Two weeks ago, Citigroup presented what it thinks is the biggest nightmare for the Fed: it said that the FOMC’s "biggest worry is not lift off and its market and economic implications, but what happens if the economic recovery dies of old age without the Fed having done anything to tighten." And, according to Citi's FX strategists, "if this were to occur, the USD would probably fall faster than it rose from July-March." A precursor to loss of faith in the Dollar's reserve currency status perhaps. Today, Citi's Steven Englander lays out what is the Fed's second biggest nightmare: a rebound which is so fast, the Fed's entire carefully planned renormalization schedule collapses.
History literally appears to be repeating. The mainstream media and our politicians are promising Americans that everything is going to be okay somehow, and that seems to be good enough for most people. But the signs that another massive financial crisis is on the horizon are everywhere.
Same slide, different day, as the crude crash continues, with both WTI and Brent tumbling to multi-year highs, below $49 and $52 respectively. This happened despite the news overnight that China is accelerating 300 infrastructure projects valued at 7 trillion yuan ($1.1 trillion) this year, suggesting that China will focus more on fiscal policy than monetary easing, which in turn led to much confusion in the SHCOMP, which fluctuated up and down for the day several times before finally closing unchanged. There was no confusion about the stops slamming USDJPY, and its Nikkei225 derivative which tumbled 3%, sending Japanese Treasury yields to fresh record lows. Record low yields were also seen in Germany, Austria, Belgium, Netherlands, Finland, France (and many other places), which in turn forced the US 10 Year to finally dip back under 2.00%. In fact, taken together, the average 10Y bond yield of the U.S., Japan and Germany has dropped below 1% for the first time ever, according to Citi.
"The new information on global slowing may be less important than the realization that policymakers have few tools to deal with any kind of slowing, let alone a major shock. G3 10yr government rates now average 1.27, within 10bps of the all-time pre-tapering low of 2013 (Figure 1). So if the last 100bps of rate reduction did not stimulate global growth, it does not seem likely that another 20-30bps or so in the presence of negative demand shocks will do the trick. The market takeaway from their comments is that the US economy is not strong enough to stand on its own, leaving little hope for the rest of the world, which is already slowing. Moreover since investors and business do not have particular confidence that the policy response will be effective, any upgrading of the risk of negative shocks raises the probability that we may be put into a zone to which there is no adequate response."
And it all started off so promisingly, when after the biggest selloff in US stocks in two months, the BOJ and its preferred banks once again sold 6J (i.e., bought USDJPY) in the morning Japan session (while collecting CME liquidity rebates of course), sending the pair from below 108 to half the way to 109, and naturally taking global futures higher while pushing yields lower when as ITC says a "large TY seller knocked USTs to lows during the session" - hmmm, wonder who the large seller was. And then... the "rebound euphoria" fizzled a la Sodastream, sending the Nikkei sliding 1.2%, and US equity futures back to unchanged with the bond surge returning and sending German Bunds to new all time highs once again, while the Dax briefly broke below under 9000 before stabilizing at the key support level. It is unclear what caused the failure in central bank euphoria, although some suggest that the latest bevy of disappointing economic news wasn't quite bad enough.
For those just catching up on the main news event of the weekend, namely the sudden surge in Scotland "Yes" vote polling surpassing 50% for the first time, here is a complete round up of the background, updates and expert reactions from RanSquawk, Bloomberg and AFP.
The consensus expectation is overwhelming that Fed Chair Yellen will deliver a dovish message at Jackson Hole. Macro investors have largely eliminated their short Treasury position and look to be long risk, particularly via equities and EM. FX positioning is long USD and long EM, the long USD largely because the euro zone economy is slipping again and the ECB is hinting at further ease. Our question is whether Yellen can be more dovish than what is now priced in, not whether she will be dovish on the Richter scale of dovishness. Full dovish, semi-dovish, or contingent dovish.
This is a tricky period for asset markets, warns Citi's Steven Englander. Positioning still reflects a risk-on view but the risk-on enthusiasm is in EM, equities and Asia rather than peripheral Europe. Investors are still long risk, despite the geopolitical tensions and Fed Chair Yellen’s modest nod to the risk of faster than expected tightening, Englander cautions, concluding that investors continue to anticipate a soft landing despite all the discussion to the contrary.
This shortened week is dominated by a veritable explosion of critical jobs market data on Thursday. As Citi's Steven Englander notes, there are five key US labor indicators - two of which will be initial asset market drivers: Citi expects disappointment; and three more that will give signals more relevant to the medium term evolution of asset markets and Citi think will give a more positive signal.
Goldman Sachs, like most of the mainstream economists believes today's FOMC statement will likely be "broadly neutral" with no indication of sooner rate rises than expected (despite what we have noted as the timing not being better), some modest upgrades to the economic outlook (to keep the "everything's good and you don't need us anymore" meme alive), and continued taper at the same pace (with maybe some acknowledgemnet of the transitory pop in inflation). UBS, on the other side, suggests there is a chance of some FOMC surprises with Janet Yellen pulling a semi-Carney as Citi's Steven Englander has previously noted "the Fed needs more volatility in order to maintain its illusion of omnipotence."
"Words speak louder than actions until words stop working then we promise some actions... or more talk about actions." That appears to be the communication method-of-choice for the world's central bankers and The Bank Of Japan's Kuroda stepped into the breach today with his own demands. As Citi's Steven Englander translates, Kuroda is telling investors not to buy JPY just because the BoJ is being very reticent on policy ease (do as we say, not as we do). However, there is an important second message which is intended to be delivered to the Japanese bureaucracy - "Mr. Kuroda also acknowledged limits to what the BOJ can do to generate long-term growth."
With The White House proclaiming Russian stocks a "sell" today (and in the meantime Russian stocks and the Ruble strengthening), it is clear, as Citi's Steven Englander notes, that the Russia/Ukraine crisis may be the first major political conflict that is played out in international financial markets. The difference, Englander points out, between this and standard imposition of sanctions is that both sides have some options that can inflict damage on the other side; and this has significant implications for investors in the short- and medium-term.
Hinting that the worst is yet to come, was none other than India's Central Bank governor Raghuram Rajan himself, who yesterday in an interview in Mumbai with Bloomberg TV India, said that "international monetary cooperation has broken down." Of course, when the Fed was monetizing $85 billion each and every month and stocks could only go up, nobody had a complaint about any cooperation, be it monetary or international. However, a 4% drop in the S&P from its all time high... and everyone begins to panic.
From Citi: From the viewpoint of domestic US economic conditions the Statement is completely anodyne. From the point of view of EM, the Fed has just said "hasta la vista, baby"
One question that keeps popping up, and was addressed to some extent by NAB's recent report, is whether all the elements of the current Bitcoin are necessary for a viable alternative currency. And, as Citi's Steve Englander asks (from a libertarian and pragmatic perspective), if they are not, or can be improved on, where does that leave Bitcoin’s first mover advantage?