Trade Deficit

A high level overview of the drivers of the capital markets.

Now that the 3:30 pm pump has been exposed to the world, and having been priced in and frontran (such as yesterday) it changed to the 3:30 dump, algos are desperately searching for another daily calendar trading opportunity. It appears the opening of Europe and Japan for trading are just these two much needed "fundamental" catalysts. As the charts below show, it appears there is nothing more bullish for the two key carry pairs, the USDJPY and the EURUSD, than Japan opening at 8pm Eastern, and then Europe opening next, at 3:30 am Eastern.

We started off the overnight session with various pseudo-pundits doing the count-up to a 100 in the USDJPY. It was only logical then that moments before the 4 year old threshold was breached, the Yen resumed strengthening following comments from various Japanese politicians who made it appear that the recent weakening in the currency may suffice for now. This culminated moments ago when Koichi Hamada, a former Yale professor and adviser to Japanese Prime Minister Shinzo Abe, told Reuters that level of 100 yen to dollar is suitable level from the perspective of competitiveness. The result has been a nearly 100 pip move lower in the USDJPY which puts into question the sustainability of the recent equity rally now that the primary carry funding pair has resumed its downward trajectory. Another result is that the rally in the Nikkei225 was finally halted, closing trading unchanged, and bringing cumulative gains since the morning before the BoJ’s announcement last Thursday to 8.9%. Over that the same time period, the TOPIX Real Estate Index is up an incredible 24%, no doubt reflecting the prospect of renewed buying of REIT stocks from the BoJ’s asset purchasing program.

A big picture look at the drivers of the global capital markets.

If there is one thing the Fed taught the world's investors it was to front-run them aggressively; and whether by unintended consequence or total and utter lack of belief that despite a 'promise' to do 'whatever it takes' to stoke 2% inflation the BoJ are utterly unable to allow rates to rise since the cost of interest skyrockets and blows out any last hope of recovery, interest rates are collapsing. Japan's benchmark 10Y (that is ten years!!) yield just plunged from 55bps (pre-BoJ yesterday) to 34bps now. That is a yield, not a spread. Nothing to see here, move along. Of course, not to be outdone, Japanese stocks (Nikkei 225) are now up 6.75% from pre-BoJ (3% today) trading at 13,000 - its highest since September 2008 (Lehman). But there is one market that is showing its concerns at Japan's inevitable blow up - Kyle Bass' 1Y Jump risk has more than doubled in the last 4 months.

Some people believe that by imposing losses on investors and reducing the Cyprus banking system liabilities, the European powers have addressed the problems in Cyprus (if harshly). A dangerous dynamic has been set in motion, which will likely bring many unintended consequrences.

Amidst the debacles, fiascos, and nightmares is a scrappy industry that uses ingenuity and the right amount of hops to beat Wall-Street-engineered giants.

If we shed our fixation with the Fed and look at global supply and demand, we get a clearer understanding of the tailwinds driving the U.S. dollar higher. I know this is as welcome in many circles as a flashbang tossed on the table in a swank dinner party, but the U.S. dollar is going a lot higher over the next few years. In a very real sense, every currency is a claim not on the issuing central bank's balance sheet but on the entire economy of the issuing nation. All this leads to two powerful tailwinds to the value of the dollar. One is simply supply and demand: as the global economy slides into recession, trade volumes decline, and the U.S. deficit shrinks. (It's already $250 billion less than was "exported" in 2006.) That will leave fewer dollars available on the global market. The second tailwind is the demand for dollars from those exiting the euro and yen. The abandonment of the euro is already visible in these charts.

Bloomberg reported recently that Russia is now the world's biggest gold buyer, its central bank having added 570 tonnes (18.3 million troy ounces) over the past decade. At $1,650/ounce, that's $30.1 billion worth of gold. Russia isn't alone, of course. Central banks as a group have been net buyers for at least two years now. But the 2012 data trickling out shows that the amount of tonnage being added is breaking records. Based on current data, the net increase in central bank gold buying for 2012 was 14.8 million troy ounces – and that's before the final 2012 figures are in for all countries. This is a dramatic increase, one bigger than most investors probably realize. To put it in perspective, on a net basis, central banks added more to their reserves last year than since 1964. The net increase – so far – is 17% greater than what was added in 2011, which was itself a year of record buying. The message from central banks is clear: they expect the dollar to move inexorably lower. It doesn't matter that it's been holding up against other currencies or that the economy might be getting better. They're buying gold in record amounts because they see a significant shift coming with the status of the dollar, and they need to protect themselves against that risk. Embrace the messages central bankers are telling us – the ones they tell with their actions, not their words.

