Doug Noland: The Wrath

When it comes to the late-stage of a major Credit Bubble, the analysis in a way simplifies: The Bubble bursts or it inflates to only more perilous extremes. Recalling 2007, well-entrenched Bubbles develop powerful momentum with the capacity to brush off even significant shocks. Such resilience works to bolster already powerful bullish market sentiment, associated flows and speculative impulses (and “inflationary biases” more generally). This dynamic helps explain why Bubbles can go to such extremes before catching almost everyone by surprise when they eventually falter.

The Wrath

It’s not the first time that a non-farm payrolls rally wiped away inklings of market anxiety. Coming early in the month – and on Fridays – the jobs report typically makes for interesting trading dynamics. By the end of another interesting week, the timely reemergence of “goldilocks” along with Trump The Deregulator were propelling stocks higher. Long forgotten were Monday’s “Stocks Fall Most in Month…” and “Trump Rally Hits Speed Bump on Immigration Concern.” Indeed, markets were grateful to let a number of developments slip from memory.

It’s still worth mentioning a few indicators that were beginning to lean away from “Risk On”. Prior to Friday’s jump, the powerful bank stock rally had stalled. The BKX was down almost 2% from Thursday to Thursday (Italian and Japanese banks down 3.4% and 2.9%). Small cap stocks have underperformed, with the Russell 2000 down slightly y-t-d as of Thursday’s close. Many “Trump Rally” stocks and trades have recently underperform. Equity fund flows were negative for three straight weeks. In high-yield debt, the rally had similarly lost momentum. Also noteworthy, Treasuries rallied only tepidly on Monday’s equity market selloff. European bonds continue to trade poorly (Greek yields up 33 bps; French spreads to bunds widened another 10bps). This week saw bullion jump $29. The dollar Index is now down 2.5% y-t-d.

The dollar/yen has for a while now been a key market indicator. After trading as low as 101.2 on election night market drama, Trump-induced king dollar euphoria had the dollar/yen surging to almost 119 by early January. The dollar/yen traded down to almost 112 on Thursday, to a two-month low. And similar to Treasuries, the dollar/yen these days struggles to participate during “Risk On” days. Trading slightly higher Friday, the yen jumped 2.2% against the dollar this week.

February 1 – Reuters (Sinead Carew and Jamie McGeever): “U.S. President Donald Trump and a top economics adviser on Tuesday unleashed a barrage of criticism against Germany, Japan and China, saying the three key U.S. trading partners were engaged in devaluing their currencies to the harm of American companies and consumers. The comments from Trump at the end of a White House meeting with pharmaceutical executives, as well as from trade adviser Peter Navarro…, were the starkest indication yet that the first-term Republican president is prepared to jettison two decades of ‘strong dollar’ policies advocated by predecessors dating back to the Clinton administration. The criticism also signals a weakening of the U.S. commitment to an agreement among the financial leaders of the world’s top 20 economies, struck after the 2008 financial crisis, that countries would not pursue policies to target exchange rates for competitive purposes.”

February 2 – Nikkei Asian Review (Mikio Sugeno): “By accusing Germany and Japan of intentionally devaluing their currencies, the Donald Trump administration has attacked normal monetary policy designed to maintain healthy inflation, a dangerous step that could upend an understanding long shared by major economic powers. It was a moment Haruhiko Kuroda had been dreading. The Bank of Japan governor told reporters Tuesday after the central bank’s two-day policy meeting that the new U.S. administration is still taking its first steps, and that the BOJ ‘will see how things play out.’ He knew anything he said could be misconstrued. Several hours later, the president called out China and Japan by name as having devalued their currencies over the course of years: ‘They play the money market, they play the devaluation market’ while the U.S. sits idly by, Trump said.”

This week offered some important clarity: Trump is no devotee of king dollar, while he views QE as a mechanism for currency devaluation. Oh, how the world is changing. Throughout the markets, king dollar has been integral to recent global risk embracement. I’ll assume global “Risk On” has been fueled in part by significant carry-trade speculative leveraging (short yen, euro, swissy instruments to provide financing for higher-yielding securities elsewhere). There are now major uncertainties that should ensure heightened currency market volatility going forward. This creates a less compelling risk vs. return calculus for carry trade leverage, increasing the probability that, once commenced, a de-risking/de-leveraging dynamic could become self-reinforcing.

February 3 – Bloomberg (Randall Jensen): “Asia’s two biggest central banks moved in opposite directions on Friday. In Beijing, the People’s Bank of China tightened monetary policy by raising the interest rates it charges in open market operations. In Tokyo, the Bank of Japan intervened in the bond market to reassert control over 10-year yields it has promised to anchor around zero… The backdrop: growing tensions with the U.S. as President Donald Trump accuses both China and Japan of unfair trading practices and keeping currencies low, and expectations the Federal Reserve is gearing up for multiple rate increases this year. ‘The world’s no longer synchronized, with the Fed’s tightening posing challenges for central bankers across Asia and beyond,’ said Frederic Neumann, co-head of Asian economic research at HSBC… ‘Asia’s got one foot on the gas, and one on the brake.’”

February 3 – Wall Street Journal (Shen Hong): “China’s central bank raised key interest rates in the money market Friday, reinforcing a shift toward tighter monetary policy aimed at deflating asset bubbles and reducing long-term financial risk. The latest effort by the People’s Bank of China follows a similar decision shortly before the weeklong Lunar New Year holiday to increase the borrowing cost on special loans to a select group of commercial lenders, a move widely interpreted as an effective policy interest-rate increase.”

