What is happening to you America? Once upon a time, the United States was a place where free enterprise thrived and the greatest cities that the world had ever seen sprouted up from coast to coast. Good jobs were plentiful and a manufacturing boom helped fuel the rise of the largest and most vibrant middle class in the history of the planet. Cities such as Detroit, Chicago, Milwaukee, Cleveland, Philadelphia and Baltimore were all teeming with economic activity and the rest of the globe looked on our economic miracle with a mixture of wonder and envy. But now look at us. Our once proud cities are being transformed into poverty-stricken hellholes. We are in the midst of a long-term economic collapse that is eating away at us like cancer, and things are going to get a lot worse than this. So if you still live in a prosperous area of the country, don't laugh at what is happening to others. What is happening to them will be coming to your area soon enough.
“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.
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."
A high level overview of the drivers of the capital markets.
Now that the 3:30 pm pump has been exposed to the world, and having been priced in and frontran (such as yesterday) it changed to the 3:30 dump, algos are desperately searching for another daily calendar trading opportunity. It appears the opening of Europe and Japan for trading are just these two much needed "fundamental" catalysts. As the charts below show, it appears there is nothing more bullish for the two key carry pairs, the USDJPY and the EURUSD, than Japan opening at 8pm Eastern, and then Europe opening next, at 3:30 am Eastern.
We started off the overnight session with various pseudo-pundits doing the count-up to a 100 in the USDJPY. It was only logical then that moments before the 4 year old threshold was breached, the Yen resumed strengthening following comments from various Japanese politicians who made it appear that the recent weakening in the currency may suffice for now. This culminated moments ago when Koichi Hamada, a former Yale professor and adviser to Japanese Prime Minister Shinzo Abe, told Reuters that level of 100 yen to dollar is suitable level from the perspective of competitiveness. The result has been a nearly 100 pip move lower in the USDJPY which puts into question the sustainability of the recent equity rally now that the primary carry funding pair has resumed its downward trajectory. Another result is that the rally in the Nikkei225 was finally halted, closing trading unchanged, and bringing cumulative gains since the morning before the BoJ’s announcement last Thursday to 8.9%. Over that the same time period, the TOPIX Real Estate Index is up an incredible 24%, no doubt reflecting the prospect of renewed buying of REIT stocks from the BoJ’s asset purchasing program.
A big picture look at the drivers of the global capital markets.
If there is one thing the Fed taught the world's investors it was to front-run them aggressively; and whether by unintended consequence or total and utter lack of belief that despite a 'promise' to do 'whatever it takes' to stoke 2% inflation the BoJ are utterly unable to allow rates to rise since the cost of interest skyrockets and blows out any last hope of recovery, interest rates are collapsing. Japan's benchmark 10Y (that is ten years!!) yield just plunged from 55bps (pre-BoJ yesterday) to 34bps now. That is a yield, not a spread. Nothing to see here, move along. Of course, not to be outdone, Japanese stocks (Nikkei 225) are now up 6.75% from pre-BoJ (3% today) trading at 13,000 - its highest since September 2008 (Lehman). But there is one market that is showing its concerns at Japan's inevitable blow up - Kyle Bass' 1Y Jump risk has more than doubled in the last 4 months.
Some people believe that by imposing losses on investors and reducing the Cyprus banking system liabilities, the European powers have addressed the problems in Cyprus (if harshly). A dangerous dynamic has been set in motion, which will likely bring many unintended consequrences.
Amidst the debacles, fiascos, and nightmares is a scrappy industry that uses ingenuity and the right amount of hops to beat Wall-Street-engineered giants.
If we shed our fixation with the Fed and look at global supply and demand, we get a clearer understanding of the tailwinds driving the U.S. dollar higher. I know this is as welcome in many circles as a flashbang tossed on the table in a swank dinner party, but the U.S. dollar is going a lot higher over the next few years. In a very real sense, every currency is a claim not on the issuing central bank's balance sheet but on the entire economy of the issuing nation. All this leads to two powerful tailwinds to the value of the dollar. One is simply supply and demand: as the global economy slides into recession, trade volumes decline, and the U.S. deficit shrinks. (It's already $250 billion less than was "exported" in 2006.) That will leave fewer dollars available on the global market. The second tailwind is the demand for dollars from those exiting the euro and yen. The abandonment of the euro is already visible in these charts.
Bloomberg reported recently that Russia is now the world's biggest gold buyer, its central bank having added 570 tonnes (18.3 million troy ounces) over the past decade. At $1,650/ounce, that's $30.1 billion worth of gold. Russia isn't alone, of course. Central banks as a group have been net buyers for at least two years now. But the 2012 data trickling out shows that the amount of tonnage being added is breaking records. Based on current data, the net increase in central bank gold buying for 2012 was 14.8 million troy ounces – and that's before the final 2012 figures are in for all countries. This is a dramatic increase, one bigger than most investors probably realize. To put it in perspective, on a net basis, central banks added more to their reserves last year than since 1964. The net increase – so far – is 17% greater than what was added in 2011, which was itself a year of record buying. The message from central banks is clear: they expect the dollar to move inexorably lower. It doesn't matter that it's been holding up against other currencies or that the economy might be getting better. They're buying gold in record amounts because they see a significant shift coming with the status of the dollar, and they need to protect themselves against that risk. Embrace the messages central bankers are telling us – the ones they tell with their actions, not their words.
Up until just a week or so ago, the euro, the market seems to be telling us, has been saved, and peripheral Europe is widely seen as being out of the woods. Thanks to the ECB - who are willing to pump as much liquidity into the markets as it needs - it seems rising debt levels, greater political fragmentation, and a worsening economy somehow don't really matter and it is impolitic to sound pessimistic. But is peripheral Europe really suffering primarily from a liquidity crisis? It would help me feel a lot better if I could find even one case in history of a sovereign solvency crisis in which the authorities didn’t assure us for years that we were facing not a solvency crisis, but merely a short-term problem with liquidity. A sovereign solvency crisis always begins with many years of assurances from policymakers in both the creditor and the debtor nations that the problem can be resolved with time, confidence, and a just few more debt rollovers. The key point is that bankers are not stupid. They just could not formally acknowledge reality until they had built up sufficient capital through many years of high earnings – thanks in no small part to the help provided by the Fed in the form of distorted yield curves and free money – to recognize the losses without becoming insolvent.
A dispassionate review of yesterday's developments and today's.
China’s economic model, which has delivered a genuine economic miracle over the last 30 years by lifting more people out of poverty than ever before in human history, is increasingly tapped out. While the authorities have been talking about rebalancing the economy since at least 2006, BNP Paribas' Richard Iley notes that China’s macroeconomic imbalances have become progressively more extreme. The economy now has an investment share of ~48% of GDP, which, Iley explains, no other economy has been able to reach, let alone sustain. Unsurprisingly diminishing returns are increasingly apparent. Largely uneconomic investments in sectors already suffering overcapacity, such as real estate and steel, continue to accelerate, fuelling exponential growth in energy consumption and producing increasingly unbearable levels of pollution as we discussed here. Despite the long-term gulf between reform rhetoric and concrete action, ‘hype’ at least continues to spring eternal.