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Guest Post: Why Are Markets Confused?

Tyler Durden's picture




 

Authored by Steen Jakobsen, CIO Saxo Bank via his blog at TradingFloor.com,

"Confusion is a word we have invented for an order which is not understood." – Henry Miller 

Why are markets so confused? I am slightly perplexed as to why the market has such a hard time comprehending and adjusting to the subtle changes made by the US Federal Reserve over the past two FOMC meetings. To me, the Fed's actions appear rather straightforward and logical and this may be a good thing for markets and the next recovery phase. 

Three conclusions should be drawn from the latest FOMC text and press conference: 

  1. Chairman Ben Bernanke is done as chairman: He had enough class in the press conference this week to make sure everything was about monetary policy and the job at hand rather than a focus on his own agenda and persona. Let me also, for the record, state this: I have never been a friend of Bernanke’s theories and stewardship during this crisis – he has taken the US directly into a debt trap with the false premise of the “wealth effect” based on super-easy money. But I do respect his integrity, even his firm belief in his agenda and at all times, he has been measured in his communication and shown great respect for the office of the chairman of the Federal Reserve. His predecessor, Alan Greenspan, made the FOMC into a personal PR campaign for his own brilliance (or lack thereof). Chairman Bernanke has re-established the “office of chairman” to its rightful position. Who comes next is a totally different story and scary if any of the prominent names mentioned thus far are nominated. (Likely candidates to succeed Fed’s Bernanke in 2014)
  2. Inflation undershooting with no policy response is the hidden message in Fed policy: Inflation in the US is undershooting its target and showing a falling trend. “Officially”, the Fed sees this as transitory and a mean-reverting process, but in historic context this is “an issue” that would have been addressed by an increase in asset purchases and forward guidance. Instead, the Fed’s projections are for a PCE inflation in the range of 0.8 percent to 1.2 percent (from 1.3 percent to 1.7 percent in March) for 2013.  Signalling no anticipation of an additional policy response despite the lowering of inflation forecasts means the Fed is clearly sending a signal: something is rotten in the state of the markets! It is clear that the Fed now feels that the “wealth effect” has been too vigorous in asset markets and that we are in the early stages of an asset bubble. And the last thing you want to do when asset markets are overheating is to overreact to a falling inflation rate, hence the lack of a policy response signal despite huge noise from St. Lois Fed’s Bullard (link: Bernanke ignores low inflation. Market doesn’t)
  3. Changing regulatory framework: Few people realise how "dramatic" the Dodd-Frank Wall Street Reform and Consumer Protection Act was for the Federal Reserve. Dodd-Frank increased the Fed's regulatory power under Title III – Transfer of powers to the comptroller, the FDIC and the FED, which, among other practical changes, meant there is now a new position on the Board of Governors, the vice chairman for supervision. Clearly, when you have regulatory responsibilities for bank holding companies (read: too big to fail banks) – and when you think the market is getting irrationally exuberant in its valuations you - want to reign in the froth or "reach for yield" before it becomes excessive or even dangerous. The fact that the Fed is now directly responsible for the banks they support through super-easy money makes them less prone to continue this game of extend-and-pretend relative to how they would have behaved without this increased power. Note also that the Federal Reserve on May 13 announced that stress tests from the largest 18 US bank holding companies must be submitted no later than July 5. 

Another development along the same lines should have you worried about the potential for deflating asset prices: U.S Weighs doubling leverage standard for biggest banks. Yes, indeed, "The standard would increase the amount of capital the lenders must hold to 6 percent of total assets, regardless of their risk. It’s twice the level set by global banking supervisors." This is critical for markets.

 So putting all of the above together, what other conclusions can we draw? 

