Steen's Chronicle: Bubbles, regulation and credibility
Positions:
UW Fixed Income (Gov + Credit)
OW US$ (vs. JPY, AUD and NZD)
UW Gold+ Silver
OW Cash .
(Overweight(OW) vs. Underweight(UW)
I did some extensive sharing of charts on both Tradingfloor.com & Twitter.com this Sunday (click on links to see them) – also below the piece I have written earlier this month on some of the main issue.
Why Bubbles, regulation and credibility?
I think it explains the sea change in markets perception of QE and what is to come and most importantly it explains why Fed will hike rates despite having zero economic grounds to do so.
Bubbles – Fixed income is clearly in massive bubble – anyone willing to argue -40 bps or even -60 bps makes sense is short of experience in this market and even worse if highly educated and brilliant economist like Fed's Vice-chairman Stanley Fischer can state that "negative rates is working more than I expected" when he only needs to call a Danish or Swiss Bank to get the "real story" is simply scary – and by the way: BOJ NIRP has worked brilliantly, right?
Furthermore the massive cross-asset-correlation, Xcross, has made it impossible to hedge or run for cover:
Lower for longer is no longer a clear future path, maybe this chart explains why?
Clearly the one thing central banks wants to raise: inflation is not working – and by the way QE3 did same damage to the US!
With ECB failing to "deliver" more of same – the yield curves in Germany (and Japan has steepened and surprise, surprise we are suddenly back to ZERO interest rates from deeply negative!)
Japan 2 vs 10 Y yield curve
Japan and German 10 Y yield
Regulations – In my opinion the October change to Money Market funds in the US is one of the biggest events in 2016, and the reason for this is that it dries out the funding for foreign banks in the US and Commercial Papers programs:
For those of you not yet familiar with these changes here is Vanguard customer briefing:
https://personal.vanguard.com/pdf/VGMMR.pdf
Basically due to Lehman Prime Funds can no longer guarantee the "buck" – or NAV of 1$ - instead they need to trade at actual NAV – this has made Prime Fund less "safe" and since October 2015 500 billion US$ has left Prime Funds.
Prime Fund v.s Government Money Funds have one product in difference: Ability to buy Commercial Papers issued in the US (Foreign banks being bigger users of this facility)
Total Asset in Prime Funds (US$)
SO…..500 billion US$ is missing in "funding"…which has meant:
Higher LIBOR, TED spreads and Cross Currency Funding costs:
Three month LIBOR (ICE)
TED spread
JPY cross currency swaps(1 yr)
J
Credibility – Fed and central banks overall have little credibility left – Fed promised even guaranteed us three to four hikes in 2016 – now they are desperate for "normalisation" despite the economic data remaining dodgy, but… they are now privately and publicly addressing the fact that "too low for too long…creates misallocation of capital and social injustice…" – A remarkable admission, although above charts on inflation or lack of it must be huge disappointment for them!
This is their solution to the inequality – not to continue feeding it….and more important I think Fed wants/needs/understands that not delivering hike is end of their communication policy, fortunately for them there is good news from overseas as China PPI this week marches further and closer to being positive again.
China Producer Prices has led world into deflation now it looks like its coming back again..
China PPI (YoY)
The Fed is almost forced to move to show market we can actually count on them…..of course this is my private estimation but why not use a stock market at all time high, combined with fixed income yields at all time low to take some credibility back – historically Fed would have hike margins several times on the bank, but in today's world of never crisis management this is a non-starter.
Fed always cut rates on sell-off in market, I think market is starting to add two and two together and finding out that: Yes, Fed needs to hike, Market needs higher rates, world can't continue to be sit around and wait for next Fed, BOJ or ECB meeting.
Too high correlation between assets kills – always – and complacency rules supreme.
Conclusion
The above is summary of factors in play – of course there are a lot of things I left out, but throughout this crisis only one rule stood its test: The price of money dictates everything – for first time in eight years market is now all of sudden in doubt, and policy makers more so. This may not be the last pretend-and-extend but now the two way trading have started, the best sign I have seen in years!
Safe travels,
Steen Jakobsen
Chief Investment Officer, Saxo Bank A/S
PS:
Saxo Bank hosts a daily morning call where our traders and strategists from the #SaxoStrats team review the key overnight developments and give their views on trading ideas as well as current themes and drivers across the major asset classes. The call starts at 8.40 CET and lasts no more than 15 minutes, with a recording posted as a squawk in the SaxoTrader later in the morning. To join us each morning, click on the below link and log in as a guest. You can also follow on your mobile. http://MorningCall.Saxo
My links.
Macro Digest: SEC's new rules might trigger liquidity crisis (August 31st, 2016)
https://www.tradingfloor.com/posts/macro-digest-secs-new-money-market-rules-liquidity-crisis-8030302
Steen's Chronicle: Fed delivery too little, too late — USD boosted (August 22nd, 2016)
Macro Digest: Bond alert and why China rules the world (August 10th, 2016)
https://www.tradingfloor.com/posts/macro-digest-bond-alert-and-why-china-rules-the-world-7982310
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