What The Bulls Must Believe

Tyler Durden — Sat, 25 May 2013 15:26:22 +0000

Via Sean Corrigan of Diapason Commodities' Tangible Ideas,

Even if the monetary fuel for this whirl of self-reinforcement is not lacking, the market still needs a narrative around which it can cluster psychologically. It needs a canon of shared myth about which the bard can weave a reassuringly familiar refrain so as to reinforce the sense of community when the members of the clan gather to listen to his warblings amid the flickering fires and guttering torchlight of the Great Hall at night.

If, in contrast to the slow?evolving customs of traditional society, the tribe we personify as the Market is a promiscuous sort, ever ready to cast off one cycle of songs for another, it nevertheless becomes fiercely, if fleetingly, fanatical about the one which happens to take its fancy at any given time. We may have traded Homer for Hendrix, Mallory for Metallica, and Snorri Sturulson for Seasick Steve, but we are still all suckers for a good saga.

As far as your author can see, the one presently enjoying the greatest vogue contains several key themes, among them:?

(a) the belief that China will successfully re?organize itself without enduring a wrenching and potentially disastrous financial dislocation and that it will turn from a hotbed of smokestack centralism and price?insensitive cronyism into a gleaming wonderland of happy, freemarket consumers without its published growth rate ever dipping much below 7% per annum;

(b) the even more fervent hope that ?Abenomics? is working: that a materially well?endowed bastion of greying penny?pinchers will be so spell?bound at the artificially?induced jump in its stock markets and so bamboozled by the thought of having prices go up, instead of down, that its garrison will instantly rush to the nearest Mall and liquidate its surplus savings in an orgy of long?suppressed self?indulgence – all without threatening the ability of the world?s second largest debtor government to continue to sell enough bonds to make up the ~50% shortfall it suffers between revenue and outlay or without pushing up the interest rate payable thereon beyond the hefty 25% of taxes it currently absorbs;

(c) the lazy assumption that, post?Cyprus, nothing significant can now go wrong in Europe, that debt spreads will continue to shrink, and that outbreaks of both social unrest and secessionism can readily be quelled by the mere hypnotic suggestion of that latter day Mandrake the Magician who heads the increasingly fractious governing council of the region?s central bank. And, if that were somehow not enough, we can rest assured that ?austerity? is behind us and a restorative shot of crude Keynesianism lies only an X on a German ballot?paper away;

(d) and finally, the spreading confidence that the Goldilocks Republic has again entered the broad uplands of that Panglossian La?La land where all evidence of economic strength is a heartening testimony to the ongoing US recovery but where, miraculously, any contrary signs simply ensure that the nation?s tutelary deities at the Fed will redouble their efforts at stimulus, especially once that curmudgeonly old tightwad, Ben Bernanke (“I have the best inflation record of any post?war Chairman”), yields his staff of office to a real interventionist.

What could possibly go wrong?

Why Central Bankers Rule The World

Asia Confidential — Sat, 25 May 2013 15:00:00 +0000

What's been amazing of late hasn't been the market swings but the extent to which central bankers have contributed to them. Every press conference, statement and newspaper leak of central banks has been pre-empted, interpreted and re-interpreted - all in real time and often within seconds. Investor dependence on the thoughts and actions of central banks isn't new, but it seems to have reached unparalleled and absurd heights.

The big question is: why? The obvious answer is that the trend has been driven by greater central bank intervention in markets via quantitative easing (QE) and zero interest rate policies. But Asia Confidential suspects there's more to it than that and the field of psychology may offer some clues. For instance, it's well documented that people have a tendency to defer to authority, particularly in times of crisis. Could this explain at least some of the investor behaviour towards central banks? It's worth exploring given the apparent reliance of stock and bond markets on the world's central bankers. At a minimum, being aware of possible investor biases, including your own, could put you one step ahead of others.

Reading Fed tea leaves

Will the U.S. Federal Reserve slow stimulus or not? That's been one of the big questions on the minds of investors over the past month. We first had rumours of a Wall Street Journal article suggesting the Fed had mapped out a strategy for the winding down of QE. Then the article came out a day later, confirming the rumour. Since that time, various Fed members have come out publicly, some pushing for an end to QE, others for its continuation. The release of Fed Open Market Committee (FOMC) minutes on Wednesday gave us some more clues. Or did it?

Let's first take a look at some of the key passages from the minutes:

"A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome. One participant preferred to begin decreasing the rate of purchases immediately, while another participant preferred to add more monetary accommodation at the current meeting ... Most participants emphasized that it was important for the Committee to be prepared to adjust the pace of its purchases up or down as needed."

And this:

"... participants generally continued to expect that inflation would move closer to the 2% objective over the medium run. Nonetheless, a number of participants expressed the concern that inflation was below the Committee's target and stressed that future price developments bore careful watching ... A couple of participants expressed the view that an additional monetary policy response might be warranted should inflation fall further. It was also pointed out that, even absent further disinflation, continued low inflation might pose a threat to the economic recovery by, for example, raising debt burdens."