Up until just a week or so ago, the euro, the market seems to be telling us, has been saved, and peripheral Europe is widely seen as being out of the woods. Thanks to the ECB - who are willing to pump as much liquidity into the markets as it needs - it seems rising debt levels, greater political fragmentation, and a worsening economy somehow don't really matter and it is impolitic to sound pessimistic. But is peripheral Europe really suffering primarily from a liquidity crisis? It would help me feel a lot better if I could find even one case in history of a sovereign solvency crisis in which the authorities didn’t assure us for years that we were facing not a solvency crisis, but merely a short-term problem with liquidity. A sovereign solvency crisis always begins with many years of assurances from policymakers in both the creditor and the debtor nations that the problem can be resolved with time, confidence, and a just few more debt rollovers. The key point is that bankers are not stupid. They just could not formally acknowledge reality until they had built up sufficient capital through many years of high earnings – thanks in no small part to the help provided by the Fed in the form of distorted yield curves and free money – to recognize the losses without becoming insolvent.

A dispassionate review of yesterday's developments and today's.

China’s economic model, which has delivered a genuine economic miracle over the last 30 years by lifting more people out of poverty than ever before in human history, is increasingly tapped out. While the authorities have been talking about rebalancing the economy since at least 2006, BNP Paribas' Richard Iley notes that China’s macroeconomic imbalances have become progressively more extreme. The economy now has an investment share of ~48% of GDP, which, Iley explains, no other economy has been able to reach, let alone sustain. Unsurprisingly diminishing returns are increasingly apparent. Largely uneconomic investments in sectors already suffering overcapacity, such as real estate and steel, continue to accelerate, fuelling exponential growth in energy consumption and producing increasingly unbearable levels of pollution as we discussed here. Despite the long-term gulf between reform rhetoric and concrete action, ‘hype’ at least continues to spring eternal.

SYFMUDD

The same pattern we have seen every day for the past week is back - slow overnight levitation as bad news piles on more bad news. What bad news? First as noted earlier, a collapse in Chinese imports and a surge in exports, which as SocGen explained is a harbinger of economic weakness in the months to follow, leading to yet another negative close for the Shanghai Composite. Then we got the UK January construction data which plunged by 7.9% according to ONS data. Then the Bank of Italy disclosed that small business lending was down 2.8% in January. We also got a negative Austrian Q4 GDP print.  We also got Spanish industrial output plunging 5% in January (but "much better" than the downward revised -7.1% collapse in December). Capping the morning session was German Industrial Production which not unexpectedly missed expectations of a 0.4% increase, printing at 0.0%, although somewhat better than the horrifying Factory Orders print would have implied. Finally, the ECB announced that a total of EUR4.2 billion in LTRO 1+2 will be repaid in the coming week by 8 and 27 counterparties, about half of the expected, and throwing a monkey wrench in Draghi's narrative that banks are repaying LTRO because they feel much stronger.  Yet none of this matters for two reasons: i) the Japanese Yen is back in its role as a carry funding currency, and was last trading at 95.77, the highest in four years, and with Jen shorts now used to fund USD purchases, the levitation in the stock futures was directly in line with the overnight rout in the Yen; and ii) the buying spree in Spanish bonds, with the 10 Year sliding overnight to just 4.82%, the lowest since 2010.

China's trade balance recorded the first February surplus in three years of USD 15.3bn, while forecasters looked for a deficit of -6.9bn. The trade surplus in the first two months was much higher at USD 44.4bn, compared with a deficit of USD 4bn during the same period in 2012, which points to a significant positive contribution from net exports to Q1 GDP growth. However, if these figures were indeed close enough to the actual situation, such strong exports may turn out to be more of a curse than a blessing for China. Against the backdrop of a meagre global recovery and heightened concerns over potential currency wars, China's bi-lateral trade surplus with the US, as suggested by Chinese data, reached a record high in four years; and China snatched market shares from neighbours. None of these will be the most welcomed development. Particularly, there is evidence that the People's Bank of China has been intervening to keep the yuan from appreciating.

New highs will become a daily headline feature it seems until we actually have a down day. 

Thursday, Jobless Claims fell (340K vs 347K previous), Productivity (-1.9% vs -2% previous) and Costs (4.6% vs 4.5% previous) were very poor reports, and the Trade Deficit grew (-$44.45B vs -$38B). Lastly, Consumer Credit expanded to $16.2 billion from $14.6 billion primarily on student loans (in a bubble) and auto loans (subprime auto loans booming).