  1. A Margin call is underway due to the changing regulatory framework: Even the policy makers are saying now that asset bubbles must be prevented from growing too large, which means a deleveraging environment. 
  2. Who's the next Fed chairman? This is all unfolding as we are rapidly reaching the transition period to a new Fed chairman. Who will that be? Bernanke got us into the debt trap – who will take us out? Markets don't like uncertainty.
  3. Normalisation from extremely easy money to easy money.  I'm convinced that by the end of Q3/beginning of Q4 the Federal Reserve will start trying to put the genie back in its bottle, but it will be too late – it’s already escaped. Monetary policy is now moving towards normalisation. I expect Fed asset purchase tapering to begin by October with more volatility and the concomitant bloated VaR to follow.

Then of course, we need to put this into the global macro context to see how this affects other economic and market themes: 

  1. Asia’s current account surplus is under pressure – coming from a level of 5-7 percent of GDP in 2005/2007, it's now at 1 percent and still falling. I see Japan and China going into actual deficits over the next two years – meaning dis-saving and drawing down the balance of savings overseas, which means less US and OAT (French bond) buying but also a total stop for a global recycling of capital from Asia into deficit-ridden governments globally. This means the recent rise in interest rates is just as much about less “free floating capital” from trade as from less “potential” printing from the major global central banks. This will mean a higher marginal cost of capital and a drive towards more balanced global economies.
  2. The commodity Super Cycle is on hold (if not at full stop). This is mainly a China story. China has driven half of all commodity buying in the world in the past five years. China is now slowing down due to a number of factors: a credit and house bubble, an anti-corruption drive to reduce the speculative/capital flight trading between Hong Kong and China (which reduces trade and hence growth), an outdated business model that is now in its 34th year. The country is also in need of a serious overhaul to address corruption, the lack of quality health care and a lack of investment assets. The world is starting to realise that China is transitioning to 4-5 percent growth range rather than the 6-8 percent that was officially declared (Electricity consumption was up a mere 4.3% in Q1 – normally a good peg. This means serious reform needs in “one-trick pony" economies such as Australia, South Africa, Malaysia, Brazil, Mexico and other resource-driven economies.
  3. Overconfidence in recent economic and policy action. All change – Last station – All change.. was a piece I wrote on how when the market is overconfident it tends to overleverage through the use of value-at-risk (VaR) models.

VaR starts to bloat when an impulse, like a failed quantative easing programme from Japan, increases volatility. Volatility is the first derivative of price, such as fast-moving prices making the VaR numbers bigger (more volatility equals more risk). This, in turn, sees risk managers telling traders to reduce risk, which makes the prices move even more quickly and even discontinuously. The big moves in Japanese government bonds and USDJPY will also mean that volatility spills over into other markets as various emerging market debt and coffee futures volatility is nearly always contagious. 

The market deals extremely poorly with paradigm shifts or cycle changes. One reason for this is that there has been no need for any strategy except for the just-buy-the-dip mantra. This may have ended and that could be the best signal to the markets since the global financial crisis started. Sorry to be the messenger, but the only way for investors to understand risk and leverage is by having them lose money.

Essentially then, the balance of this year could be an exercise in re-educating the market to long-lost concepts such as loss, risk, inter-market correlations and price discovery. I will even predict that high-frequency trading systems will suffer, as will momentum-based trading and, most interestingly, long-only funds. Why? Because, at the end of the day, they are all built on the same premise: predictable policy actions, financial oppression and no true price discovery. We could be in for a summer of discontent as policy measures and markets return to try to search out a new paradigm. This will be good news for all us.

 

Jakobsen offers details on his strategic themes to take advatange of this view here.

 

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Tue, 06/25/2013 - 12:03 | 3691416 Judge Crater
Judge Crater's picture

After reading this posting, I am confused.

Tue, 06/25/2013 - 12:11 | 3691446 nope-1004
nope-1004's picture

That's because the FED has stated that they may taper at some point in the future, but to date they have NOT.  Everyone is running with the theory and rumor and creating all kinds of stories for how the 'end' will be.

I'd like to see the Fed end QE altogether.  Would love to see the TBTF banks blow up.  Ain't gonna happen though.  The Fed's policies are ineffectual so their biggest monetary tool is to spread rumors.  They've been talking about "exit strategy" for years.... has it happened?  Now they've changed the term and called it "taper".  Will it happen?