Confused? You should be, as the markets certainly were. The S&P 500 initially rose on the comments and later fell on those same comments.

It became clear to many investors that the statements contained little fresh information. In essence, the Fed will play it by ear. If the economy improves, it'll scale back stimulus. If the economy doesn't improve, the current stimulus will remain.

But that didn't stop the commentariat from using the minutes to support their points of view. The bulls emphasised that the U.S. economy was improving and though QE tapering may take place, it wouldn't have a negative economic impact. The bears suggested that the U.S. economy was showing signs of deceleration and there's no way that the Fed would reduce stimulus. In other words, the minutes suited everyone, and no-one, because they were open to many interpretations.

There are two things to note about the reaction to the minutes. First, it shows the extraordinary power that the Fed has over markets now. It's amazing to think that Bernanke's predecessor, Alan Greenspan, has been utterly discredited for his part in creating the credit bubble. And even though Bernanke was at the helm when the Fed had no clue about the pending bubble, his reputation, and that of the Fed, has not only stayed intact but grown.

Second, does the obsessive focus of investors on the Fed distract them from more important issues? For instance, let's look at the potential impact of a normalisation in U.S. interest rates. Currently, the interest paid on U.S. government debt is about 1.5% of GDP. In a US$15.7 trillion economy, that's about US$235 billion in interest paid.

If you saw 10-year bond yields rise from close to the current 2% to the long-term average of 6.6%, the interest on government debt could multiply. The U.S. could possibly be paying US$500 billion or more in interest, on top of that already being paid. That's a lot and would more than offset GDP growth of 2%, perhaps rising to 3% if the economy improves.

To put the possible increased amount of interest paid into context, it could dwarf the recent so-called sequestration cuts of US$85 billion. More interest paid on debt would mean less money elsewhere and likely more serious government cutbacks. And that's assuming that bond yields don't spike above long-term averages.

Would Bernanke really allow that happen? Probably not. Particularly when the less painful way to reduce debt and the interest paid on that debt is through inflation via QE.

Japan's bizarro world

If investors are stalking the Fed's every move, they're doing the same thing with the Bank of Japan (BoJ), and to a degree that's becoming comical.

The background is that the new government installed a new BoJ chief, Haruhiko Kuroda, in March. Kuroda's mandate was to print a bucket load of money to buy bonds and stocks in order to reinvigorate the economy and end 15 years of deflation.

Investors have warmed to the story, sending stocks up nearly 40% and the yen down 18% this year. That's despite stimulus only recently being initiated and the evidence of success or otherwise still not yet known.

The story's positive glow has taken a darker turn over the past week though. On May 22, commenting on the sharp spike in Japanese government bond (JGB) yields, Kuroda said that gains in yields should be expected as the economy improves. The problem was that he'd previously said that the central bank aimed to lower interest rates. It sent the Topix index down 6.9% on the day, the largest decline in two years. And bond yields swung 17.5 basis points intraday, briefly reaching a one-year high of 1%.

A three year chart of 10-year JGBs is shown below, courtesy of Bloomberg.

Then the next day, after a further spike in bond yields, Kuroda said the stimulus already announced by the government was sufficient but conceded he needed to communicate better with markets. The stock market swung wildly as Kuroda spoke, and after, moving 6% intraday, but finishing slightly up.

The problem, of course, is that investors had put total faith in Kuroda's ability to turn the economy around and that faith's now being questioned. The question is why investors had such faith in the first place.

Also, the focus on the BoJ's every move may mean investors are ignoring more pertinent issues. For example, if the BoJ succeeds with its aim to raise inflation to a targeted 2%, that means interest rates will rise. With interest paid on government debt equivalent to 25% of Japanese revenue, any rise in rates could prove diabolical. If the BoJ doesn't succeed, the enormous government debt load will compound and bond markets may eventually revolt. It seems like a lose-lose situation, and if that's right, the BoJ's every move takes on less importance.

Cognitive biases at work

What's behind this investor obsession with central banks then? It's obvious that central bank invention in bond and stock markets (direct and indirect) is greater than at any time in recent history. Undoubtedly, investors are struggling with this. Normal market operations are no longer normal. Investors have had to turn into part-time political scientists in order to anticipate market movements.

But is there more to it? I'd suggest that there might be and investors could be turning to time-old psychological biases to try to cope with the new environment.

Of course, the application of psychology to finance, known as behavioural finance, isn't new. It's a growing area of study though given the recognition that most investors are far from rational actors when it comes to markets.

Anyhow, here are five psychological biases that may explain some of the recent obsession with the actions of central banks.

