Five Bricks In The 'Wall Of Worry'

Via Macro Man blog, 

While Macro Man has run a small short in the SPX over the last several months (though he took half off near the post-Brexit lows), he has not necessarily characterized himself as particularly bearish on the world.   For sure, there have been causes for concern- notably the through the looking glass impact of negative interest rates- but on the whole he has subscribed to a "muddle through" scenario for most macro outcomes.

Increasingly, however, he's observing a bit of cause for concern.   Admittedly, much of this is through the financial market channel...but that may be because in many parts of the world, the growth and inflation impulse has been lousy for a couple of years.  This is not to say that he's rushing out to purchase shotguns and tinned beans; rather, it's merely an acknowledgment that the bigger the confluence of disquieting factors, the greater the possibility of a financial accident that spills properly into the real economy.

For the relentlessly bullish, consider these another five bricks to add to the wall of worry:

1) Ten year yields reach all time lows.  While no single market has a monopoly on wisdom, it's certainly been the case over the last decade that bond investors have been more prescient than their equity counterparts at sniffing out trouble in both the real economy and the financial system.  While the low levels of US bonds yields generally reflects the dearth of yield on offer elsewhere, the recent nosedive is clearly indicative of concern that the global economy has received a nasty shock.  Generally, investors should treat the bond market like E.F. Hutton: when it talks, you really ought to listen.

It seems virtually inconceivable that the Fed will put rates up before December, and quite possibly not even then.  This in turn sends a similar message to a pilot shouting "OH NO" into the intercom of an airborne 747.  Even if the current rally in bonds is overcooked, the secular trend of yield curve flattening at such low levels of yield is not a bullish one.

2)  China.   OK, it's not exactly new news, but the great Chinese currency devaluation continues apace.   While the Chinese have previously used periods of global turmoil to adopt a policy of stability, this time around they seem more interested in kneecapping the RMB as quickly as possible.  If anything, the Brexit volatility has encouraged an acceleration in the RMB's devaluation against its reference basket:


Macro Man observed right after the Brexit vote that upside pressure on USD/CNH was likely to intensify, and so it's proved.   Stories circulated yesterday about PBOC agents intervening in the forward market (so as not to draw down stated reserves too quickly), which serves as a useful reminder that capital continues to flow out of China at a solid clip; upside pressure on USD/RMB will only intensify this phenomenon.   As we observed last August and again in January, when developed markets notice, good things rarely happen.

3) GBP/JPY.   Obviously there is nothing magical about the GBP/JPY cross; there's no secret squirrel following its progress and using its undulations to make a series of unusually prescient bets in global markets.   Yet its collapse represents the twin loci of pressure in foreign exchange markets: sterling weakness and yen strength.  To put things into perspective, this time last year GBP/JPY was around 187, a week or two shy of making a push up to 195.  Now?  it's looking all but certain to crash through 130.

Now, some observers may point out this decline has merely retraced the move from late 2012 through last summer, and this would of course be correct.   However, the pace of the decline is naturally substantially faster than the rally, and the twin pressures upon sterling (to weaken) and the yen (to strengthen) reflect a substantial disequilibrium that has yet to be reflected in, say, US equity markets.  Not that it should move Spooz tick for tick; of course it shouldn't.  But insofar as the pair reflects negative outcomes on both sides of the ledger (yes, a weaker pound will help UK exporters, but it's difficult to permanently devalue your way to prosperity) , it merely adds to the deflationary impulse being felt in many parts of the globe.   Historically, the US at least has been relatively immune to these types of events; then again, historically the US has had a much bigger growth buffer than it currently enjoys (solid Q2 tracking notwithstanding.)

4)  UK economic newsflow.  So another couple of property funds throw up gates amongst reports of significant investor concern.   While it's true that this was probably an inevitability given the liquidity mismatch between assets and liabilities, the fact is that it's come in the immediate aftermath of the Brexit vote...which sends a signal that it will have an impact.   Prosaically, the lessons learned from financial crisis are that when confronted with gates, you sell what you can, not what you want.  We'll see if they're applied this time around.   More immediately, consumer confidence has taken a significant tumble; perhaps yesterday's elimination of a couple of Tory also-rans will provide a boost, but somehow Macro Man thinks not.

 5) Italian banks.    As slow-moving train wrecks go, the Italian banking collapse has moved at light speed compared to Greek sovereign debt.   By most other standards, however, it's been a long, drawn-out, and painful process.  Banca Monte dei Paschi was founded in 1472, and it feels like it's been collapsing ever since.   While the authorities implemented a short selling ban yesterday, it seems difficult to credit that short sellers were the reason for bank's demise (as opposed to a veritable Mt. Etna of turds on the balance sheet).  It does seem like the long drama may be reaching its denouement soon, however; BMPS has more than  halved in price since the Brexit vote, and barring a reverse split will soon reach the "Planck price" of the minimum possible increment.

Perhaps the penny will remain suspended in mid air and the can will be kicked down the road once again.  In that case, dip-buyers can probably look forward to another relief rally.

But there's a funny thing about the wall of worry.   The more bricks you add to it, the smaller the remaining space to exit risk positions through the front door.  As Macro Man noted, he's not headed for the basement bunker yet...but he's getting a little nervous.


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