As most know by now, over the past month or so, pressure on the currencies of EM deficit countries has intensified again. Goldman's EM research group, however, remains negative on EM FX, bonds, and even stocks suggesting using any strength, like this week's exuberance to add protection or cover any remaining longs. Central banks in most of these countries have become more active in attempting to stem pressure in the last two weeks. But with a Fed decision on ‘tapering’ looming, investors have also become more cautious and are now focused on the parallels with prior crisis periods. In what follows, Goldman provides some concise answers to the questions on the EM landscape that we encounter most often, confirming their longer-held bearish bias.
The ongoing deterioration in earnings is something worth watching closely. The recent improvement in the economic reports is likely more ephemeral due to a very sluggish start of the year that has led to a "restocking" cycle. The sustainability of the uptick is crucially important if the economy is indeed truly turning a corner toward stronger economic growth. However, with interest rates rising, oil prices surging and the Affordable Care Act about to levy higher taxes on individuals, it is likely that a continuation of a "struggle" through economy is the most likely outcome. This puts overly optimistic earnings estimates in jeopardy of be lowered further in the coming months ahead as stock buybacks slow and corporate cost cutting continues to become less effective.
This is our first out of four series where we look at all the various bail-out schemes concocted by Eurocrats.
Today we look at how the ECB has evolved since 2007. In the next three posts we will look at the Target2 system, various fiscal transfer mechanisms and last, but not least the emergence of a full banking union.
The yield on 10 year U.S. Treasuries is skyrocketing, the Dow has been down for 5 days in a row and troubling economic news is pouring in from all over the planet. The much anticipated "financial correction" is rapidly approaching, and investors are starting to race for the exits. We have not seen so many financial trouble signs all come together at one time like this since just prior to the last major financial crisis. It is almost as if a "perfect storm" is brewing, and a lot of the "smart money" has already gotten out of stocks and bonds. Of course a lot of people believe that we will never see another major financial crisis like we experienced in 2008 ever again. A lot of people think that this type of "doom and gloom" talk is foolish. It is those kinds of people that did not see the last financial crash coming and that are choosing not to prepare for the next one even though the warning signs are exceedingly clear. The following are 18 signs that global financial markets are heading for a vicious circle...
Deutsche: "Either The Central Banks Lose Credibility Soon Or The Markets Have Overstretched Themselves"Submitted by Tyler Durden on 08/19/2013 08:46 -0500
Some unpleasant observations from Deutsche Bank below for fans of either central planning and/or risk assets, as having one's cake and eating it too is no longer an option, and one or the other is finally set to snap. To wit: "Yield curves are very steep suggesting a challenge to central bank guidance credibility is at a tipping point. Either the data really are strong and the central banks lose credibility soon or the markets have overstretched themselves, allowing for a partial recovery in lower rates." A "tweeted out" Bill Gross is praying to the Newport gods it's the latter.
Following this period of extraordinary monetary policy accommodation, Barclays Barry Knapp notes it stands to reason that, although there is some room for additional risk premium contraction (the aggregate measure for the S&P 500 remains above the long-term mean), the equity market on a stand-alone basis can hardly be considered cheap. In fact, looking across a broad range of balance sheet and income statement metrics over a period we would characterize as representative (albeit with a somewhat large dispersion of 1973-present), the equity market is above the long-term mean on every measure. But it gets better. There is little doubt that liquidity will prove challenged in coming weeks but market participants appear to be far too relaxed about events as equity market risk measures are close to the low risk point of their post-crisis range. So expensive valuations and risk complacency - BTFATH?
In a somewhat stunning revelation from the masters-of-money-printing, the SF Fed (whose former head is none other than alleged Fed chairwoman frontrunner Janet Yellen) has found that "asset purchase programs like QE appear to have, at best, moderate effects on economic growth and inflation." One has to wonder why this sudden change of heart? Perhaps to pave the way for the less-than-enamored-with-QE Larry Summers' arrival... as we noted previously his views that “QE is less efficacious for the real economy than most people suppose." Or maybe this is a way for Ms. Yellen, to ingratiate herself with the president by indirecly toning down expectations she would go "feral hog" on the CTRL-P button? In any case, markets appear a little concerned at this rising Fed canon of removing the liquidity spigot despiet the all-time-highs in stocks.
There are real-world consequences to over-issuing credit and currency. Eventually this leads to a bidding war for trust: Whose credit/cash will be trusted to retain its purchasing power? There is a grand irony here, of course; as issuers of credit/cash attempt to debase their currency to boost their exports, their debased currency buys fewer real-world resources.
The raw economic truths from the Street. What's the difference between your common street thug or hustler and the K Street/Wall Steet/Central Banker? Read this to find out...