Deference to authority. Studies have shown that people defer to authority, particularly during extreme crises. Stanley Milgram conducted the most famous experiment into this in 1963. The context for the experiment was that after World War Two, many wondered how ordinary people could commit unspeakable crimes. Milgram sought to test this in a laboratory to see how far people would go when an authority figure ordered them to hurt another human being. The shocking answer was: very far. While an extreme example, the lesson for investors is that many people will often do what an authority figures tells them to do, either overtly or otherwise.
Conformity, or the herd principle. The best-known study on this was done by Solomon Asch in the 1950s showing that people will deny evidence from their own eyes to fit in with others. This suggests that groups exert a tremendous influence over individual decision making.
Group conformity. A corollary of the above is that people conform more strongly with others that are in the same group as them. If your an economist, you're more likely to conform with the thinking and actions of other economists.
Cultural conformity. Collectivist cultures, particularly in Asia, are more conformist in their behaviour. This is because non-conformity is seen as deviance. Average conformity rates range from 25-58% in collectivist cultures compared with 14-39% in so-called individualist cultures. This explains much about Japan...
Adherence to social norms. Other people affect us even when they're not there. Studies by Robert Cialdini suggest that most people are strongly influenced by thinking about how others would behave in the same situation, particularly if they're unsure how to act. For instance, a decision about whether we buy into the stock market is often influenced by society's view of such a purchase. That makes for bad investing!

These are just some of the biases that may have contributed to the heavy reliance of financial markets on the words and deeds of central bankers.

Bias awareness means better investing

An understanding of these psychological biases is critical if you accept that they may be behind at least some of the investor behaviour of late. An awareness of the biases means that you can work to minimise them if they're impacting your own decision making. Minimising psychological biases can make for more rational, objective investment decisions. And a tidy edge over others.

This post was originally published at Asia Confidential (http://asiaconf.com).

Bond Vortex In The Works?

Bruce Krasting — Sat, 25 May 2013 14:51:51 +0000

I got an email from a friend who runs money for a hedge fund that got my interest:

may want to take a look at convexity vortex in mbs market and implications...

"Convexity vortex'? What's that about? A bit more from this fellow, I'll call him 'MP':

Some familiar with it say the vortex is 19 bps away..2.2% on ten year treasury, 3% on the CMM..if breaks, MBS holders subject to extension and duration risk. Would now have to increase convexity hedging. Would lead to price gaps and significant selling. With shortage of treasuries due to bernank and co. and low liquidity, could be very disruptive.

That got me interested. A layman's explanation of convexity:

When mortgage interest rates fall, the probability that an individual will re-finance a mortgage increases. When mortgage interest rates increase, the likelihood of a re-financing of the mortgage goes down. Therefore, in a rising rate environment, the average life of a pool of mortgages increases. For example, if a bond fund held Mortgage Backed Securities (MBS) with an assumed 10-year average life, AND interest rates rose, the average life of the MBS portfolio would be extended for a few years. This is convexity. The last thing that a bond manager wants in a rising rate environment is to have the average maturity of the portfolio extended, as this adds to the losses. As a result, MBS players hedge their portfolios against "duration risk" by shorting Treasuries (ten-year paper). The higher rates go (and the speed that rates are increasing) forces more and more of the convexity selling.

MP believes that there is a magic number of around 2.2% on the ten-year bond that will bring out an avalanche of convexity selling. The 2.2% tipping point is very close to where the T-bond sits today.

The fellow who brought this to my attention is a perm-bear on bonds. Given that, I sought out a confirmation from another guy (call him JH) who has been bullish on bonds for many years. JH sits on the bond desk of a big international bank. When I posed the question to the Bond Bull I got a surprising response:

I don’t disagree – I would guess we have a huge concentration of mortgages that would go out of the money at 2.25% 10yr UST, slowing prepays, extending servicer portfolios, bringing on longer duration UST selling ……

So there is a vortex risk in front of us. The weaker the ten-year gets (higher yield), the more selling is required. Is the Vortex going to happen? That depends on the performance of the bond market, AND on how the dealer community is positioning themselves against what is a clear Event Risk. The bond bull, JH, had this to say about the probability of a vortex being reached:

in the absence of a real, organic, self-sustaining recovery, I think this all self-corrects – in the medium term anyway, IF it actually gets to that 2.20% range we could see convexity selling.. but in this environment those higher rates won’t sustain.. in fact, I don’t think they even get to 2.20%, but if they do, and convexity selling ensues, and it’s exacerbated by a ‘thin float’ due to the Fed’s presence, it’s temporary and I’d argue a massive buying opportunity

JH does recognize that there are risks:

generally speaking, and in regards to ‘taper’ of QE, soon as the Fed pulls back, we will see a spike/knee-jerk higher in rates (which I argue we are seeing in ‘anticipation’ of this happening; imo misguided)

Bernanke has recently said that the Fed is in the process of changing the monthly QE purchases. He has said that the amounts of POMO (QE) that is completed on a monthly basis will vary based on "incoming information". From this I conclude that the Fed will, in the coming months, announce a taper of its purchases. When this happens, it's likely that the bond market will "spike/knee-jerk" higher in yield - and when that happens the convexity selling will bring even higher yields.

The Fed isn't going to like that result. They do not want to lose control of the long end of the yield curve. So, if and when the convexity selling hits post a QE Taper, the Fed might respond by increasing the next month's QE in an attempt to drive long rates back down. Bernanke has basically promised to do just that.

What happens if we get this scenario?

1) The Fed cuts the monthly QE from $85Bn to $50Bn,

2) The bond market craps out and 2.2% ten-year is reached.

