It Ain't Priced In
I had an e-mail exchange with an old fried who now works for a large macro hedge fund up in Greenwich. The broad topic was the very long list of signs that the global economy is hitting the skids. He had this to say:
…certainly does not point to robust job growth…manufacturing activity globally really falling sharply..think weakness in Europe spilling over to those who export to the region..retail sales in Europe plunging…China growth may now be down to 3% in our view…U.S. q2 may be sub 1.5%..Europe- contraction…Brazil sub 3%...Australia slowing sharply...
I almost fell of the chair reading this. Say this group is right about China. What does it mean if its growth rate falls to 3%? A very hard landing for all manner of things, is the answer.
There have been many China bears the past year or so, but against these bearish views there has been a widespread belief that China will muddle through. My point is that China GDP = 3% is absolutely not priced into today’s market.
Swiss reserves jumped an incredible CHF 59B ($61B) in June. The only question in my mind is, “How long can this last?” Switzerland can’t increase reserves on an unlimited basis; they can’t absorb Euro60B a month.
The current boss at the Swiss National Bank (SNB), Thomas Jordan is responsible for the Peg policy that is behind the unwanted reserve creation. It’s important to remember that Jordon is relatively new to the job. He stumbled into the hot seat when the former head of the SNB, Philippe Hildebrand’s wife got nailed trading currency when she shouldn’t have been.
Jordan is a well-educated technocrat who is also an old hand at the SNB. He inherited the currency peg policy from Hildebrand, but history will mark his name in the books if the policy fails. I’m sure that Jordon is aware of this. What’s his state of mind?
Jordan doesn't have the full support of the government behind him. The same domestic politics that successfully dumped Hildebrand are working against Jordon.
If Switzerland is to maintain the current 1.2000 peg to the Euro, there has to be something more in the offing. The endless intervention is not going to work. The FX market is much bigger than the capacity of the SNB. The only option left for Jordon is exchange controls and a complete shutdown of the Swiss border. Jordon has hinted that these steps are coming on several occasion in the past month.
When Switzerland adopts exchange controls, the rest of Europe will soon follow. What will be the global market response from these measures? It will scare the crap out of capital. I think exchange controls will bring a panic; there is no safe place to hide in a panic. The possibility of this happening is not in the price of assets today.
I jumped on the short EURUSD ship last Friday (link). A gain of nearly four big figures in a week would normally have me taking the quick leveraged profits. Actually, I doubled down.
To my old eyes there was something different in the Euro trading on the week. What was missing was a “bid”.
The relative stability of the FX market (particularly the EURUSD) has been a mystery for me the past year or so. It’s as if there has been an invisible hand in the market, quietly intervening at critical times. This type of “official guidance” would explain the range trading and low volatility. I have given credit to the BIS for this activity in the past, although there is no confirmation of that.
Last week the FX market appeared to be missing that support (from whomever). We raced down from Monday through Friday, and ending up at the lows of the year. To me, it looks like a run to 1.200 is in the cards.
The question is, "What happens when that magic number is achieved"? There is very little technical support under EURUSD 1.200. It looks like it is all “air” below that level:
While the idea of the EURUSD at parity is not news to my readers, I don’t think this possibility is in the "mind" of the market today. A big down move EURUSD move would crush the S&P.
Last Sunday there was some euphoria in the markets and press over the EU Summit. The source of that optimism was an agreement to recapitalize Spanish banks in a fashion that did not add to the debt burden of Spain. The deep thinkers in Brussels lead us to believe that the money for Spain’s banks was coming from the ESM or EFSF. That there would be a “true” transfer of risk out of the country.
Unfortunately, those technocrats lied to us a week ago. Seven days later we find that there is no transfer of risk at all.
Not only will Spain be on the hook for any investments made in Spanish banks by either the EFSF or ESM (via a state guarantee), but the actual guarantee has been structured such that the liability will not be recorded on Spain’s books as a debt.
The question of whether the Spanish bank bailout subordinates existing bond holders has now been answered. The bondholder are sitting in the back of the bus. And they wont like being there.
Do those technocrats think the markets are stupid, and won't notice this sham?
As it turns out, the much-touted Spanish bailout is more of the same crap we have been seeing from the EU leaders for the past two years. They are unable to realize a loss, their only response is to kick the same can a bit father down the road. I’m surprised that the change in terms for Spain's bank bailout has not gotten more attention in the press this weekend. I think it will be a topic of conversation next week.
If I’m right, the Europe story goes to Red Alert status for the balance of the month. Once again, I don’t think this is “priced in”.
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