In a sense the markets are experiencing a "Vietnam Moment" where we all believed what we were told and we all accepted the official headlines until the day came when we found out we had been flimflammed and you know the results of that fiasco. We believe that the markets are quite close to a shift in psychology where people and institutions alike no longer blindly accept the stories as told.
1:1 In the beginning, Ben Bernanke hath said, let there be liquidity.
1:6 And so each among them sayeth the following benediction: “May the Fed bless you and keep you; may the Fed extend its balance sheet to shine upon you; and may the Fed lift up asset prices and protect you from harm”
Still confused what that fateful FOMC day just three weeks away from today may bring, in the aftermath of a Jackson Hole symposium which was mostly focused on the adverse side effects of Quantiative Easing and the proper sequencing of unwinding the Fed's nearly $4 trillion balance sheet? Here is the explanation straight from the firm whose chief economist has dinners with none other than the Fed shadow Chairman, Bull Dudley, on a frequent basis. To wit: "First, we expect Fed officials to adjust the “mix of instruments” somewhat away from QE towards forward guidance at the September meeting, which appears to be an appropriate strategy in light of these results. Second, we expect that the FOMC will focus most if not all of the tapering on Treasury purchases rather than (current coupon) MBS purchases, consistent with the evidence that the latter are more effective in lowering mortgage rates and easing financial conditions." So: $10-15 billion reduction in TSY monetization announced in September, enacted in October, and a seismic shift in FOMC communication away from actual intervention to promises of such, aka forward guidance. Judging by the recent track record of "forward guidance" so far, the global market volatility exhibited so far may well be just a walk in the park compared to what is coming.
While many begrudge the rise in interest rates and their concomittant tightening of financial conditions, Nomura's George Concalves notes that the move has been a "blessing in disguise" for most long-only bond investors. Insurance companies and pension-funds, who need 'yield' to cover long-term liabilities, have been underweight since the Fed began Operation Twist (on the basis of the yield became too compressed) but the recent sell-off in Treasuries (which does not reflect any asset-allocation or great rotation since stocks have been just as weak) enabled these funds to put money to work. This helps to explain the very notable flattening in the yield curve (5s30s -17bps in the last week) as duration extension is more economically attractive. Concalves suggests Taper fears are overdone and that should rates back up another 25bps, there is more dry-powder to put to work in bonds.
Deutsche: "Either The Central Banks Lose Credibility Soon Or The Markets Have Overstretched Themselves"Submitted by Tyler Durden on 08/19/2013 09:46 -0400
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.
A recent survey of asset managers globally, managing USD 27.4 trillion between them, found that 78% of defined-benefit plans would need annual returns of at least 5% per year to meet their commitments, while 19% required more than 8%, "a target of 5% per year can be reached but only by using leverage, shorting, and derivavtives." And sure enough, as Deutsche Bank (DB) reports, in short, investors have rarely been more levered than today! According to DB, a MoM change in NYSE margin debt >10% has to be taken as a critical warning signal as there are astonishing similarities in the sequence of events among all crises. As the S&P 500 just hit a new all-time high, investors might want to ask themselves when it is a good time to become more cautious – yesterday, in our view. Simply put, the higher margin debt levels rise, the more fragile the underlying basis on which prices trade; with even a less severe sell-off in equities capable of triggering a collapse.
The JGB market was completely unfazed by the news that the prime minister’s office was reconsidering the planned consumption tax hike. While the tax hike is unlikely to be changed; in BNP's view, the market’s lack of response to tail risk looks like proof that its function has been impaired by the BoJ’s massive buying. Even if the Abe regime is opting for financial repression to reduce the public debt, however, BNP warns that some degree of fiscal reform is needed to control the long-term interest rate. If the unfazed market is deemed to mean that fiscal reforms can be shelved without fear of a bond-yield spike as long as massive BoJ buying continues, serious problems could ensue.
From Bill Gross: "Capitalism depends on the successful offering and capture of carry in its multiple forms. If capitalism is faltering (recession) in developed/developing economies and yields are close to the zero bound, then portfolios should have less carry than before. If prospects are mediocre, portfolios should be overweight carry. If prospects are very bright, they should again be underweight bond carry. If we can be mindful of this, and accurately forecast it, we will be successful. This may be the most important conceptual change I have ever written about in an Investment Outlook. Readers who have stuck with this Outlook at least to this point have a scoop, if not a magic feather."
Compared to last week's macro-event juggernaut, this week will be an absolute bore, although with a bevy of Fed speakers on deck - both good and bad cops - there will be more than enough catalysts to preserve the "upward channel" scramble in the S&P and the zero volume levitation to new all time daily highs despite the lack of daily bad news. Speaking of Fed speakers, we have Fisher today, Evans’ tomorrow followed by both Plosser and Pianalto on Wednesday. The key overnight data point was the continuation of July PMIs out of Europe, this time focusing on the service industry. As Goldman summarizes, the Final Euro area Composite PMI for July came in at 50.5, marginally above the Flash reading and consensus expectations (50.4). Relative to the June final reading, this was a sold 1.8pt increase, and building on consecutive increases in the past three months, the July Euro area PMI stands 4.0pts above the March print. Solid increases were observed across all of the EMU4 in July, most notably Italy. The July reading is the highest Euro area PMI level observed since July 2011.
Any backwardation in gold at all is serious. Recently, a related phenomenon has occurred: the GOFO rate has gone negative.
This might just be the cruelest time to be an asset allocator. Normally we find ourselves in situations in which at least something is cheap; for instance when large swathes of risk assets have been expensive, safe haven assets have generally been cheap, or at least reasonable (and vice versa). This was typified by the opportunity set we witnessed in 2007. Likewise, during the TMT bubble of the late 1990s, the massive overvaluation of certain sectors was offset by opportunities in “old economy” stocks, emerging market equities, and safe-haven assets. However, today we see something very different. As Exhibit 2 shows, today we see something very different. As Exhibit 2 shows, today’s opportunity set is characterized by almost everything being expensive. As I noted in “The 13th Labour of Hercules,” this is a direct effect of the quantitative easing policies being pursued by the Federal Reserve and their ilk around the world.
The multi-bubble machine called the Fed is at it again. This time they managed to create a gigantic bond bubble which will dwarf both the dot-com- and the housing bubble combined.
"Perhaps the success that central bankers had in preventing the collapse of the financial system after the crisis secured them the public's trust to go further into the deeper waters of quantitative easing. Could success at rescuing the banks have also mislead some central bankers into thinking they had the Midas touch? So a combination of public confidence, tinged with central-banker hubris could explain the foray into quantitative easing. Yet this too seems only a partial explanation. For few amongst the lay public were happy that the bankers were rescued, and many on Main Street did not understand why the financial system had to be saved when their own employers were laying off workers or closing down." - Raghuram Rajan
Danger and opportunity arrive hand in hand.
- Risk on assets supported by yesterday's speech by Bernanke, who said that highly accommodative policy needed for the foreseeable future and that current unemployment of 7.6%, if anything, overstates health of US labour market.
- ECB's Weidmann said that the ECB has not tied itself to the mast with forward guidance, which does not rule out rate hikes when inflationary pressures emerge.
- The BoJ kept their monetary policy unchanged and retained plan for JPY 60-70trl annual rise in monetary base.