3) Convexity selling occurs and drives the bond market down another notch to a 2.5% yield.

4) The Fed responds to the disarray in the bond market and announces that in the next month QE will be increased to $150Bn.

This is a realistic outcome. It could happen in the next 90-days. There are two ways that a situation like this plays out. JH, the bull, could be proven right in that bonds purchased with a 2.5% handle will be a good investment. The bond bear, MP, had this to say about the Fed ramping up monthly QE in response to a market correction in yields:

if Fed has to increase buying to stabilize, I would argue it is a very negative development for all markets.

I'm not smart enough to figure how this one plays out. It has a great deal to do with two unknowns - how dealers are positioned, and how the news flow from the Fed progresses over the next month or two. The fact that two guys who trade bonds for a living are well aware of the 'vortex risk' as rates approach 2.2% tells me that all of the bond guys are watching this. So, to some extent, the news is already in 'today's print' for bond yields. The opposite could also be the result. When a market understands that there will be forced selling at a certain level, the market always tries to push to the level where the stop-loss selling has to occur. To me, this suggests that the bond market is going to try to test the 2.2% rate.

I do agree with MP; if the bond market gets soft, the Fed will respond with a very large dose of monthly QE. And I further agree that if it plays out like this - it will prove to be a very negative development for all markets. The inescapable conclusion from this scenario is that QE is FOREVER. Taper talk will prove to be just talk. When players come to understand that the only leg the markets are standing on is endless/massive QE, there will be a shudder of fear.

What's the probability of this playing out as described? I would normally say that the 'worst case' will not happen. But there is something else going on in bond land that is running parallel to the Taper/convexity selling that the US is facing. Japan is looking at a very similar outcome (for much different reasons). As Kyle Bass pointed out last week (Zero Hedge LINK), the promise of 2% inflation and 1% bond yields doesn't have a happy ending. In an effort to cap Japanese bond yields, the Bank of Japan will respond with ever higher amounts of QE. The BOJ has to do this - the entire Abenomics goes up in smoke if the Japanese bond markets puke.

There are forces developing over the next few months that may push the BOJ and the Fed to take some extraordinary actions. That these two big CBs are facing the same potential outcome, at the same time, is troubling for me. I see this evolving story as a possible turning point. The key CB's will have gone from Offense to Defense.

For five-years the CBs have enjoyed being on the offense. They have successfully controlled things so far. But I can't imagine how they can continue to be "successful" when they are forced to defend (versus lead) the bond markets.

The Gods Of The Marketplace

Tyler Durden — Sat, 25 May 2013 14:27:49 +0000

Submitted by Mark J. Grant, author of Out of the Box,

"It's the lure of easy money. It has a very strong appeal."

                 -Glenn Frey, Smuggler's Blues

Investors borrowed $384.4 billion in April, a 1.3% gain from the previous month and a 29% rise from the same month last year. This is an all-time record for margin debt and it exceeds the previous high mark set in June 2007. Some may see this as an increased sign of investor confidence but I am not one of them. To me this is a giant red warning flag blowing in the financial breeze indicating the leveraging of dumb money making very risky bets.

"Every swindle is driven by a desire for easy money; it's the one thing the swindler and the swindled have in common."

                     -Mitchell Zuckoff

Substances based upon some sort of white powder are quite dangerous. They can overcome your good sense and then they it can be quite difficult to extricate yourself from them. The Great Depression was caused, in large part, by massive leverage utilized in the equity markets. This was the white powder of 1929. It took a decade and a World War before America was able to loosen the grip of the stuff.

The white powder of 2008/2009 was easy money provided by the American banks. It wasn't the subprime mortgages that caused the problem but the leverage that was used to buy them and then various securities that were appended to them. It took the coordinated efforts of the world's central banks to stop the carnage. Money for nothing, money from nothing and checks for free.

Chicks were still expensive but at least we could afford them once again.

"I came to a stark realization: chronic surpluses could be almost as destabilizing as chronic deficits."

              -Alan Greenspan

The economies of Europe are in recession by any definition that you would like to use.

America is sputtering and barely above the red line.

Japan is now on steroids and the recent volatility in their equity and bond markets is astounding if not scary.

All over the globe the white powder is being dispensed once again but this time there is far more of it than ever in history. It is being made by the central banks and so people think it is sanitized but let me tell you; there is no such thing! We are once again in the crack house of substance abuse!

In each age the gods of the marketplace show up once more. The packaging may be different but the powder is the same. Each dealer uses the same line, "Nothing addictive here."

"With the Hopes that our World is built on they were utterly out of touch,

They denied that the Moon was Stilton; they denied she was even Dutch;

They denied that Wishes were Horses; they denied that a Pig had Wings;

So we worshipped the Gods of the Market who promised these beautiful things."

-Rudyard Kipling

The Dreaded Curse of the IMF!