The overthrow of President Mohamad Morsi by popular demand and supported by the army inaugurates yet another volatile episode in Egypt’s long and turbulent transition. Macro stabilisation in Egypt hinges on a swift and cohesive transition, and given the current bloodshed, that appears unlikely - which leaves Barclays 'muddle-through scenario' - where political/religious divides delay formation of civilian government - as the most likely; postponing fiscal reforms indefinitely, and undermining further the fiscal and debt sustainability of the already-troubled nation. This is a major problem, since, after all; among the main reasons behind the mass protests of 30 June were the continued deterioration in most socioeconomic indicators, faltering public services (notably provisions of fuel and electricity), rising risks of macroeconomic instability and slow progress in implementing socioeconomic and fiscal reforms over the past year.
We have discussed the idea of a VaR shock (driven by Abe/Kuroda's loss of control) a number of times recently but as Saxo's Steen Jakobsen fears, reality is about to hit as the marginal cost of capital normalizes. The world, so far, has been kept in artificial equilibrium by the way quantitative easing (QE) and fiscal policies bring support and endless liquidity to the 20 percent of the economy that mostly comprises large and already profitable companies and banks with good credit and good political access. The premise for supporting these companies is based on the non-existent wealth effect which unfairly culminates in supporting the haves to the detriment of the have-nots. However, as Jakobsen notes below, things are rapidly changing; the recent increase in yields has happened despite no real improvement in the underlying data. The the next few days are potential major game changers – the bloated VaRs will make people hedge and over hedge, and the normalization process of rising risk premiums and higher real rates (higher yield plus lower inflation) will lead to more selling off of those trades that have "worked so far"... and increase volatility in their own right.
"The opposite of currency wars is not necessarily currency peace; it can easily be interest rate wars," is the warning Citi's Steve Englander sends in a note toda, as EM and DM bond yields have relatively exploded in recent weeks. The backing up of yields represents an increase in risk premium, so this will likely have negative effects on asset markets and the wealth effect abroad as well. It is difficult to explain the magnitude of the yield backup in terms of normal substitution effects, and broadly speaking, if you were to compare the backing up of bond yields with the beta of the underlying economy and asset markets there would be a good correspondence. So, Englander adds, it is fear, not optimism that is driving bond markets.
Here's the challenge the Status Quo monetary and fiscal authorities faced in the 2008 global financial meltdown: how do we maintain the power structure and keep the masses passive while masking the fact that the Status Quo is broken? The solution: sell bonds to fund benefits to the masses, lower interest rates to zero to keep the explosive rise in fiscal deficits affordable, and rapidly inflate new bubbles in assets that painlessly enrich the top 25% of households who then increase their borrowing and spending, i.e. the "wealth effect." The political calculus is simple: the bottom half of households don't vote, don't contribute to political campaigns and don't have enough income to borrow huge sums of money to enrich the banks. They are thus non-entities in the fiscal-monetary project of maintaining the power structure of the Status Quo. All the Status Quo needs to do is borrow enough money to fund social programs that keep the masses passive and silent: food stamps, Section 8 housing vouchers, Medicaid, Medicare, Social Security, SSI permanent disability, unemployment, etc. Unfortunately for the Powers That Be, the cost of placating the rapidly increasing marginalized populace is rising much faster than tax revenues.
As the markets elevate higher on the back of the global central bank interventions it is important to keep in context the historical tendencies of the markets over time. Here we are once again with markets, driven by inflows of liquidity from Central Banks, hitting all-time highs. Of course, the chorus of justifications have come to the forefront as to why "this time is different." The current level of overbought conditions, combined with extreme complacency, in the market leave unwitting investors in danger of a more severe correction than currently anticipated. There is virtually no “bullish” argument that will withstand real scrutiny. Yield analysis is flawed because of the artificial interest rate suppression. It is the same for equity risk premium analysis. However, because the optimistic analysis supports the underlying psychological greed - all real scrutiny that would reveal evidence to contrary is dismissed. However, it is "willful blindness" that eventually leads to a dislocation in the markets. In this regard let's review the three most common arguments used to support the current market exuberance.
Curious how to trade those Goldman recommendations, such as today's uberbullish "strategic" call seeing nothing but blue skies all the way through 2015? Here is a quick reminder courtesy of your friendly FX wizard, Goldman's Tom Stolper. "On April 18 we recommended going long EUR/HUF. Our view has been that higher US yields would hurt a number of EM currencies (including the HUF). We also thought that ongoing monetary easing in Hungary would further compress interest rate differentials, leading to a gradual weakening in the currency. Although both macro drivers materialized, the HUF strengthened, contrary to our expectation.... we recommend closing the position with a potential 2.86% loss (including negative carry of about 32bp in total)."