February 2 – Bloomberg (Chikako Mogi and Masaki Kondo): “The Bank of Japan whipsawed markets as it fought to assert control over rising bond yields. The Japanese central bank first disappointed with a smaller-than-expected increase in bond purchases Friday morning, which spurred the 10-year yield and the yen to advance. Its unscheduled offer later to buy an unlimited amount of debt for some maturities sent rates and the currency falling. ‘The operation was a surprise aimed at definitely stopping the rise in yields,’ Takenobu Nakashima, quantitative strategist at Nomura… ‘What’s astonishing is that the BOJ is offering to buy at yields lower than where the markets are. In other words, the BOJ will pay to buy, showing that it wants to halt the yield even at its cost.’”

The overarching thesis for 2017 holds there’s a high probability for a tightening of global monetary conditions that would catch inflated markets extraordinarily vulnerable. In short, the Crowded King Dollar Trade is exposed to Trump Administration antipathy toward dollar strength, with potential implications for market de-leveraging (waning liquidity). Secondly, the two major sources of global QE/liquidity – the ECB and BOJ – are more susceptible to policy reassessment than generally perceived by complacent markets. Both central banks are trapped in flawed policies, and both are poised to be on the receiving end of The Wrath of Trump. What’s more, the Japanese have traditionally accepted U.S. direction with obedience. (The BOJ must be wondering what happened to Bernanke’s “enrich thy neighbor”.) Third, Beijing officials seem seriously determined to try to rein in China’s out of control Credit Bubble. This increases the odds of a major Credit event unfolding in China in 2017, with all the associated policy, market and economic uncertainties.

When it comes to the late-stage of a major Credit Bubble, the analysis in a way simplifies: The Bubble bursts or it inflates to only more perilous extremes. Recalling 2007, well-entrenched Bubbles develop powerful momentum with the capacity to brush off even significant shocks. Such resilience works to bolster already powerful bullish market sentiment, associated flows and speculative impulses (and “inflationary biases” more generally). This dynamic helps explain why Bubbles can go to such extremes before catching almost everyone by surprise when they eventually falter. The VIX dropped 10% during Friday’s rally, punishing those that were tempted to play for a market reversal with cheap option trades. The VIX closed the week at 10.79, trading Friday at the lowest level since early 2007.

To be sure, option pricing fails to reflect political uncertainties. This week our President put many “on notice”, foe and friend alike. The Wrath list included Iran, China, Germany, Mexico, the ECB and BOJ, and even our dear friends in Australia. A U.S. television commentator quipped that it really takes a lot to get Australians upset with America, yet President Trump found a way. If the stock market had been under significant pressure this week, the rumblings questioning our President’s competence and emotional stability would have ratcheted up.

So many fascinating developments and perspectives:

February 2 – UK Independent (Ben Chu): “‘In many respects we’re coming to the last seconds of central bankers’ fifteen minutes of fame which is a good thing,’ Mr Carney told the Bank of England Inflation Report press conference, referencing Andy Warhol’s line about everyone in the world being famous for fifteen minutes in their lives in the future.”

And there was the Bloomberg article, “Finance Makes America Great, Say Larry Summers, Joe Ricketts.” “…Finance and economic life work best when they are based on openness, transparency, principle and are free from political motivation,’ Summers said, adding that independent central banks, strong currency, common rules, and ‘no ad hoc threats or bribes from public officials, no matter how powerful, are what make the market system function best… There’s something else you learn at the Museum of American Finance,’ Summers said. The U.S. is an exceptional nation ‘because of what it has strived to achieve for the last 75 years in the global system.’”

The problem is that finance doesn’t make America great. The global “system” today is nothing as imagined 75 years ago and, for good reason, most people in the world have little trust in international finance. Central banks are not independent and “finance and economic life” have been anything but free from “political motivation.” Instead, unfettered global finance and central bank-led inflationism have created serial booms and busts that evolved into today’s perilous financial, economic, social and geopolitical discord. The unprecedented inflation of finance is fundamental to the problem – and not, as should be abundantly obvious by now, constructive when it comes to finding a lasting solution.

I could only chuckle at the headline: “Dan Loeb: Trump Will Make Hedge Funds Great Again.” In a meeting with pharmaceutical executives earlier in the week, a delightful President Trump promised to slash regulation and red tape. But he just needs a little something in return from the industry: Dramatically Lower Prices. The Art of the Deal.

Our new President and his Administration are at this point an enigma. Folks are beginning to accept that he’s not going to change, which is none too comforting to many. Shock and dismay understate reactions both at home and abroad. Yet when it comes to financial markets, when anxiety begins to strike simply repeat, “de-regulation, tax cuts, de-regulation, tax cuts…” The President certainly has everyone’s attention, with Wall Street and corporate America having donned kid gloves.

But I don’t believe anyone is comfortable that they understand what the President and his inner circle really have in mind. Whatever it may be, they’re going to be in your face tough and idiosyncratic. How big of a conflict are they willing to accept early in the new Administration? At the end of the day, I suspect they don’t share the view that America will be made great again through hedge funds, inflated securities prices and ever greater quantities of “money” and Credit. Sure, they’ll play the game so long as they see it to their advantage.

Markets, of course, remain convinced that buoyant securities prices are more indispensable than ever – and that Trump will bluster but knows better than to mess with the markets or their benefactor, central banking. Not that they’re in any hurry to burst Bubbles, but the Trump folks have their own perspectives, ideas and ambitions. I suspect that Carney’s “15 minutes of fame” comment resonates within The Inner Circle. A new era has commenced, and these central bankers and Wall Street icons have occupied the limelight for too long already.


Original Post 4 February 2017

Categories: Doug Noland, Perspectives