Pivotfarm — Sat, 25 May 2013 12:33:46 +0000

It looks like the International Monetary Fund has been jinxed. It’s fated. It’s doomed! The next managing director should start wearing garlic around their neck already or at least burn sage in their office to ward off evil spirits. Seems these days that anyone that steps into the shoes of the Managing Director of the IMF ends up becoming fated, the object of all desire. The man (or woman) to be in the sites of all our guns. The one to be bumped off.

Christine Lagarde has defended herself. She has stated, declared, promised and reiterated countless times until she has gone blue in the face that she did not do anything untoward. “I always acted in the interests of the state and in conformity with the law” she said last night before she headed off at double-quick speed to chit-chat with her lawyer. All image! Outwardly calm and collected. Inwardly, terrifiée. She is an ‘assisted witness’ in the Adidas case, embroiling Bernard Tapie (and the 45 million euros that were awarded to him, which Lagarde never appealed against as Finance Minister of France) and Sarkozy’s (illegal?) election funding in 2007 and 2012. Being an ‘assisted witness’ is a nice way of putting it that you aren’t going to be prosecuted yourself, but you had some dangerous dabbling and fancy footwork going on and the judge knows more than you think. Why is it that the French always allow their past Ministers and Presidents to be ‘assisted’? I thought they hated their image of ‘assistanat’ (translate as: (state) dependency)!

Jacques de Larosière (yes, another Frenchman), Managing Director of the IMF from 1978 until 1987 once wrote about moral hazard. Moral hazard is the name given by insurers to people who take risks just because they are insured and that they wouldn’t have taken those risks had the insurance policy not existed. Maybe he should have got on the blower to Lagarde before she took the risk of toying with Tapie and told her that; and maybe he should have stunted Strauss-Kahn’s ardent desires in room 2820 of the Sofitel Hotel NY before he took the risks.

But Lagarde and Strauss-Kahn are not the only ones that have been involved in scandals. Some of other Managing Directors have too (thankfully, not all of them, and not all of them while they were in office at the IMF).

Rodrigo de Rato y Figaredo (2004-2007)

He resigned for ‘persona reasons’. Listed as the worst CEO ever in 2012 of Bankia and charged in July 2012 for ‘accounting irregularities’.

Horst Köhler (2000-2004)

Had to resign from the Presidency of Germany because he said that Germany should be ready to go to war to defend their own interests of free-trade and to crush instability and regional insecurities in the world (so as to maintain standards of German revenue and trading possibilities), whatever the cost. Imperialism didn’t go down well.

Michel Camdessus (1987-2000)

Strongly criticized for his blinkered imposing of measures in East Asian countries and in Latin America. It caused unprecedented crises in countries like Argentina and rioting in Mexico. He resigned.

Jacque de Larosière (1978-1987)

Acquitted of any wrongdoing (but still involved) in the French Credit Lyonnais banking scandal. But, is there smoke without fire?

The other Managing Directors did nothing (bad, that is, apparently…unless, someone knows something the rest of us can’t find). Perhaps the reasons why the scandals involve the most recent MD is a telling tale of our modern times. Just for the record, here are the others.

H. Johannes Witteveen (1973-1978)

Pierre-Paul Schweitzer (1963-1973)

Per Jacobsson (1956-1963)

Ivar Roth (1951-1956)

Camille Gutt (1946-1951)

Of course, the IMF has long realized that they are in for a rough ride. They thought they had the right candidate in Lagarde (she was a woman, not a womanizer). But, they didn’t think she like the pesos more than the petting. Still, better to have Lagarde than to face another upheaval, so it’s not surprising that the executive board has backed her to the hilt. But, if all else fails, just wing it. Ride the wave and right out the storm. People love two things in life when it comes to reading about the people that govern us and run our lives up there at the lofty tops of society. We love a good scandal. We love a good scandal with loads of sex. We love a god scandal with loads of money. We love a good scandal with loads of money and sex. Monsieur Dominique Strauss-Kahn had the first: loads of sex. Madame Christine Lagarde got the second right. Third time lucky! Who will Mr. or Ms. X be that gets the full 18 rating? The new Mission Impossible! We’ll be watching you!

Originally posted http://www.tothetick.com/the-dreaded-curse-of-the-imf

FX Price Action: What's Next?

Marc To Market — Sat, 25 May 2013 11:50:38 +0000

The main development in the foreign change market over the past week has been the short squeeze of the yen, and to a lesser extent, the Swiss franc.

The move coincided with a backing up in JGB yields, with the 10-year approaching the 1.0% threshold, a nearly three-fold increase since the BOJ announced its more aggressive monetary stance in early April. The Nikkei took it on the chin, falling 12.5% between Thursday's high near 16k and Friday's low just below 14k.

Many of the foreign investors who have poured almost $80 bln into Japanese equities this year have hedged the currency risk, by selling the yen. However, given the slide in Japanese share prices, the may be over-hedged. To reduce the hedge yen needs to be bought.

At the same time, Japanese investors are not exporting their savings. Instead they appear to be taking profits on some of the foreign assets they had previous acquired. This is more consistent with the behavior on investors who do not expect the recent yen weakness to be sustained or substantially extended.