 

Tue, 06/25/2013 - 12:18 | 3691467 EscapeKey
EscapeKey's picture

The Fed lie.

And the banks (ie PDs) stand ready to back the lies of the Fed.

Any questions?

Tue, 06/25/2013 - 12:36 | 3691527 Ghordius
Ghordius's picture

yes. does this rule apply to the biggest of the Primany Dealers? I mean... China

Tue, 06/25/2013 - 12:44 | 3691553 famousisourname
famousisourname's picture

China is a wild card cause IF they back the yuan by gold or brics gold trade notes all those us t-bonds will come home to us, bye bye us dollar.

Tue, 06/25/2013 - 12:22 | 3691472 SheepDog-One
SheepDog-One's picture

'FED policies 'ineffectual'....I don't see it that way at all, they knew exactly what they were doing from 2007 on with threats of 'hand over the checkbook or you get tanks in the streets' and then the lies that all we'd need is a little TARP over the banks and then we'd be just fine...well maybe a couple hundred more billion here....maybe a QE or 4 there.... $30 trillion dollars of monetization later just as they planned nothing was ineffectual at all, all according to plan and there will be no easy glide down either into 1 global bank/currency...it will be abrubt 1 day event coming one of these days.

Tue, 06/25/2013 - 12:19 | 3691475 YuropeanImbecille
YuropeanImbecille's picture

The one thing we can be 100% sure about is that the next FED chair will be a jew and diehard zionist like all the other FED chairs.

 

Tue, 06/25/2013 - 12:29 | 3691503 nugjuice
nugjuice's picture

Whoaaaa there buddy, be careful dropping a hard 'J' like thata

Tue, 06/25/2013 - 12:30 | 3691507 Flakmeister
Flakmeister's picture

Were you molested by a Rabbi when you were a kid?

Tue, 06/25/2013 - 12:41 | 3691537 otto skorzeny
otto skorzeny's picture

If he was you wouldn't read about it in the Zionist  MSM as they only report the Catholic priests - asshole

Tue, 06/25/2013 - 13:11 | 3691644 Flakmeister
Flakmeister's picture

Actaully, the fact that Rabbis are allowed to marry means the their form of the Priesthood does not suffer from some of the problems RC church does...

Don't you have a tinpot dictator to go rescue... Umm, he was an anti-semite as well, I think I am detecting a pattern...

Tue, 06/25/2013 - 13:15 | 3691660 TuPhat
TuPhat's picture

What's that? more flak from the master or just one of your fantasies?

Tue, 06/25/2013 - 12:30 | 3691504 Unprepared
Unprepared's picture

"After reading this posting, I am confused."

The fed-friendly word is "puzzled".

Tue, 06/25/2013 - 13:02 | 3691614 slaughterer
slaughterer's picture

As FERAL PIG, the market wil ENJOY EXTREMELY EASY MONEY until Sept/Oct.  I CALL A FERAL PIG MARKET UNTIL THE LAST SECOND.  

Tue, 06/25/2013 - 13:11 | 3691647 taraxias
taraxias's picture

Actually, it's the author who seems confused. 

Tue, 06/25/2013 - 15:30 | 3692125 PacOps
PacOps's picture

Upon joining IBM in 1963 one of the first things we were taught was the concept of GIGO. It has served me well for 50 years and counting, er stacking.

 

https://en.wikipedia.org/wiki/Garbage_In%2C_Garbage_Out

 

Garbage in, garbage out (GIGO) in the field of computer science or information and communications technology refers to the fact that computers will unquestioningly process the most nonsensical of input data, "garbage in", and produce nonsensical output, "garbage out".

Tue, 06/25/2013 - 12:06 | 3691424 Kreditanstalt
Kreditanstalt's picture

I'm curious why we have to wait for another general stock market rise to see any improvement in our gold miner and gold bullion USD prices.  They should go opposite directions! 

Arent they supposed to be countercyclical?  Or has cheap money, leverage and outsize positions in paper fractional reserve gold ended that...?

