Starving For Yield
Submitted by Nic Lenoir of ICAP
Mr. Greenspan and Mr. Bernanke have alternatively said over the past decade that monetary policy was not responsible for bubbles, could help deal with the aftermath of bubbles hence it's not the Fed's job to cool the market off, and now over the past couple years Mr. Bernanke (maybe to address the markets' worries) stated that the Fed is very aware of the risks of bubbles associated with excessive liquidity. Still though, it seems to me that the real statement should be: in an over-leveraged system prices of assets respond uniquely to the supply and demand balance for monetary liquidity. Too much cash in the system leads to bubbles, and not enough leads to a collapse. Markets are so highly correlated due to advances in technology, correlation trading, and information circulation, that the system has become completely binary and relying solely on monetary availability.
Of course because we have increased the leverage in the system massively over the past 40 years, we went from the 1960s where printing $1 could lead to almost $1 worth of activity, to today where it takes over $5 to create $1 worth of GDP. The principle is the same, but the return on investment is just getting worse, that's all. For that reason we have been using a global liquidity index to track the size of the pile of money available, as it is the sole driver of financial assets prices at this point. Our EUR-USD 3M Libor analysis in comparison to the price of EURUSD if anything highlights how the availability of USD compared to EUR dominates the fluctuations of the currency pair and also drives the pricing of all assets, especially denominated in USD.
To illustrate, the recent fall in 3M Libor is driven by money fund managers chasing meager yields down to 25bps. Speaking with a close friend who works on a CP/CD dealing desk at a major banks last night, he said that they just had their best day in 2 years and that money was piling into just about any paper that yields anything more than 25bps. If you speak to a 30Y US Treasury trader at a major dealer, he will tell you how the recent vertical steepening in the 10s/30s curve is due to real money accounts, especially out of Asia, trying to lock in decent coupons. With mortgages trading rich and the front of the curve being pancake flat, they are pushed to buy 10Y Treasuries extanding the flattening down to longer maturities which leads to a vertical steepening in the very long end: every action has a reaction...
With that in mind we understand better why US equities have been climbing their way into unjustified territory in the face of disappointing data and with a serious case for a double dip building up. That has been something we have tried to highlight and track the best we could, and led me to be bullish in the near term in equities when my big picture view is in fact extremely bearish.
We have yet to see if liquidity, which has been supported by a weakening USD (easier to borrow a cheaper currency) is going to top out soon or if the slow grind lower in Libor and credit spreads will keep guiding us higher in risk appetite. Our recent observation of the MOVE index being in a territory where anyone selling in size below current levels in history ended up being bailed out by the government makes me very worried. Watching stocks and commodities is probably the wrong indicator of the actual developing bubble that really matters: the debt bubble. Libor rates below 50bs, too tight credit spreads, and too cheap volatility markets, clearly reflect that it now takes a lot more cash in the system to generate a bit of GDP, and subsequent equity appreciation. Meanwhile the day there is a glitch it is the volatility and credit markets that will explode the most.
Taking a step back from these fundamental considerations and watching the markets technically, we see that S&P and AUDUSD which are two excellent risk proxies are getting close to huge resistance levels. I have 2 different possible count for AUDUSD, but even the bullish case indicates that a pull-back here would take us back to 0.8625. The bearish case which I favor for the bigger picture gives me 0.9185 as a major resistance obtained in two different ways. We would clearly advise to start selling here. Without beating a dead horse, S&P futures give 1,126 resistance in hourly, 1,137.50 resistance in the 10-minute chart, and 1,136/1,147 resistance on th daily chart. So this cluster of upcoming resistances, combined with AUDUSD resistance, tells us that from a technical standpoint the move in risky assets is very close to an end and it may be time to turn bearish sooner than one thinks. Even if one is bullish S&P and my Elliott count is inaccurate, I see a necessary retracement down to 1,080 and possibly 1,064 at the minimum.
Good luck trading,