A band of support for the dollar extends from JPY100.60 to JPY100.00. The top of the band corresponds to a 61.8% retracement of the rally that began on May 9 near JPY98.65. The lower end of the band is the top of the month-long consolidation triangle pattern (early April through early May). The RSI, MACDs and Stochastics have turned lower. It probably takes a break of JPY99.60 to start talk in earnest that a top of some significance is in place. It would likely coincide with weaker Japanese shares.

The euro was confined to the previous week's trading range and chopped around a roughly $1.2820-$1.3000 trading range. The technical indicators we look at favor an initial upside break of this range. Additional resistance is seen in the $1.3020-40 area., which corresponds to retracement objectives and the 20- and 200-day moving averages. If this is overcome, there is potential toward $1.3200.

The euro has held support near JPY130. The measuring objective of the triangle pattern carved out mid-April through mid-May is near JPY135 and provided the JPY130 area hold, that remains a reasonable target. On the other hand, a break of JPY130 could be part of a large short squeeze on the yen another 1-2% decline for the euro.

The upticks may have to be fought for as many anticipate a refi rate cut next month and there is speculation that a negative deposit rate may be introduced then. With EONIA trading around 5 bp, another 25 bp rate cut remains more in the symbolic world than substantive. We continue to believe that the ECB will be persuaded that the cost (somewhat unknown) is greater than the benefits (elusive) of a negative deposit rate.

Soft inflation figures and a horrific April retail sales report (-1.4% vs 0.1% consensus) pushed sterling toward $1.50, which has acted as support since mid-March. Off a two-day base there, sterling tested resistance in the $1.5140 area. A move above $1.52 could see a push toward $1.53, which as it approaches may offer a new lower risk short.

Against sterling, the euro has been in a clear range for a little more than two months. It is GBP0.8400 on the downside and GBP0.8600 on the upside. The euro tested the upper end of the range twice in the second half of last week. That the resistance held would favor a test on the lower end of the range.

The euro rose to 2-year highs against the Swiss franc following news that the IMF endorsed the idea of Switzerland adopting a negative deposit rate if the franc's strength was renewed. In addition, some of the broad forces that were weighing on the yen, such as perception of a diminished need for safe havens, may have also weighed on the franc. The recovery of the yen coincided with the recovery of the franc in the second half of last week. The franc was the second strongest of the major currencies (+1.2% against the dollar), behind the Japanese yen.

The Canadian and Australian dollars were the worst performing of the major currencies over the past week, losing 0.4% and 0.8% respectively. Since around the middle of the month, the US dollar has gained almost 4% against the Canadian dollar and nearly 7% against the Australian dollar. The technical indicators we look at still have scope for additional near-term losses for both currencies. We note the Australian dollar is approaching the lower end of a two-year-old range against the Canadian dollar, near CAD0.9900.

The Mexican peso lost about 1.5% against the US dollar last week. As we noted, macro-economic fundamentals remain supportive, but the technical condition had worsened. The dollar cut through resistance in the MN12.40 area and the weekly close was the strongest for the greenback since mid-March. The MXN12.60 area offers initial resistance, given the extent of market positioning, we continue to see potential toward MXN12.80.

Observations from the latest CFTC report on CME currency futures:

1. Gross long positions were trimmed in all the currency futures we examine here, except the Canadian dollar. The adjustment to gross short positions was mixed.

2. Two positions were meaningfully adjusted (10k contracts or more change). The gross long Australian dollar position was cut by 11.6k contracts and the gross short euro position grew by 24k contracts.

3. It is the largest net and gross short euro position since last November. The gross short position is half the size of last June's record. The net and gross short sterling position are records. The net short franc position is the largest since last July,while the net short Australian dollar position is he largest since last June.

4. The gross short euro position is larger than the gross short yen position.

5. Significant moves especially in the yen, franc, Canadian dollar and Mexican peso took place after the CFTC reporting period closed. The former appreciated while the latter declined. We expect next week's report to reflect this.

Jack Lew's Triple Whammy - IRS Ignorance, Corzine Corruption, And The 'War On The Poor'

Tyler Durden — Sat, 25 May 2013 01:35:50 +0000

While some, we are sure, will view this brief clip as partisan showmanship by Representative Steve Pearce, the questions he asks Treasury Secretary should surely be responded to in some manner that is anything but the typical perfunctory shrug these matters normally garner. From Lew's apparent disbelief that the IRS Audits debacle was in any way 'political' to Lew's "waiting for the investigation' on Jon Corzine's misappropriation of funds, and finally to the "War on the Poor" that Pearce describes the current administration's policies (for the benefit of Wall Street); these few minutes are well worth some time as we 'remember' this weekend.

"For New Mexico, we recognize a war on the poor when we see it"

(h/t Sense On Cents)

Stick Save To Close The Week

David Fry — Sat, 25 May 2013 01:01:58 +0000

Bulls are a determined and desperate bunch. There were two consecutive days of large sell-offs this week but on each day dip buyers entered to make things more respectable. Let’s face it, bulls have positions to defend, so getting a green close was huge psychological win for Main Street.

