Price Action

In an age of economic policy activism, including widespread quantitative easing and associated purchases of bonds and other assets, Amphora's John Butler reminds us that it is perhaps easy to forget that foreign exchange intervention has always been and remains an important economic policy tool. Recently, for example, Japan, Switzerland and New Zealand have openly intervened to weaken their currencies and several other countries have expressed a desire for some degree of currency weakness. In this report, Butler summarizes the goals and methods of foreign exchange intervention and places today’s policies in their historical context; but moreover he discusses the evidence of where covert intervention - quite common historically - might possibly be taking place: perhaps where you would least expect it... And if the currency wars continue to escalate as they have of late, it seems reasonable to expect that covert interventions will grow in size, scope and frequency.

As the global equity and bond markets grind ever higher, abundant signs exist that we are once again living through an asset bubble – or rather a whole series of bubbles in a variety of markets. This makes this period quite interesting, but also quite dangerous. This can be summarized in one sentence:  How could this be happening again so soon?

Chaos Theory turns 50 years old this year, celebrating half a century of flapping butterfly wings in Brazil creating tornadoes in Texas.  That most famous example is especially appropriate, since it was a meteorologist named Edward Lorenz who first outlined why seemingly consistent and knowable systems can still go wildly wrong.  As it turns out, as ConvergEx's Nick Colas reminds us, small errors in measurement or observation at the start of a time series can significantly change how things look at the end.  In the current low volatility, one-variable central bank driven global equity markets, Chaos Theory may seem a quaint relic of past crises.  However, its central lesson – that complex interrelated systems create unexpected outcomes from seemingly benign inputs – is still relevant.  Students of economics like to think of their discipline as scientific, just like physics or other hard sciences.  They would do well to embrace the intellectual honesty neatly encapsulated by the central lessons of Chaos Theory. The problem is that current market price action - that slow steady grind higher - indicates marginal buyers don’t fret very much about the future.  No matter how little we really know about it.

A look mostly at prices in the currency market and the outlook.   

Despite (or in fact 'due to' in this alice-through-the-looking-glass market) terrible data overnight in Europe and weak data this morning in the US, equities went from strength to strength thanks to a pre-European POMO vertical liftathon that pulled equities 1% higher on nothing (nothing at all). This faded but was helped into the close by a JPY-driven spurt to hold above 1650 in the S&P 500 at another all-time high (intraday) and close. Behind the scenes it was a mess though. Treasuries rallied (after recoupling with stocks) and did not play in the final hour frolicking. VIX ended the day higher (and notably divergent). High-yield credit closed weaker and credit markets are significantly divergent now as releveraging begins to bite. The USD pushed on to new highs intraday (highest since July 2010) which we are sure will help earnings. While the market has done its best to pressure the oil markets lower, today saw WTI gush higher back over $94 once again. The big story is in gold and silver which were jerked lower at around the US open (ending the day down 3.8% and 5.6% respectively on the week). As a reminder for those calling for the death of gold - AAPL is down over 8% in the last 3 days (the death of AAPL?).

So much for Europe's "recovery." In a quarter when the whisper was that some upside surprise would come out of Europe, the biggest overnight data releases, European standalone and consolidated GDPs were yet another flop, missing across the board from Germany (+0.1%, Exp. 0.3%), to France (-0.2%, Exp. 0.1%), to Italy (-0.5%, Exp. -0.4%), and to the entire Eurozone (-0.2%, Exp. 0.1%), As SocGen recapped, the first estimate of eurozone Q1 GDP comes in at -0.2% qoq, below consensus of a 0.1% drop. The economy shrank by 1.0% yoy, the worst rate since Dec-09. The decline of 0.5% qoq in Italy means that the economy has been in recession continuously since Q4-11. A 0.2% qoq drop in France means the economy has ‘double-dipped’, posting a second back-to-back drop in GDP since Q4-08. The increase of 0.1% qoq in Germany was disappointing and shows the economy is not in a position to support demand in the weaker member states (table below shows %q/q changes).

The overnight economic data dump started in China, where both exports and imports rose more than expected, at 14.7% and 16.8% respectively, on expectations of a 9.2% and 13% rise. The result was a trade surplus of $18.16 billion versus expectations of $16.15 billion. The only problem with the data is that as always, but especially in the past few months, it continued to be completely made up as SocGen analysts, and others, pointed out. The good data continued into the European trading session, where moments ago German Industrial Production rose 1.2% despite expectations of a -0.1% drop, up from 0.6% and the best print since March 2012. The followed yesterday's better than expected factory orders data, which also came at the best level since October. Whether this data too was made up, remains unknown, but it is clear that Germany will do everything it can to telegraph its economic contraction is not accelerating. It also means that any concerns of an imminent ECB rate cut, or a negative deposit rate, are likely overblown for the time being, as reflected in the kneejerk jump in the EURUSD higher.

