World-Wide De-Risking/Deleveraging
Doug Nolan
Despite close calls Saturday night and again on Thursday night, we at least made it through the week avoiding “the start of WWIII.”
I’m afraid the same cannot be said for the beginning of WWDD (World-Wide De-Risking/Deleveraging).
Key speculative leverage epicenters were under notable pressure this week – global bond markets, EM currencies and bonds, and big tech.
Some Headlines:
“Resurgent Dollar, Higher Yields Send EM Currencies to 2024 Lows”; “US Nods to ‘Serious’ Japan, S.Korea Concerns Over Slumping Currencies”; “Korea Discusses Currency Concerns with Japan, Ramps Up Jawboning”; “Indonesia's Plunging Rupiah Twists the Policy Plot”; “Indonesia Ramps Up Steps to Shield Economy From Strong Dollar”; “Philippine Peso’s Drop Past 57 Puts Pressure on Central Bank”; “Japan’s Yen Hits a Fresh Three-Decade Low of 154”; “China Pledges to Steady Yuan as Asian Currencies Come Under Pressure.”
Under the Friday Bloomberg (Marcus Wong) headline, “‘Super Peso’ Slides as Middle East Risk Threatens Carry Trade”:
“The Mexican peso slumped the most in four years, as increasing conflict in the Middle East sapped demand for the currency that has been one of the favorite targets for carry trades.
The peso tumbled more than 6% against the dollar as news began to filter through Friday of an Israel retaliatory strike on Iran, in what some in the market described as a ‘flash crash.’
The currency had climbed to the strongest in almost nine years last month, driven by relatively high local interest rates and low currency volatility.”
We can assume that global “carry trades” (borrow in cheap currencies to lever in higher-yielding instruments) have mushroomed over recent years to the Trillions, with speculative leverage seductively bolstering liquidity and asset prices virtually everywhere.
Such massive speculative leverage has become untenable.
So-called “flash crashes” are anathema to leverage.
And with the Mexican peso a major (and favored) EM currency, Thursday night’s market dislocation confirmed the backdrop has turned precarious for “carry trade” leveraged speculation.
April 19 – Bloomberg (Catherine Bosley and Matthew Burgess):
“Central banks from Jakarta to Seoul intensified the defense of their currencies, as Asia’s struggle against a resurgent dollar faced a fresh challenge from reports of armed conflict in the Middle East.
Bank Indonesia increased its interventions on Friday to support the rupiah and urged government-backed firms to avoid making huge dollar purchases.
The State Bank of Vietnam’s deputy governor said it was ready to intervene in the foreign exchange market…
With the won shy of a 17-month low against the greenback, South Korea pledged to respond immediately to excessive currency market volatility.
Asian currencies have slid precipitously against the dollar as investors lose hope of imminent reduction to US borrowing costs.”
For the week, the Mexican peso declined 2.6%, the Indonesia rupiah 2.5%, the Philippine peso 1.9%, the Brazilian real 1.6%, the South African rand 1.3%, and the Colombian peso 1.3%.
It may be a bit early to declare a full-fledged global currency crisis, but things moved decisively in that direction this week.
The situation becomes more serious when the Bank of Japan (BOJ) is forced to intervene, potentially unleashing disorderly currency trading and “flash crash” contagion across the “carry trade” universe.
Major currency crisis dynamics will be at full force when Beijing loses control of its renminbi currency peg.
It’s a challenge to envisage a more precarious environment to be locked into a dollar-peg currency regime.
April 16 – Bloomberg (Tania Chen and Iris Ouyang):
“China’s second attempt in a month to loosen its grip on the yuan is opening up the door for the currency to test a psychological milestone that hasn’t been seen since November.
The yuan will weaken to test 7.30 per dollar by the end of this quarter, according to 10 analysts polled… after Beijing moved to guide the managed currency weaker Tuesday....
While that is less than 1% from the yuan’s current level, the path leading to it will be paved with official pushback against sharp declines, they said.”
Losses are mounting throughout Asian currency markets.
The Japanese yen has declined 8.8% y-t-d, the Thai baht 7.4%, the South Korean won 6.8%, the Taiwanese dollar 5.6%, the Indonesian rupiah 5.3%, the Malaysian ringgit 4.0%, and the Philippine peso 3.9%.
China’s vulnerable currency is today tethered to a surging dollar, while its struggling export sector confronts competitors benefiting from devalued currencies.
Beijing would surely prefer to relax the peg and weaken the renminbi.
Understandably, maintaining stability remains a top priority.
So, officials are left to yearn for a gradual and smooth currency devaluation.
But any indication that Beijing has decided to loosen the peg triggers trepidation of a disorderly devaluation.
