaker party – perhaps even because it is the weaker party – it can and often does push the envelope in this way.

Amid this saber rattling between the Chinese and the Japanese, there is a
concurrent thaw of relations between China and the U.S. A little over 48 hours after the drama began in the East China Sea, the USS Benfold, a U.S. missile destroyer, arrived at the Chinese port of Qingdao on what the U.S. Navy said was a scheduled visit. It is the first time a U.S. Navy ship has visited China since the Chinese canceled a visit from the aircraft carrier John C. Stennis at the last minute in May. It is also the first visit since the Permanent Court of Arbitration in The Hague ruled in favor of the Philippines in its dispute with China on July 12.

Why a U.S. destroyer would pay a courtesy call to a Chinese port during an intensifying argument between Japan and China is unclear. It seems unlikely that China invited a U.S. ship there to cause problems between the U.S. and Japan. The Benfold would have had enough time to turn around if it needed to. But it underscores the hollow nature of the war of words, fishing trawlers, and uninhabited islands in the Pacific. Strain in the relationship between China and Japan is important, as is
where the United States situates itself, but ultimately, this is balance of power politicking, not a prelude to imminent violence.

The Power of Fantasy in a Relationship

Sexual fantasies can improve a relationship, new studies show, if you fantasize about your partner

By Elizabeth Bernstein

     Research shows that 95% to 98% of the population has sexual fantasies. Photo: Getty Images

When relationship researchers gathered recently for their big international conference, one presentation drew a lot of attention because it offered an answer to a question often asked but rarely examined: Can sexual fantasies improve your relationship?

The answer: Yes—as long as you are fantasizing about your partner.

Previous research shows that just about everyone—between 95% to 98% of the population—has sexual fantasies. Not everyone, of course, wants to act on them. In general, men’s fantasies are more sexually explicit. They are more likely to fantasize about multiple partners, some studies found. Women’s fantasies contain more romantic and emotional content.

“Fantasies reflect how we cope with our insecurities and whether we want to promote intimacy or escape from it,” says Gurit Birnbaum, a social psychologist and associate professor of psychology at the Interdisciplinary Center, a private university in Herzliya, Israel, who is the lead researcher on the new studies. “Tell me your fantasies and I will tell you what your personality is and what you want out of your relationship.”

A study published in the January, 2015, issue of the Journal of Sexual Medicine found typical types of fantasies for both men and women include feeling romantic emotions during sex, imagining a particular atmosphere and location, receiving oral sex and (particularly for men) having sexual intercourse with two women.

What people fantasize about is determined by a number of factors, experts say, including hormones, age, past sexual experiences, relationship length and satisfaction level, personality and even emotional attachment style. People who avoid emotional attachment—psychologists call this having a highly avoidant attachment style—typically fantasize about casual, nonemotional sex. People with a highly anxious attachment style, who crave emotional attachment and worry they will lose the person they love, are more likely to fantasize about pleasing their partner. People with a secure attachment style are most likely to fantasize about romantic, loving sex.

Past research has looked at who and what people fantasize about, but generally not the impact these fantasies have on relationships. The vast majority of people in exclusive relationships fantasize about someone other than their partner, research shows, and people who are in an unhappy relationship do this more than others. A study of 349 people in heterosexual romantic relationships, published in the Journal of Sex Research in 2001, found that 98% of men and 80% of women fantasized about someone other than their partner at least occasionally. Most of the fantasies about someone else were about a person the participants had never been with sexually, yet a fifth of men and a third of women reported fantasizing about previous sexual partners.

The study also showed that fantasizing about someone else isn’t necessarily harmful for your relationship. The men’s fantasies about sex with someone else didn’t lead them to cheat, which is in keeping with the anecdotal evidence, experts say. “If fantasizing about other people was harmful, not many relationships would survive because almost all of us do it,” says Justin Lehmiller, the director of the social psychology graduate program at Ball State University, in Muncie, Ind., who is a sex researcher.

Fantasizing about one’s partner increases desire for him or her and leads to more supportive, affectionate and loving behavior, new research shows. Fantasies about someone else may not hurt a relationship, but they don’t help it, either. Illustration: Jason Schneider

Now, three new studies presented at the biennial conference of the International Association of Relationship Researchers, held recently in Toronto, show that fantasizing about your partner will help your relationship. It increases your desire for the person you are with and leads you to show them more love, affection and support. Fantasizing about someone else won’t hurt your relationship, the studies show, but it won’t help it, either. The studies haven’t yet been published in a scientific journal.

In the first study, 102 individuals who were in a heterosexual, monogamous relationship were brought into a laboratory and asked to fantasize about their partner or someone else. One-quarter of the people were told to fantasize sexually about their partner; one-quarter were told to fantasize about solving a problem with their partner; one-quarter were told to fantasize sexually about someone other than their partner; and one-quarter were told to fantasize about solving a problem with someone other than their partner.

The participants were then asked to describe the scenario they imagined in detail, including how they felt afterward. The study found that the people who had sexual fantasies about someone other than their partner felt guilty. And the people who had sexual fantasies about their partner had more interest in their partner.

“All they had to do is fantasize sexually about their partner and—boom!—their sexual desire increased,” says Dr. Birnbaum, the lead researcher.

In the second study, the researchers followed 100 heterosexual, monogamous couples for six weeks.

Participants were asked to independently record their perceptions of their relationship in a diary each day, without showing their partner, rating how strongly they agreed with statements such as, “I feel committed to the relationship;” “I feel doubts about my compatibility with my partner;” and “I feel my partner is highly valued by other people.”

The participants also reported on whether or not they fantasized about their partner that day.

This study found that on days when people said they had fantasies about their partner, they were more likely the next day to say they felt more committed in the relationship and more trusting of and affectionate to their partner. People also had fewer doubts about their relationship on days after they had fantasized about their partner.

In the third study, 48 heterosexual, monogamous couples were asked to keep diaries for three weeks, with each partner recording in detail every fantasy they had about their partner or someone else. They also recorded their relationship interactions each day, such as whether they expressed love, did something nice for their partner or were supportive or critical.

When the participants fantasized about their partner, they were more likely to act positively the next day. When they fantasized about someone else, they weren’t mean to their partner the next day, but they didn’t behave better toward them either.

The takeaway? “Even if you are not satisfied with your relationship, fantasizing about your partner boosts your relationship perception and satisfaction,” Dr. Birnbaum says.