People always stop and stare at traffic accidents (no matter how minor) and arguing couples (no matter how unattractive); ConvergEx's Nick Colas has the same problem with the ever-moribund CBOE VIX Index, even though it’s essentially the exact opposite of the proverbial train wreck. Even with the zombie-like march higher for US stocks, surely the uncertain state of the world would demand more than a 13-handle VIX? Well, it doesn’t; and Nick offers up some off-the-beaten track explanations for why “13” isn’t the right answer. Implied volatility should either be higher or… (gulp)… much lower. The biggest overlooked factor for both directions: the role of technology in society and commerce.
In the past months and right after implementing Quantitative Easing Unlimited Edition, the Fed began surfacing the idea that an exit strategy is at the door. With the latest releases of weak activity data worldwide, the idea was put back in the closet. However, a few analysts have already discussed the implications of the smoothest of all exit strategies: An exit without asset sales; a buy & hold exit. We have no doubt that as soon as allowed, the idea will resurface again. Underlying all official discussions is the notion that an exit strategy is a “stock”, rather than a flow problem, that the Fed can make decisions independently of the fiscal situation of the US and that international coordination can be ignored. This is logically inconsistent as we address below...
The "Excel Spreadsheet Error" In Context
As we have discussed numerous times over the past year, there is a quiet movement among the world's central banks to diversify their reserves away from the pejorative USD. Whether it is direct trade linkages, hording physical precious metals, or simply buying foreign sovereign debt, there is a trend emerging. The latest defection, as BusinessWeek reports, is Australia's plan to invest about 5% of foreign currency reserves in China. The decision "represents the first time that the RBA will have invested directly in a sovereign bond market of an Asian country other than Japan," the country's deputy governor noted, adding that this step was an "important milestone" to "stronger financial linkages" leaving Australia "better positioned to benefit from the shift in global economic growth towards Asia." Of course, palling up to its closest trade partner is a big driver, but in a somewhat barbed comment on the strength of the AUD, Lowe noted, "quantitative easing that has taken place in a number of countries is having a significant effect on exchange rates of freely floating currencies... which is clearly making for difficult conditions in certain parts of the Australian economy."
Near multi-generational low bond yields, driven at least in part (and some think in full) by the undeniably large asset purchase program (Quantitative Easing (QE)) that the US Federal Reserve has been implementing in one form or another since the 2008 Global Financial Crisis (GFC), have pushed the question of whether or not the bond market is a bubble to the front of many people's minds. However, while the chart below of over 220 years of 10-year treasury yields shows the extraordinarily low bonds yields, they have resulted from many fundamental and rational drivers (expectations of weak economic growth and safe haven flows amid the European sovereign debt crisis) in addition to Fed purchases. So while bond prices look expensive, there is nothing particularly bubbly about the bond market today.
“Recovery” has become the shibboleth constantly invoked by people running things after the crisis of 2008. Unfortunately, no such recovery was underway. It was papered over by the twin Federal Reserve policies of quantitative easing and financial repression – a combination of the nation’s central bank loaning vast new amounts of money into existence at ultra-low interest rates (hardly any interest to pay back) and creating steady monetary inflation to reduce the burden of existing debt by shrinking the dollar value of the debt. The program was a racket in the sense that it was fundamentally dishonest. The presumed purpose of these shenanigans from the point of view of the Federal Reserve and the White House was to keep the financial system stable and afloat, and therefore to keep “normal” American daily life going. Unfortunately, it was based on the unreal assumption that the financial norms of, say, 2006 could be ginned back up again, and this premise was just inconsistent with the reality of a post-Peak-Cheap-Oil world. Unfortunately, there was no organized counter-view to this wishful thinking anywhere within the boundaries of the political establishment.
Yet another round of less than impressive macroeconomic data from China and Eurozone failed to deter equity bulls and heading into the North American crossover, stocks in Europe are seen higher, with tech and financials as best performers. The disappointing PMI data from Germany, where the Services component fell below the expansionary 50, underpins the view that the ECB will likely cut the benchmark interest rates next month and may even indicate that it is prepared to provide additional support via LTROs. As a result, the EONIA curve bull flattened and the 2/10s German spread flattened by almost 3bps to levels not seen since June 2012. In turn, Bund future hit YTD peak at 146.77 and the next technical level to note is 146.89, 1st June 2012 high. However it is worth noting that the upside traction is also being supported by large coupon payments and redemptions from France, the second highest net market inflow for 2013.
