"With the recent weakness in risk, are we understanding more about how addicted markets have been to the Fed's QE? Or is this just a temporary unrelated blip? The Fed will turn off the QE tap later this month and in our opinion volatility has been increasing as the market adjusts. We've long felt that the Fed pulling back from QE would be an issue for markets and it’s tempting to be bearish here."
Russia’s weighing of capital controls if net outflows intensify.
It has been a night of relentless and pervasive disappointing economic data from just about every point on the globe: first the Chinese HSBC manufacturing data was well short of expectations (50.2 vs. Exp. 50.5), which was promptly spun as bullish and a reason for more stimulus by the PBOC even though the central bank has been constantly repeating it will not engage in western-style shotgun easing. Then Japanese wages, household spending and industrial production came in far below expectations - in fact at levels which suggest Japan is once again in a recession - which once again was spun as bullish, because the BOJ has no choice but to do more of the same failed policies that have made Abenomics the laughing stock of the world. Finally, moments ago Europe reported the lowest inflation data in 5 years, as well as core CPI sliding to just 0.7%, and which was, wait for it, immediately spun as bullish for risk as once again the local central bank would have "no choice but to ease." In other words, thank god for horrible news: because how else will the rich get even richer?
The key question now is “Can the U.S./global economy handle a meaningful downturn in financial asset prices?” The short answer is that it may not have a choice. The Federal Reserve has done what it can to juice the American economy and has the balance sheet to prove it. Central banks, for all their power, do not control long term capital allocation or corporate hiring practices. Fed Funds have been below 2% for six years. If the U.S. economy can’t continue to grow in 2015 as the Federal Reserve inches rates higher, there are clearly larger issues at play. And those private sector problems will need private sector solutions.
The Hong Kong protests, which we covered over the weekend, and which took a dramatic turn for the worse overnight when thousands of students camped out and demand universal suffrage on the city streets and were in turn tear-gassed and arrested en masse by the local riot police demanding students disperse or else, and where the leader of the student protest, Joshua Wong - who had been previously arrested and was released on Sunday night - has openly called for the resignation of Hong Kong Chief Executive Leung Chun-ying in an interview with Hong Kong Cable TV, have done the unthinkable: they have impacted financial markets and the "wealth effect" transmission mechanism of the local billionaires.
There may be one great conspiracy dictating the course of the capital market, but if there is not, what is the near-term outlook for the dollar?
First it was the foreign exchange markets, then commodities, followed by fixed income markets. Now it’s the equity markets. Wherever we look, volatility has been creeping higher. To some extent, this is not surprising. At the end of the US Federal Reserve’s first round of quantitative easing, and at the end of QE2, the markets wobbled. So with QE3 now winding to a close (and with the European Central Bank (ECB) still behind the curve), a period of uncertainty and frazzled nerves should probably have been expected.
It was all up to the Japanese banana market to fix things overnight: after the biggest tumble in US equities in months, and Asian markets poised for their third consecutive weekly drop, the longest streak since February, Japan reported CPI numbers that despite still surging (for example, in August TV prices soared 9.5%, but "down" from 11.8% the month before), when "adjusting" for the effects of the April tax hike, missed across the board. As a result the USDJPY was at the lows and threatening to break the recent parabolic surge higher which has helped move global equities higher in the past few weeks when the usual spate of GPIF-related headlines, because apparently the fact that Japan will and already has begun sacrificing the retirement funds of its citizens just to keep Abe's deranged monetary dream alive for a few more months has not been fully priced in yet, sent the USDJPY soaring yet again.
“Money amplifies our tendency to overreact, to swing from exuberance when things are going well to deep depression when they go wrong.”
Just last week, we explained why Blackrock - the largest asset manager in the world - is gravely concerned about the 'broken' corporate bond market. Simply put, thanks to The Fed's continued presence in the Treasury market has left the corporate bond market a liquidity-starved ticking time-bomb if faith in the stability of defaults ever falters (with firm balance sheets at record high leverage) and "selling" begins. As the following chart from Deutsche Bank highlights, the current level of liquid assets as a proportion of total HY assets is about as low as it has been tracking data back around 25 years. In other words, the massive (and likely levered) positions The Fed has forced the world to take on by its repression face a dramatic liquidity risk cost if they are ever to 'realize' any gains from the Fed's handouts (by actually selling). That's what every bond manager 'knows'...
For investors, Fed stimulus has trumped all other factors. It has lowered risk premia and inflated asset prices. The gig is soon up, but investors have yet to adequately adjust. Unfortunately, they will attempt to do so with significantly compromised market liquidity. The path to normalization is made even more challenging, because Japan and Europe are in recession, and China is slowing.
If yesterday the bombardment, no pun intended, of bad news from around the globe was too much even for Mahwah's vacuum tubes to spin as bullish - for stocks - news, then tonight's macro economic updates have so far been hardly as bombastic, with the only real news of the day has Germany's IFO Business Climate reading, which dropped from 106.3 to 105.8, declining for the 5th month in a row, missing expectations, and printing at the lowest level of since April 2013! (More from Goldman below) Net result: Bunds yields were once again pushed in the sub-1% category, even if stocks today are higher because the European data is "so bad it means the ECB has no choice but to do (public instead of just private) QE" blah blah blah.
Just over a year ago, we warned on the very real concerns about corporate bond liquidity drying up and the potentially huge problems associated with that, if and when the Fed ever pulls the rug out from the one-way street of free-money injections. It appears, as Bloomberg reports, having realized, we suspect, that they can't get out of their positions, the world’s largest money manager, Blackrock, believes the corporate bond market is "broken" and in need of fixes to improve liquidity "before market stress returns." Ironically, as we have also explained in great detail, it is this 'broken' market that has enabled corporations to borrow cheap enough to buyback half a trillion dollars of their stock in 2014. As Blackrock concludes, rather ominously, "the risk posed by investors trying to dump bonds after the Federal Reserve raises interest rates is “percolating right under” the noses of regulators."
European stocks, U.S. equity index futures fall after Euro area PMI for Aug. missed ests., while bond yields for German, Spanish, U.K. debt fall. Copper rises with positive Chinese PMI data, while oil gains as OPEC discusses output cut. European health care stocks among largest underperformers as U.S. plans tighter rules on tax inversion M&A.