Why would one wait to withdraw funds from China, with devaluation only a matter of time?
With rising risks of disorderly devaluation and capital controls?
Meanwhile, the currency derivatives time bomb ticks.
Ongoing bank renminbi support only exacerbates already heightened banking system risks, while market players are given additional time to accumulate currency hedges.
April 16 – Bloomberg:
“A selloff in Chinese small-cap stocks extended Tuesday as tighter market oversight pledged by the cabinet sparked fears over the delisting of those with weak financial health.
The CSI 2000 Index fell 7.2%, taking the decline this week to 11%.
The CSI 300 Index, which tracks mostly blue-chip firms, outperformed.
The benchmark slipped 1.1% after rallying more than 2% on Monday.
Traders are reacting to a late Friday statement by the State Council, which vowed to strengthen stock listing criteria and urged companies to improve corporate governance and beef up dividend payouts.”
China’s small cap CSI partially recovered, reducing the week’s losses to 5.5%.
The index is down 18.7% y-t-d.
Recall that China’s small cap indices crashed to multi-year lows during the February hedge fund (“quant”) crackdown.
This week’s disorderly trading points to intensifying speculator de-risking/deleveraging pressures.
It’s worth noting that Tuesday’s China small cap meltdown corresponded with equity market downdrafts throughout Asia.
Japan’s Nikkei 225 slumped 1.9% in Tuesday trading, on its way to a 6.2% pounding for the week.
South Korea’s Kospi fell 2.3% Tuesday (down 3.4% for the week), Taiwan’s TAIEX 2.7%, (down 5.8%), Thailand SET Index 4.5% (down 4.3%), Philippine’s PSEi Index 2.4% (down 3.2%), and Hong Kong’s Hang Seng Index 2.1% (down 3.0%).
Hedge funds and levered speculation have proliferated throughout Asia in recent years.
Especially after this week’s drubbing, we can assume the levered players are reeling.
And with the global leveraged speculating community a key transmission mechanism between markets and geographies, unfolding trouble at the “periphery” needs to be closely monitored.
Fragile EM bond markets remained under pressure this week.
In dollar-denominated EM bonds, Indonesia yields rose 13 bps to 5.28% (one-month rise 39bps), Philippines eight bps to 5.39% (35bps), Panama 23 bps to 5.41% (50bps), Colombia six bps to 7.69% (52bps), and Brazil three bps to 6.73% (25bps).
Over the past month, local currency bond yields were up 116 bps in Turkey, 66 bps in Colombia, 61 bps in Brazil, 58 bps in Mexico, 52 bps in Hungary, 50 bps in Peru, and 50 bps in the Philippines.
I would typically expect stress at the “periphery” to take some time to be transmitted to the “core.”
Moreover, the “core” might even enjoy temporary liquidity benefits from “periphery” risk aversion.
Not today.
That the “core” today faces acute endogenous de-risking/deleveraging risk is an alarming aspect of the current environment.
Friday afternoon Bloomberg headlines:
“‘Mag Seven’ Get Crushed to Lead Losses in Stocks” and “Tech Stocks’ Biggest Weekly Rout Since 2022 Roils Markets.”
Friday trading action was the type that tends to foreshadow a panic.
One of history’s most over-owned stocks and Crowded Trades, Nvidia posted a one-session loss of 10%.
Netflix sank 9.1%, Advanced Micro 5.4%, Micron 4.6%, and Meta Platforms 4.1%.
The Semiconductors 4.1% Friday loss pushed the week’s loss to 9.2% - the largest weekly loss since July 2022.
The Nasdaq100’s (NDX) 5.4% weekly drop was the largest since November 2022.
These stocks and indices are the favorites for the option-trading crowd.
I won’t dive deeply, but it’s a good time to emphasize that inflating fundamentals become a key facet of Bubbles.
And I have never seen this dynamic play out as powerfully as it has throughout AI.
A late Friday CNBC headline:
“Investors Are Hoping Big Tech Earnings Next Week Could Revive a Flagging Bull Market.”
Stock prices ebb and flow, but I wouldn’t count on earnings to revive the Bubble.
European semiconductor heavyweight ASLM missed earnings badly, while powerhouse Taiwan Semiconductor turned more cautious on the outlook.
Global financial conditions have tightened, and more significant tightening is likely.
The AI Bubble is a creature sustained by loose conditions.
Loose market conditions fueled self-reinforcing speculative excess that stoked only looser conditions and a historic mania.
Loose conditions and melt-up dynamics fed the illusion of unlimited cheap finance to fund endless data centers (loaded with hardware) and AI spending plans around the globe.
