Macro Digest: Market is ripe for risk, surprisingly (Stress Indicators)

Dear All,

 

This weeks look at Stress Indicators is now online  (Please if possible you link as its gives you better charts….plus PDF attachment with all the indicators for your "consumption".

 

http://www.tradingfloor.com/posts/market-ripe-risk-surprisingly-1725178060

 

Upon running Saxo Bank's Stress Indicators this morning I was very surprised to see that most indicators are now very clearly in a risk-on mode. I would have expected the Syrian conflict, high oil prices, the Italian banking mess and the anticipation of upcoming tapering of asset purchases by the Federal Reserve to have done more damage to these indicators.

AUD versus JPY - ultimate risk indicator
AUD versus JPY is the 'ultimate risk indicator' because it is the one currency pair that captures: China (AUD), Asia (AUD, JPY), growth, carry trading and trade volumes. 

Fisher-Gartman risk index
Note that the Fisher-Gartman risk index is making new highs. This risk index is like many others predominantly designed to use daily data points which always means rate spread and VIX volatility. The conclusion which can be drawn from this index is clear, particularly on a day where US Congress votes on intervention in Syria and where we are one week away from one of the most defining moments in Federal Reserve Chairman Ben Bernanke's reign (the Federal Open Market Committe meeting on September 17-18) and it's apparent that the market could not care less.

This leaves us with two interpretations:

1. Our old mantra of the potential for year-highs here in September based on markets resetting the outlook for growth and hence the amount and timing of Fed tapering. (1770/1800 should be the 'ideal' target if this is for real.)
2. Misalignment of perception and reality of the market. The one indicator which is 'off' in our sampling is real rates, which are setting new highs every day. Considering that the world, at least the financial world, has barely survived on zero interest rates since the Lehman Brothers collapse in 2008 (exactly five years ago this month), then this is deeply concerning.

Fed's bigger issue - lack of reaction to forward guidance
We have already seen the housing market cool, and certainly Friday's non-farm payrolls data was a major disappointment for the 'green shooters'. The Fed uses the wording "substantial improvement" of the economy (unemployment), but I do not think that even the Fed believes that lower unemployment rates via less participation constitutes real improvement.

See Mike Shedlock's piece: Just how distorted is the U.S Unemployment rate number?

The Fed's bigger issue though is its inability to get the market to react to its forward guidance, hence I expect vice Fed chair Janet Yellen to force through an extension of "low for even longer...", extending the zero-bound calendar for rates by one year to 2016 (Mid-2015 the consensus for now - Fed Chicago link). I also expect Fed staff to bring the Fed's growth forecast down from 2.45 percent for 2013, closer to Wall Street's consensus of 1.6 percent, combined with a worst very light touch of tapering (i.e: USD 10 billion - with USD 5 bln each in mortgages and Treasuries).

 10-year Treasury note yield index

Source: Saxo Bank and StockCharts.com

Fixed income market set on tapering
It is apparent that the fixed income market has already decided that the Fed will go ahead with a slow unwinding of asset purchases but also that the Fed's forward guidance should not be followed. This is evident because short-term rates have risen relatively more than long-term rates. We are testing a very long-term trend in the US 10-year yield.

I have taken a stance as per my video on being 80 percent in bonds, but it's a 12-month call based on considerable cooling of of the economy, as higher rates, lack of reforms, spending cuts, fiscal constraints, and less China growth will get both the US and Germany zero-bound in 2014.

Peak in September for green shoots
I remain probably alone in thinking that we are seeing a peak here in September for green shoots, the gap between perception and reality of Fed's action but also for flow out of fixed income. The big fixed income names have seen their AUM drop dramatically, but with 10 year rates @ 3.00% - I feel the "relative" value is in fixed income with the added bonus of having a "free put" on the stock market going into a September and October which generally tends to test our nerves:

See also Zerohedge: 1987, 2008 and 2013?

Finally, we have been constructive on the US dollar but feel it's time to change direction for a test of 78.00/79.00 in DXY - the US dollar index. The catalyst, if possible, could be the above-mentioned 'QE not tapering is coming' - or more directly, the emerging market crisis which has left USD-based EM countries in dire need of relief through a cheaper US dollar. World growth needs a weaker USD and it will probably come via the terms of trade. If not, the current account trend we have spoken so often about - Asia and EM from 5-7 percent CA surplus to zero-bound CA - will go negative before improving.

It's a hard call to make, especially against Europe and EURUSD. For now though, as the recent September BIS FX survey shows, 87 percent of all FX trades are based on the US dollar as being one of the currency pairs. Alas, the path of least resistance seems to be a weaker rather than stronger USD.

US dollar index - cash settle

_{Source: Saxo Bank and StockCharts.com}

Safe travels into the September 17-18 FOMC meeting and the coming Syria conflict.

Steen Jakobsen

 

 

 

Med venlig hilsen  |  Best regards
Steen Jakobsen  |  Chief Economist

 

Saxo Bank A/S  |  Philip Heymans Allé 15  |  DK-2900 Hellerup
Phone: +45 39 77 40 00  |  Direct: +45 39 77 62 23  |  Mobile: +45 51 54 50 00

 

Please visit our website at www.saxobank.com

 

This email may contain confidential and/or privileged information.
If you are not the intended recipient (or have received this email
by mistake), please notify the sender immediately and destroy this
email. Any unauthorised copying, disclosure or distribution of the
material in this email is strictly prohibited.

Email transmission security and error-free status cannot be guaranteed
as information could be intercepted, corrupted, destroyed, delayed,
incomplete, or contain viruses. The sender therefore does not accept
liability for any errors or omissions in the contents of this message
which may arise as a result of email transmission.