Why the hell must Chipotle, BoA and NetFlix go up to show any value in gold??????

Tue, 06/25/2013 - 12:18 | 3691448 King Nothing
King Nothing's picture

The price needs to be low so when they default on gold delivery they can cash out instead for less then a 1/3 of what they got paid, then I am willing to bet once they have cashed the majority of the calls, the silver price will sky rocket again to 65-70 dollars and Gold to 2,200-2,500 and 2017 will be the next cycle down.

 

I expect by or in October for there to be a default requiring massive cash in lieu of gold/silver. Gold will then rise for the next 5 years. 

 

Thats my take but I'm just a hairless sheep.

Tue, 06/25/2013 - 12:19 | 3691476 SheepDog-One
SheepDog-One's picture

Yea goldbugs don't worry....the gold to hedge against currency printing will go back up just as soon as inflated paper stawks go back up.

Wait...what??

Tue, 06/25/2013 - 12:53 | 3691580 KnightTakesKing
KnightTakesKing's picture

Welcome to the new abnormal.

Tue, 06/25/2013 - 13:02 | 3691613 gatorengineer
gatorengineer's picture

Housing will be crushed again in this bond move, wealth destroyed..... gold down, the puzzle isnt gold down as much as oil holding.....

Tue, 06/25/2013 - 13:08 | 3691631 walküre
walküre's picture

oil up yesterday when everything else sold off .. didn't go unnoticed

Tue, 06/25/2013 - 13:20 | 3691665 TuPhat
TuPhat's picture

Some of my IRA was in paper gold.  I took it as a disbursement today and will buy physical when the price bottoms.  Or as close to it as I can guess anyway.  I will pay the taxes and get something I can put in my sock drawer. 

Tue, 06/25/2013 - 12:10 | 3691443 SheepDog-One
SheepDog-One's picture

Why are 'markets' cornfused? Well, what else do you expect from the spoiled Sweet 16 brat who has had such an easy free ride and been promised a new Ferrari, then suddenly told her allowance will be cut because her parents are out of money? Whatever.

Tue, 06/25/2013 - 12:13 | 3691453 SheepDog-One
SheepDog-One's picture

The author 'respects Bernanks integrity' lol whatever.

Tue, 06/25/2013 - 12:26 | 3691494 otto skorzeny
otto skorzeny's picture

Ben has "class"? He doesn't even have the common decency to give us a reach-around as he sodomizes America's savers.

Tue, 06/25/2013 - 12:16 | 3691465 kchrisc
kchrisc's picture

Off-Topic:

I always check-in with the propaganda media to keep up on what's being "shaped" propaganda wise--what they are ignoring, what they are focusing on, what they are spinning. It's mind-numbing.

So check out this headline from NBCNews.com:

"Daughter: Mandela opens eyes, smiles at news of Obama's S. Africa visit" Looks like a new game to see how many times they can work the name/word Obama into a headline/"story." LOL
Tue, 06/25/2013 - 12:24 | 3691480 SheepDog-One
SheepDog-One's picture

LOL....YAY ObaMao the lyin'King Simba comin YAYYYY YAAYYYYYY!!!

Tue, 06/25/2013 - 13:12 | 3691652 walküre
walküre's picture

For once he will dress the part. Can't wait to see Obama in traditional African costumes and gear. Green and yellow will look dazzling on him and Mo' can finally hide in an African cloak dress. Picturing her with a water jug on the top of her head. The two of them walking into the African sunset. It will fit and look completely natural.

Tue, 06/25/2013 - 12:23 | 3691490 Herd Redirectio...
Herd Redirection Committee's picture

I just try to ignore the propaganda as much as possible.   Its possible to survive without a cell/smart phone and national multimedia news outlets (ZH not included!)

Tue, 06/25/2013 - 21:57 | 3693128 kchrisc
kchrisc's picture

Sorry, no can do, as it is VERY important. The propaganda informs one as to what they hold important and in what direction they are moving.

Case in point is what they have had to say or not say about the various scandals the past month or so. Very enlightening.

