Carry Trade

The downside technical correction in the dollar that we have been anticipating appears to have begun against most of the major currencies.  The drift lower against the yen over the past month has ended, and although we are skpetical of the impact of the stimulative monetary and fiscal policies in Japan, technically it is difficult to resist the momentum for additional yen weakness.  

There is "not a chance," that the Fed will be able to unwind its balance sheet in an orderly manner, "because everybody is front-running [them]," as the Fed is creating "serial bubbles," that are increasingly hard to manage since "we're getting in deeper and deeper every time." David Stockman has been vociferously honest in the last few days and his Bloomberg Radio interview with Tom Keene was extremely so. While Keene tries his best to remain upbeat and his permabullish self, Stockman just keeps coming with body blow after body blow to the thesis that this 'recovery' is sustainable. "They are using a rosy scenario forecast for the next ten years that would make the rosy scenario of the 1981 Reagan administration look like an ugly duckling," he exclaims, adding that the Keynesian Krugmanites' confidence is "disingenuous" - "the elephant in the room - the Fed," that are for now enabling rates to stay where they are. The full transcript below provides much food for thought but he warns, if the Fed ever pulled back, even modestly, "there would be a tremendous panic sell off in the bond market because it is entirely propped up... It's to late to go cold turkey."

The likely outcome of the Cyprus crisis now looks to be even worse for the average Cypriot that appeared likely over the weekend. Those who think countries would be better off outside EMU rather than in, just might be able to test their hypothesis. We suspect they will be sadly surprised to learn that the only thing worse of getting in is getting out.

When one thinks of the US banking system, the one thing few consider these days is the threat of a liquidity shortage. After all how can banks have any liquidity strain at a time when the Fed has dumped some $1.7 trillion in excess reserves into the banking system? Well, on one hand as we have shown previously, the bulk of the excess reserve cash is now solidly in the hands of foreign banks who have US-based operations. On the other, it is also safe to assume that with the biggest banks now nothing more than glorified hedge funds (courtesy of ZIRP crushing Net Interest Margin and thus the traditional bank carry trade), and with hedge funds now more net long, and thus levered, than ever according to at least one Goldman metric, banks have to match said levered bullishness to stay competitive with the hedge fund industry. Which is why the news that at noon the Fed reported that Primary Dealer borrowings from its SOMA portfolio, which amounted to $22.3 billion, just happened to be the highest such amount since 2011, may be taken by some as an indicator that suddenly the 21 Primary Dealers that face the Fed for the bulk of their liquidity needs are facing an all too real cash shortage.

With the G-20 (and G-7) concluding with what appears to be a slap on the wrist and a wink-and-a-nod to Japan, it seems the game of competitive devaluation will continue. Much pixel and ink has been spilled the 'potential' winners and losers in such an evolving game, but as Bloomberg notes, there has been one winner in the last 10 years each time the world has fretted over "currency wars". As fear (and actuality) of currency wars flares, the USD has borne the brunt of the buying. From 2004's JPYtervention to Mantega's 2010 comments and each time in between, when competitive devaluation is on the world's lips, then the USD is implicitly bid as the currency du jour is offered to any and every willing carry trade riderthere is. The trouble is - for the lowly US investor - each time the USD is bid, so the US equity market has hit an FX-translated earnings hump and fallen back. So while talking heads will exaggerate the nominal performance of Japanese and British equity markets as their currencies free-fall, perhaps the US investor should be careful what they wish for.

JPY could fall a lot further because weak JPY has been the most effective tool to create equity market wealth and spur Japanese demand. Moreover, Citi's Steven Englander notes, Japanese policymakers do not have many other options. If JPY is ticket for the Nikkei to regains ground lost versus other equity markets, USDJPY would have to go into three digits. By implication JPY would have to weaken a lot more. The loss of market share in part reflects long-term structural issues but Japanese governments (like others) are more mindful of incurring the anger of domestic political constituencies by making tough structural reforms than of G20 counterparts by weakening the exchange rate. From a political perspective, the Nikkei-JPY relationship is too much a good thing for Japanese policymakers to give up - but divergences are abundant at the short- and long-end of the JGB curve - and too much of a good thing in this case is a disaster.

All in all, the market took apple`s takedown rather well, which is probably bullish! 

It’s all a money game on Wall Street.

There are very few free lunches in the world, there will be some costs or unintended consequences of this newfound commitment towards a weaker Yen.

Presenting Dave Collum's now ubiquitous and all-encompassing annual review of markets and much, much more. From Baptists, Bankers, and Bootleggers to Capitalism, Corporate Debt, Government Corruption, and the Constitution, Dave provides a one-stop-shop summary of everything relevant this year (and how it will affect next year and beyond).

It's a time bomb.

A mere three weeks ago, Nomura's Bob Janjuah forcefully suggested that complacency warranted a tactical risk-off position given the misplaced confidence heading into the plethora of event-risk ahead. It seems, 60 points later, that he is on to something; but this time he is more critically concerned: "Investment decisions based largely on the greater fool theory and predicated by the assumption that central bankers can sustainably and credibly misprice money, supporting a significant misallocation of capital, without any major negative consequences, are in general not good investments."

AUDJPY is getting smacked hard in this evening's admittedly thin trading given the US holiday. China's double-whammies of PMI data (both official and HSBC versions - with the latter revised lower from Flash to its lowest level since March 2009) and some weak Aussie retail sales data is weighing very heavily on the critical carry trade pair. S&P 500 futures traded down in line with AUDJPY from Friday's close but once the China PMI came as weak as it was so the 'Good is Bad', the PBoC have to do something crowd started buying and dragged ES up a few points. Juxtaposing these dismal macro data was a better than expected China Services PMI and Aussie manufacturing index - as the Schrodinger 'economy is good and bad' headlines continue to confound. For the 'bad-is-good' crowd who see stimulus as the solution, we offer three words 'steel overcapacity' and 'malinvestment' and a must-read story from Reuters on the Chinese turning on themselves...

"This market isn't real. The two percent on the ten-year, the ninety basis points on the five-year, thirty basis points on a one-year – those are medicated, pegged rates created by the Fed and which fast-money traders trade against as long as they are confident the Fed can keep the whole market rigged. Nobody in their right mind wants to own the ten-year bond at a two percent interest rate. But they're doing it because they can borrow overnight money for free, ten basis points, put it on repo, collect 190 basis points a spread, and laugh all the way to the bank. And they will keep laughing all the way to the bank on Wall Street until they lose confidence in the Fed's ability to keep the yield curve pegged where it is today. If the bond ever starts falling in price, they unwind the carry trade. Then you get a message, "Do not pass go." Sell your bonds, unwind your overnight debt, your repo positions. And the system then begins to contract... The Fed has destroyed the money market. It has destroyed the capital markets. They have something that you can see on the screen called an "interest rate." That isn't a market price of money or a market price of five-year debt capital. That is an administered price that the Fed has set and that every trader watches by the minute to make sure that he's still in a positive spread. And you can't have capitalism if the capital markets are dead, if the capital markets are simply a branch office – branch casino – of the central bank. That's essentially what we have today."