The tech industry is today all geared up for a massive AI build out that will now confront a problematic tightening of global conditions and crisis dynamics.
April 16 – Bloomberg (Craig Torres):
“Federal Reserve Chair Jerome Powell signaled policymakers will wait longer than previously anticipated to cut interest rates following a series of surprisingly high inflation readings.
Powell pointed to the lack of additional progress made on inflation…, noting it will likely take more time for officials to gain the necessary confidence that price growth is headed toward the Fed’s 2% goal before lower borrowing costs.
If price pressures persist, he said, the Fed can keep rates steady for ‘as long as needed.’
‘The recent data have clearly not given us greater confidence and instead indicate that is likely to take longer than expected to achieve that confidence,’ Powell said…”
It's late in the game for Powell, John Williams and other Fed officials to rethink their dovish pivot.
The damage of signaling easier conditions in the throes of loose market conditions and Bubble excess has been done.
And it’s not hyperbole to assert that this damage could prove catastrophic.
Analysts clinging to forecasts of multiple 2024 rate cuts may yet be proven correct.
Money Market Fund Assets sank $112 billion last week, the second largest decline ever.
It’s worth noting that this outflow exceeded the week of October 18th, when $98 billion exited the money fund complex.
That big October outflow was the largest since $169 billion fled during the week (9/17/08) of the Lehman collapse.
Tax payments undoubtedly played a role in last week’s outflow (as they apparently did last October), but there’s more to the story.
Last October’s big outflow also unfolded as financial conditions tightened.
Yields were spiking higher (10-year Treasury yields traded to 5.0% on 10/19), CDS prices were surging (i.e., high yield CDS traded to 531bps on 10/20), and global currencies were faltering (i.e., yen and renminbi near multi-decade lows).
Geopolitical risks were elevated following the October 7th Hamas terrorist attack and Israeli response.
In short, financial conditions were tightening, and de-risking/deleveraging risks were rising.
The Fed would soon be talking rate cuts.
As the dominant intermediator of “repo” securities finance, the money market complex is integral to leveraged speculation and marketplace liquidity.
After October’s big outflow, Money Fund Assets would inflate one-half a Trillion to a recent record high of $6.112 TN (17-month gain of $1.5 TN, or 33%).
I would not be surprised if last week’s big outflow marked an inflection point in both leveraged speculation and system liquidity excess.
Ten-year Treasury yields traded up to 4.69% intraday Tuesday, the high back to November 1st.
MBS yields jumped to 6.22%, with a 13-session 65 bps surge.
It’s ominous to see Treasury yields spike in the face of a fledgling global currency crisis and acute geopolitical risks.
A confluence of developments risks a highly destabilizing de-risking/deleveraging.
Dollar strength and rising global yields are placing significant pressure on global “carry trades.”
“Hot money” outflows and increasingly fragile currencies are forcing central bank interventions.
The attendant liquidation of Treasury holdings fuels a self-reinforcing rise in global yields.
Here at home, rising Treasury, MBS, and corporate yields spur hedging-related sales and some deleveraging.
Sinking tech stocks and related indices (i.e., NDX and SOX) trigger the unwind of margin debt, while forcing derivatives-related selling/deleveraging.
Deleveraging in both fixed-income and equities marks a fundamental shift in the market liquidity backdrop.
But here’s where things get more interesting.
I’ll assume Treasury and MBS “basis trade” (leveraged holdings of Treasuries/MBS matched against short futures contracts) leverage so far remains unaffected by rising yields.
But highly levered “basis trades” are inherently vulnerable to unexpected bouts of market illiquidity and dislocation (i.e., March 2020’s market dislocation).
The now unfolding global de-risking/deleveraging risks unleashing a cycle of waning liquidity, market dislocation and crisis.
If “basis trade” deleveraging takes hold, crisis dynamics would immediately gain powerful momentum.
While bank stocks posted solid gains this week, bank CDS price moves were notably un-bullish.
JPMorgan’s nine bps two-week CDS jump was the largest in almost a year, with Bank of America’s two-week nine bps gain the largest since October.
My fears may come to fruition.
For a while, I’ve been contemplating a scenario where the Fed would be forced to respond aggressively to de-risking/deleveraging despite elevated inflation and bond market vulnerability.
I’ve asserted that more large-scale QE and major central bank balance sheet inflations are inevitable.
There’s just an egregious amount of debt and speculative leverage overhanging global stability.
I see today’s currency instability and bursting tech Bubble as harbingers of impending market and central bank crises.
Little wonder Gold has gained 15.9% y-t-d to $2,392 and Silver 20.6% to $28.69.
0 comments:
Publicar un comentario