Durable Goods Orders beat expectations coming in at 3.3% vs 1.4% expected, and prior, -5.9%; Ex-transportation, which gives a better picture of conditions since they're generally volatile like Boeing 787 orders for example, would be at 1.3% vs 0.4% expected, and prior -1.7%. This gave bulls some hope. But that news was sold hard early in the day Friday.

There really wasn’t any other news Friday and many traders were leaving early for the long weekend thus volume started to slacken making it easy for some algos (they never take a holiday) to bid things up squeezing some shorts.

The volatility in Japan markets continued as their leaders haven’t learned how to describe new policies as Bloomberg notes. We covered two Japan ETFs this week, EWJ and DXJ. Notably, DXJ was the best performing ETF in 2013 until this week. DXJ is interesting as it has a short-hedged position on the yen which benefits U.S. holders. EWJ is also popular but with the yen in sharp decline, it really hasn't benefitted U.S. holders as much.

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NYMO

The NYMO is a market breadth indicator that is based on the difference between the number of advancing and declining issues on the NYSE. When readings are +60/-60 markets are extended short-term.

NYSI

The McClellan Summation Index is a long-term version of the McClellan Oscillator. It is a market breadth indicator, and interpretation is similar to that of the McClellan Oscillator, except that it is more suited to major trends.I believe readings of +1000/-1000 reveal markets as much extended.

VIX

The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge". Our own interpretation is highlighted in the chart above. The VIX measures the level of put option activity over a 30-day period. Greater buying of put options (protection) causes the index to rise.

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The market’s performance Thursday and Friday are misleading since there is so much destruction in many sectors globally. But the media depends on selling what’s going on with the DJIA. It’s just window dressing for the tourists frankly.

Next week will feature Consumer Confidence; Case-Shiller HPI, GDP; Jobless Claims; Pending Home Sales; Chicago PMI; and, the dueling U of Michigan Consumer Sentiment data. The Fed will continue POMO actions throughout the week with the largest liquidity add Friday.

Let’s see what happens.

Guest Post: Are Pipeline Spills A Foregone Conclusion?

Tyler Durden — Sat, 25 May 2013 00:58:13 +0000

Submitted by Daniel Graeber of OilPrice.com,

Exxon Mobil hasn't asked federal regulatory authorities to restart the Pegasus oil pipeline, which burst open in a neighborhood in Mayflower, Ark. In March, a 22-foot rupture in the pipeline spilled about 5,000 barrels of diluted Canadian crude oil into an area of marshland, though the company said it's been effectively cleaning the area with long-term remediation in mind. Policymakers on both sides of the Canadian crude oil debate have focused on issues ranging from emissions to economic stimulus. If pipelines like Keystone XL have any chance of approval, perhaps pipeline integrity should be the focal point of real policy debates.

Exxon said it was still looking into what caused a 22-foot gash to appear in the wall of its 65-year-old Pegasus oil pipeline. Arkansas Attorney General Dustin McDaniel said his office was pouring over 12,500 pages of information sent to his office by Exxon. Those documents were related to maintenance, inspection and safety of the 850-mile oil pipeline. Exxon, for its part, said it was combing over data taken from inside the pipeline itself in an effort to figure out what happened before the spill. That inspection, a spokesman said, could take at least another month.

Exxon already removed the damaged section and replaced it with new pipe. About a month after the Arkansas incident, about a barrel of oil leaked from the same pipeline about 200 miles north of Mayflower. The "wait and see" reaction to the Pegasus spill, and potentially the delay in the restart, may be part of Exxon's evaluation of the debate over the Keystone XL pipeline. Last week, a measure dubbed the Northern Route Approval Act passed through a Republican-led committee on its way to the full House. The bill would leave the fate of Keystone Xl in the hands of policymakers, who may have a vested interest in seeing that the project gets built.

Rep. Jerrold Nadler, D-N.Y., cast his vote against the Northern Route Approval Act. He expressed frustration that lawmakers were moving the debate away from renewable energy and focusing more on how best to circumvent normal review processes. Last year, the White House passed new laws that would stiffen the penalties for pipeline safety violations and mandate more inspections. That decision followed a 1,000-barrel spill in the Yellowstone River and a 20,000-barrel spill in Michigan. Lawmakers debating Keystone XL, however, have pressed for few additional assurances for pipeline integrity.

Canadian Prime Minister Stephen Harper told the Council on Foreign Relations last week the "real" environmental issue with oil from Canada was whether it traveled through a pipeline or by rail. One of the "real" issues has to do with emissions. Upstream, emissions work out to be "almost nothing globally," the prime minister said. Downstream, it's more likely that a train will derail than a pipeline will burst open, he said.

Talking points over pipelines are focused on economic and energy security interests on one side of the argument versus emissions and cleanup on the other. Given the legacy of pipeline spills since the Keystone XL debate began more than four years ago, the "real" issue may be the lack of debate over just why so many of these pipelines have burst open in the first place.