In what could to grow into a class action in US courts, a Chinese woman is suing the Federal Reserve after discovering that the real value of the USD250 she put in an account in 2006 had shrunk by 30%. She claims it was the result of the Fed issuing too much money, and as The South China Morning Post reports, her son Li Zhen, the lawyer, called the lawsuit "litigation for the public good". Alleging "abuse of monopoly in issuing currency," the People's Court of Kunming has yet to rule on the litigants' demand that the Fed cease-and-desist from its quantitative easing policy. While this may seem frivolous, there are some interesting points being made that bear watching, as Li notes, since "the Fed is private institution which enjoys monopoly over the issuing of currency, US Dollar holders can sue it for printing too much money."
Caterpillar just can't catch a break. First, in January the firm was punk'd by a Chinese acquisition fraud, forcing the company to write off half of its Q4 earnings. This, of course, in the aftermath of the miss in both Q3 and Q4 earnings. And now we get the latest disappointing news from the firm as Q1 numbers are reported lower across the board.
- Q1 EPS $1.31, Exp $1.38; this includes a tax benefit of $87 million
- Q1 revenue: $13.2 billion, Exp. $13.8 billion
- Guides much lower, with revenue now seen at $57-61 billion, compared to $60-68 billion previously
- CAT forecasts profit per share of $7.00, compared to $7.00-9.00 previously.
- Operating cash flow of $900MM, but all of it generated from net working capital, i.e., inventory liquidation
- And when you can't spend on capex, you spend on buybacks: CAT to extend buyback through 2015
So much for that.
With no macro data on the docket (the NAR's self promotional "existing home sales" advertising brochure is anything but data), the market will be chasing the usual carry currency pair suspects for hints how to trade. Alas, with even more ominous economics news out of Europe, and an apparently inability of Mrs Watanabe to breach 100 on the USDJPY (hitting 99.98 for the second time in two weeks before rolling over once more), we may be rangebound, or downward boung if CAT shocks everyone with just how bad the Chinese (and global) heavy construction (and thus growth) reality truly is. One asset, however, that has outperformed and is up by well over 2% is gold, trading at $1435 at last check, over $100 from the lows posted a week ago, and rising rapidly on no particular news as the sell off appears to be over and now the snapback comes and the realization that Goldman was happily buying everything its clients were selling all along.
The main take away from events in Japan is that the BOJ shifted from a tactic of interventions (under former Governor Masaaki Shirakawa) to one of monetary policy (under current Governor Haruhiko Kuroda) . What strikes us is that the monetary policy is precisely to... well, destroy their money and in the process any chance of having a monetary policy. In our view, it was exactly because the Fed’s (undisclosed) intention was to engage in never ending Quantitative Easing, that Japan was forced to implement the policy undertaken by Kuroda. Coordination with the Fed was impossible. With Mr. Kuroda’s policy, we now have the BOJ with a balance sheet objective, the Fed with a labour market objective (or so they want us to believe), the European Central Bank with a financial system stability objective (or a Target 2 balance objective) and the People’s Bank of China (and the Bank of Canada) with soft-landing objective. It is clear that any global coordination in monetary policy is completely unfeasible. The only thing central banks are left to coordinate is the suppression of gold.
The existing (and ongoing) massive expansion of base money into the banking systems of the US, England, and Japan is without precedent. As Nomura's Richard Koo notes, at 16x statutory reserves, the liquidity 'should' have led to unprecedented inflation rates of 1,600% in the US, 970% in the UK, and 480% in Japan. However, it has not, yet. In short, Koo explains, businesses and households in these economies have stopped borrowing money even though interest rates have fallen to zero. There is little physical or mechanical reason for the BOJ’s easing program to work. But the program could also have a psychological impact - and Japanese media is on an 'inflation' full-court press currently. The risk here is that not only borrowers but also lenders will start to believe the lies. No financial institutions anticipating inflation could ever lend money at current interest rates. No actual damage will be done as long as the easing program remains ineffective. But once it starts to affect psychology, the BOJ needs to quickly reverse the policy and bring the monetary base back to 'normal'. If the policy reversal is delayed, the Japanese economy (and inflation) could spiral out of control.
Many investors are now buying yield with little regard to the price that they're paying. It's a dangerous game that's not going to end well.
Japan is not facing much criticism at the G20 meeting and this is encouraging fresh yen sales, which in turn is helping lift other currencies. We play down the speculation that China will widen its dollar-yuan band imminently.
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.