One can also spot some of their moves early from their propaganda patterns. Like when gun-control seems to pop up more and more often and in random and often unrelated articles and then, bam, "Sandy Hoax" (the school).

My ultimate fav was the "ClimateGate" emails that they ignored the living hell out of. Then about 8 or so months later they were happy to "report" that one of the UK government's "dog and pony" investigations into the content of the emails came up negative. LOL

And then their was NDAA 2012--millions of voices screaming holy-shit and treason for a month and a half and not a peep from the propaganda media.

Tue, 06/25/2013 - 12:32 | 3691502 Flakmeister
Flakmeister's picture

What happens to market whose modus operandi is alledgedly discounting future growth in earnings do with the idea that the growth paradigm has ended?

Not that any traders really care or are capable of groking that the current method of discounting FV is so flawed that beggars the imagination...

Tue, 06/25/2013 - 12:35 | 3691525 NotAMathWhiz
NotAMathWhiz's picture

+1 for the Heinlein reference (at the risk of showing your age)...

Tue, 06/25/2013 - 12:31 | 3691513 mickeyman
mickeyman's picture

The biggest problem is the deliberate distortion of economic data. We need real numbers to make sensible decisions. With faked data we can only make foolish ones.

Tue, 06/25/2013 - 12:38 | 3691534 buzzsaw99
buzzsaw99's picture

Jakobsen is a typical prop trading tbtf banker who claims to think that the usa eCONoME is improving and further feels that investors should now lose money while he gets another bonus. I hate this guy.

Tue, 06/25/2013 - 12:43 | 3691550 pods
pods's picture

Market?

lol

pods

Tue, 06/25/2013 - 13:46 | 3691761 kevinearick
kevinearick's picture

Promises, Promises

So, you can employ any form of gravity to sling-shot your development, to create space, in a trade-off, with opportunity cost. History is arbitrary and self-serving to the passive aggressive, because its gravitational machine is peer pressure, which may just as easily be a DC circuit. It is always the beginning and the end, of times.

The shelves are separated by threshold circuits, which may be constricted and expanded at will, making the multiplexer. The part of the tornado vortex you don’t see is underground. Time is separated accordingly.

The upper middle class is about to see itself, for what it is. You might want to have a new dress ready, or not. Once again, the empire has immobilized itself, in its attempt to immobilize and replace labor, for maximum extraction. You’ll have that, from time to time.

You always have a choice, to extend or implode the empire. Choosing not to decide leaves nothing but bad choices behind, best as the enemy of better. Be diligent or be weary. The empire feeds on stupidity. Keep it in check and it will serve you. Let it grow like a weed and it will strangle you.

Practical, expedient civil marriage is its own worst enemy, because its result is peer pressure robots and rebel robots without a cause, seeking their own least common denominator, which, to their ultimate horror, is 0. Once they pass unity, 1, momentum gets ugly. The natural response to passivity is aggression, which, if undisciplined, results in chaos, MAD insurance.

Military law is about positioning, reconnaissance. The derivative weapon presents itself. Civil marriage cannot produce self-disciplined children, regardless of technology. All it produces is a hollow military, encapsulated by a mercenary force, under central control, elite scapegoats for hire. Shock and awe cannot replace a real economy.

It’s not the job of the military, much less The Imperative, to enforce fiscal and monetary expansion, in a positive feedback loop, which is exactly what the empire majority has built the US Navy to do, through its scapegoat, Congress, a damsel in distress, and paper promises, beginning with the US Constitution.

Sorry folks; John Wayne was a draft-dodger, like all the other pretenders employed as an example to spawn the empire illusion, in the master slave game of ladders. His grandparents were specimens though. They sold me my first John Deere tractor and wagon. It was plastic and leg-driven, but I got a lot of work done with that outfit, learning what they don’t teach you in school – the value of your word, the ability to count, and the means to swim against the current.

The US Navy is just an entertainment company that can’t get out of its own way.

 

 

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Yes, Your One Life Matters

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