Abenomics 101 - The 15 Most Frequently Asked Questions

Tyler Durden — Sat, 25 May 2013 00:20:19 +0000

With the first arrow of Abenomics perhaps hitting its limit, it will be the second and third arrows that need to occur quickly and aggressively to carry this momentum forward (and for the economy to grow into stock valuations). Barclays lays out 15 of its most frequently asked questions below but concerns remain as the BoJ’s planned absorption of nearly 80% of new JGB issuance from the markets this fiscal year has triggered a dramatic change not only in JGB supply/demand and ownership structure but in the JGB market risk profile itself, which has moved from “low carry, low volatility and high liquidity (superior to other assets from perspective of risk-adjusted returns or Sharpe ratio)” to “low carry, high volatility and low liquidity (inferior from same perspective)”. Barclays added that with a wave of major political and policy events ahead, starting with a crucial Upper House election, there was no big change in the basic belief among foreign investors that Japan is likely to be the main source of surprise for the global economy and of volatility in financial markets.

Via Barclays:

Q1: Is the BoJ’s 2% price stability target achievable?
A1: It will be difficult through monetary easing alone

Q2: Where might a surprise appear in inflation trends?
A2: Inflation tends to jump unexpectedly when a combination of monetary easing and significant fiscal expansion coincides with some sort of supply shock.

Q3: What transmission channel is the BoJ envisioning for achieving its inflation target?
A3: Since the interest rate and credit channels are unlikely to recover anytime soon, the BoJ will have to depend largely on more accommodative financial conditions via higher share prices and a weaker yen.

Q4: What other monetary policy actions are expected?
A4: We think the BoJ will likely be compelled to ease again in 2H FY13 (most likely in October), consisting mainly of increased purchasing of ETFs as the most feasible risk asset.

Q5: How do we describe the government’s fiscal policy stance for 2013-14?
A5: Assuming no additional fiscal measures, fiscal policy will shift from a markedly expansionary stance relative to other developed nations in 2013 to an abrupt contractionary stance next year.

Q6: What is the likelihood of a return to a public-spending-driven economic recovery?
A6: If the economy is underpinned by strong overseas demand (robust exports), as in the Koizumi era, it would reduce the chances of a major fiscal expansion or resulting economic rebound fueled by public works.

Q7: Is government debt sustainable?
A7: This will depend on growth initiatives. If the government continues to depend unduly on QQE without a proper growth strategy (sluggish potential growth), the possibility of a ‘sell-Japan’ scenario would reemerge over the long term.

Q8: How has the government’s growth strategy progressed?
A8: There has been no notable progress yet. Momentum for growth initiatives may pick up depending on the Upper House election results, but key measures such as a corporate tax cut and easing of job dismissal regulations could take considerable time.

Q9: Are Japanese stocks overvalued?
A9: Japanese stocks are superficially rich as measured by valuations such as P/E. However, we believe share prices have further upside as long as excess liquidity continues to curb the ERP.

Q10: What will be necessary to ensure a more sustained rise in share prices?
A10: A more sustained rise in the liquidity-driven stock market will require a return of surplus funds to shareholders when real interest rates fall into negative territory, a cut in corporate tax rates, and higher financial leverage.

Q11: How has the structure of JGB markets changed since the launch of QQE?
A11: The post-QQE risk profile of JGB markets has changed dramatically from “low carry, low volatility and high liquidity (high Sharpe ratio)” to “low carry, high volatility and low liquidity (low Sharpe ratio).”

Q12: Will QQE trigger significant portfolio rebalancing by financial institutions?
A12: Banks will reduce their JGB holdings substantially in 2013-14. Still, their considerably higher risk tolerance levels compared with the VaR shock of 2003 should act as a buffer for JGB markets.

Q13: Will the yen’s decline accelerate? What is the risk of reversal to yen appreciation?
A13: The fall in the yen’s value could hasten if a further BoJ easing coincides with a reduction by the Fed in its QE. However, from a supply/demand perspective, purchasing of Japanese shares by overseas investors should offset the effect of portfolio rebalancing by domestic investors, suggesting that the pace of yen depreciation should slow.

Q14: What political developments can be expected after the Upper House election?
A14: If the LDP secures a majority in the Upper House, the government will have control of both houses for the first time in six years, setting the stage for a long, stable administration. The political stability could be the driving force for growth initiatives.

Q15: What are the best- and worst-case scenarios for Abenomics?
A15: The best-case scenario is the LDP wins a large majority in the Upper House election and more momentum for growth initiatives, along with QQE to ease near-term deflationary pressure. The worst case would be a retreat in growth initiatives and prolonged overdependence on QQE.

Whether the markets go for a buy-Japan or sell-Japan scenario will depend in good part on the results of important policy and political events in the next three months. Of particular note are: 1) BoJ Monetary Policy Meetings; 2) the Council on Economic and Fiscal Policy’s Basic Stance for Economic and Fiscal Management, scheduled for release in June, and the outline of growth initiatives by the Industrial Competitiveness Council and Council for Regulatory Reform; and 3) the Upper House election (as well as the Tokyo Metropolitan Assembly election, a prelude for the national poll).

Source: Barclays