On the third year anniversary of the flash crash, and in a week in which earnings season unwinds and in which there is very little macro news, the bulk of the newsflow happened overnight, starting with a drop in the Chinese Service PMI, which tumbled from 54.3 to 51.1, the lowest in two years, then we got Australian retail sales which dropped -0.1% on expectations of 0.4% gain, indicating that the Chinese slowdown is dragging down the entire Asia-Pac region further.  Afterwards, we got a barrage of European non-manufacturing PMI data starting with Spain, at 44.4, down from 45.3, the lowest since December (although one wonder if Spain has finally opened a branch of the BLS, reporting that unemployment actually dipped by 46.1k, on expectations of just a 2k decline, and down from 5k the prior month: how curious the timing of the "end of austerity" and the immediate "improvement" in the economy), then Italy Service PMI printing at 47.0, up from 45.5, on expectations of a 45.8 print, the highest since August 2011, French Services PMI rising modestly from 44.1 to 44.3, Germany's up from 49.2 to 49.6, on expectations of an unchanged print, all of which leading to a combined Eurozone PMI at 47.0, up from 46.6, and beating expectations of a 46.6 print.

In light of the recent violent down-and-up action in the precious metals, the Hard Assets Alliance (HAA) see three effects in the fallout. For starters, demand is off the charts: "We had four to five times as many buy orders and sell orders, both in number of trades and in volume. Far more significant buying than selling, and it’s continued throughout the week." Second, the demand we're seeing is from existing customers who are returning to buy in bigger volume as they see the precious metals as being "on sale" right now. Third, the surge in physical buying combined with tightening supply is resulting in the premium paid over spot price for physical bullion to march upwards quickly. For all of recent memory, the price of precious metals has been determined in the paper marketplace (e.g., COMEX; LBMA). That may now be changing. Should the availability of physical bullion start setting the price action, the spot price quoted in the paper market for gold or silver will become an anachronistic irrelevance.

Overview of the price action in foreign exchange and outlook for the week ahead.  

A peculiar trading session, in which the usual overnight futures levitation has not been led by the BOJ-inspired USDJPY rise (even as the Nikkei225 rose another 0.6% more than offset by the Shanghai Composite drop of 0.86%), which actually has slid all session briefly dipping under 99 moments ago, but by the EURUSD, which saw a bout of buying around 5 am Eastern, just after news hit that the UK would avoid a triple dip recession with Q1 GDP rising 0.3% versus expectations of a 0.1% rise, up from a -0.3% in Q4 (more in Goldman note below). Since the news that the BOE will likely delay engaging in more QE (just in time for the arrival of Carney) is hardly EUR positive we look at the other news hitting around that time, such as Finland saying that the euro can survive in Cyprus exits the Eurozone, and that Merkel has rejected standardized bank guarantees for the foreseeable future, and we are left scratching our heads what is the reason for the brief burst in the Euro.

It is one thing for the market to no longer pay attention to economic fundamentals or newsflow (with the exception of newsflow generated by fake tweets of course), but when the mainstream media turns full retard and comes up with headlines such as this: "German Ifo Confidence Declines After Winter Chilled Recovery" to spin the key overnight event, the German IFO Business climate (which dropped from 106.2 to 104.4, missing expectations of 106.2 of course) one just has to laugh. In the artcile we read that "German business confidence fell for a second month in April after winter weather hindered the recovery in Europe’s largest economy... “We still expect there to have been a good rebound in the first quarter, although there is a big question mark about the weather,” said Anatoli Annenkov, senior economist at Societe Generale SA in London." We wonder how long Bloomberg looked for some junior idiot who agreed to be memorialized for posterity with the preceding moronic soundbite because this really is beyond ridiculous (and no, it's not snow in the winter that is causing yet another "swoon" in indicators like the IFO, the ZEW and all other metrics as we patiently explained yesterday so even a 5 year old caveman financial reported would get it).

The commodity market is saying global growth is slowing. But, there is hope, as BofAML's David Woo notes, the US equity market is saying US consumers are still going strong; and the FX and European sovereign markets seem to believe Mrs. Watanabe is about to embark on a global shopping spree. However, like us, Woo thinks it is unlikely that these markets will all turn out to be right. At the same time, we agree completely with Woo's assessment that markets may be under pricing three macro risks: the ability of Beijing to ease policy aggressively in the face of strong home price appreciation may be limited; the positive wealth effect of US housing recovery may not be enough to offset the contractionary impact of fiscal tightening; Japanese money may stay at home longer than expected. As he concludes, "something will have to give and a major re-alignment of the markets, the odds of which are rising, will probably not be either smooth or benign."

In what may be a first in at least 3-4 months, instead of the usual levitating grind higher on no news and merely ongoing USD carry, tonight for the first time in a long time, futures have drifted downward, pushed partially by declining funding carry pairs EURUSD and USDJPY without a clear catalyst. There was no explicit macro news to prompt the overnight weakness, although a German 10 year auction pricing at a record low yield of 1.28% about an hour ago did not help. Perhaps the catalyst was a statement by the Chinese sovereign wealth fund's Jin who said that the "CIC is worried about US, EU and Japan quantitative easing" - although despite this and despite the reported default of yet another corporate bond by LDK Solar, the second such default after Suntech Power which means the Chinese corporate bond bubble is set to burst, the SHCOMP was down only 1 point. The Nikkei rebounded after strong losses on Monday but that was only in sympathy with the US price action even as the USDJPY declined throughout the session.

Another day, another muppet bites the dust.