Retail money tends to chase returns, resulting in a "positive" rather than a "negative" feedback loop, where mean reversion simply falls by the wayside.
As we hurtle toward the absolutely critical months of September and October, the unraveling of the global financial system is beginning to accelerate.
Asset price inflation, a disease whose source always lies in monetary disorder, is not a new affliction. It was virtually inevitable that the present wild experimentation by the Federal Reserve - joined by the Bank of Japan and ECB - would produce a severe outbreak. And indications from the markets are that the disease is in a late phase, though still short of the final deadly stage characterized by pervasive falls in asset markets, sometimes financial panic, and the onset of recession.
The week's weakness started with the surprise yuan devaluation, but the moves in everythingfrom crude oil to U.S. government debt signal that investors and traders are telling the Fed to hold off for now. Will U.S. policymakers listen? Make no mistake: the Fed marches to its own data-dependent drum. These indicators will only tell you if the central bank has the right tempo to support markets.
"We were convinced that a top has been formed over the course of the last several months and we were willing to be short but the Chinese devaluation has wrought havoc upon us, catching us and everyone else out. As we write, the September t-note future is trading 128 ¼ and that is ¼ point above our “close only” stop."
Fat-Finger, Flash-Crash, or Forced Liquidation... either way, something broke in the Italian bond futures market...
There was some serious fireworks in the Treasury market overnight, and especially just before the PBOC decided to intervene in the market not once but twice to undo at least some of the devaluation it caused earlier in the trading session. In fact, at one point the yield on the 10Y tumbled as low at 2.05% before levitating higher courtesy of Beijing (which may well have dumped some TSYs just at that moment to prop up the CNY), even as across the pond Germany's 2 Year bond dropped to a fresh record low. So what happens next? Well, it's not like the sellside is very useful in actually providing actionable advice when something not in the script happens, but for the record here, courtesy of Bloomberg, is what the 'experts' are saying.
As we noted earlier, the most surprising development out of this mornings repeat rout in the Chinese currency was not that it happened: after all as we laid yesterday out there is at least 10-15% in immediate downside left for the Yuan but that shortly before the market close, China's central bank intervened via "at least one major Chinese state-owned bank sold large amount of dollar shortly before market closed, prompting rapid gain in yuan, according to two traders at onshore banks" Bloomberg reported adding that at least one state bank continuously sold dollar until USD/CNY reached around 6.38.
- China central bank under pressure to weaken yuan further (Reuters)
- Currency Rout Goes Global as Jen Sees Risk of 50% Loss on China (BBG)
- Europe Stocks Fall Most in Two Weeks as China Sparks Growth Fear (BBG)
- German Yields Drop to Record as China Boosts Bonds Around World (BBG)
- FT to Japan, Economist to Italy: Agnelli Family Raises Stake in Economist as Pearson Exits (BBG)
- Goldman Sachs to Give Out ‘Secret Sauce’ on Trading (WSJ)
- Greece's Preliminary Bailout Deal Faces German Turbulence (BBG)
The overnight market has been a repeat of yesterday's action, when following China's repeat 1.6% devaluation of the CNY (which was to be expected since the PBOC made it quite clear the fixing would be based off the market value, a value which continues plunging), the second biggest in history following Monday's 1.9% plunge, traders appeared stunned having believed the PBOC's lies that the devaluation was a one-off and as a result the E-Mini tumbled overnight, and is now 30 points lower from last night's PBOC fixing announcement, trading at around 2058, and far below the "magical" 200-DMA support line, which has now been solidly breached.
Overnight the world realized that there is much more devaluation to come, which in turn led to a tidal move higher in the EURUSD as the European banks who had been short the EURCNH (probably the same ones that were long the EURCHF in January ahead of the SNB shocker) continued covering their exposure, and in turn pushed the EURUSD well above 1.11, while the CHF continued to tumble alongside the USD at least when it comes to Europe. In Asia, and local emergin markets, however, it was a different FX story enitrely.
This devaluation is likely not a one-time event but rather the beginning of an ongoing and persistent depreciation of the CNY versus the USD. The embedded USD short position within the carry trades will begin to result in losses and margin calls as the USD appreciates versus the CNY, thus forcing investors to liquidate some of their positions. These trades, which took years to amass, could unwind abruptly and exert an influence of historic magnitude on markets and economies.
On a broader level, the devaluation signals PBOC’s eagerness to join the global currency wars. With the competitive devaluation by various central banks gaining momentum but global trade slowing, the latest CNY devaluation could be seen as likely to force other central banks to consider similar measures before long. One currency that so far has successfully weathered the storm has been JPY... so far...
US equity markets have given up almost all of yesterday's irrational exuberance ramp gains in a perfect echo of last week's Wednesday/Thursday debacle. Bond yields are plunging - also retracing all of yesterday's losses (with 2Y -5bps since Friday now). Europe is suffering most as EUR strengthens (as it was the most popular carry trade against China), driving USD weakness and sending European stocks lower (DAX is dumping almost 3%). And finally commodities are seeing Crude and copper crushed as PMs bounce...
The entire US Treasury complex has seen yields plunge following last night's "surprise-that-everyone-except-Wall-Street-economists-saw-coming" Yuan devaluation. While there are numerous factors driving the rally in bonds, RanSquawk notes two crucial ones... that will likely persist...