China saga is not over yet

Outlook:

The S&P put in a small rise off a seriously oversold level. This does not mean it’s a reversal. It also doesn’t mean that it’s only an aberrant blip and another sell-off is inevitable, at least not right away. We need to expect gyrations, including those inspired by China and oil, in both directions. After all, the equity market is a flighty thing.

The problem lies in exaggerated moves in the fixed income space. Not only did the 10-year put in a wide range, the bar qualifies as an engulfing bear candlestick (higher open and lower close). The high was 2.20% and the low was 2.08%. Not all of this can be attributed to re-allocation from notes to equi-ties. It’s a very bad bar that should frighten us.

Market News notes that the low of 2.08% stands in horrible contract to quotes of 2.26% last week and 2.32% the week before. “The last time it closed below 2.10% was last October 28 last year.” And who, exactly, is generating all this negativity? “While China is clearly part of the problem, the big-gest complaint from financial markets players Tuesday was the inability to figure out exactly what the markets were focused on. Or who is doing the selling. It is this ‘fear of the unknown’ that is causing a ‘sell now and ask questions later’ mentality.

One likely outcome of both oil prices and China, as we wrote last week, is the Fed’s projected four hikes are almost certainly off the table, starting with the March hike expected by many. Maybe we won’t get any hikes at all, or maybe we’ll get some form of additional easing—not a rate cut, but something else that has the same general effect. This is enough reason for yields to fall and fall some more, if not for the extraordinary single-day bar we had yesterday. Here it is again, excerpted from the Chart Package.

All the blame can’t be put on oil and China. A basic reason yields slump is when market players start believing recession is right around the corner, or at best, secular stagnation. It doesn’t take a majori-ty, just enough big orders to get notice from the followers. It may not be a coincidence that several big banks are publishing notes that are extremely pessimistic, as we reported yesterday—although today the head of the JP Morgan private bank has a cheery op-ed in the FT advising “stay the course” with ad-vance country equities (but not emerging markets or commodities).

And the most risk-sensitive note, the 2-year, fell from 1.02% on the first day of the year (Jan 4) to 0.93% yesterday. Recall that it took almost all of last year for the 2-year to budge from 0.66%, where it started 2015, to 0.90% (Nov 6, 2015) and above. For most of the year, even faced with the December hike, the market was unwilling to believe the Fed’s economic outlook or the Fed’s resolve. We are 3 points from where we were before the December hike. Three points is chickenfeed.

The message from the fixed income market is “get out of Dodge.” That makes the timing of the Fed’s Beige Book today particularly interesting. As usual, we will get tiresome analysis of the choice of words, but whatever the regional Feds say, it won’t be “the sky is falling.” In fact, aside from tepid growth in household median income (after the dramatic fall from the 2008 crisis), most indicators are positive. And the Fed doesn’t track median household income in the Beige Book.

Today will likely be calmer, but don’t count on it lasting. That’s because the China saga is not over yet. Today in the Asian time zone, China succeeded in getting the onshore and offshore yuans at nearly the same price and the HIBOR rate fell back from the spike high of 66.8% to 8.3%. The FT reports the rate retreat occurred as “the PBoC stepped back and the Hong Kong Monetary Authority, the de facto central bank, continued injecting support to banks.” These are still emergency measures and still central bank intervention, regardless of which one is doing it.

Bottom line, we may be fairly sure that talk of renewed recession in the US is unfounded and possibly hogwash promoted by short-sellers--but the probability of a crisis and recession in China is not so re-mote. In a general way, the dollar benefits from this brand of uncertainty.

Fun Political Tidbit: Pres Obama, in the State of the Union speech last night, rebutted all of the absurd, extreme proposals by the Republican candidates. Amazingly, the post-speech response by the Republican Gov of S. Carolina rebutted many of them, too (albeit asserting the fiction that the US is do-ing nothing about ISIS—10,000 air sorties don’t count, apparently). Both speakers urged fixing the bro-ken political process, although Obama was too polite to point out the approval rating of Congress lies at an abysmal 9%.

But distaste for mainstream politicians is only one reason voters like Trump, who promises his snakeoil will cure everything that ails the republic. These voters, or at least the ones being polled, are the same people who are buying lottery tickets for the chance to make $1.5 billion dollars tonight. They actually do know that the odds of hitting the jackpot are one in 292.2 million. As the NYT reports, these are “really, really bad odds. The odds of being struck by lightning this year are one in 1.19 million, making it about 246 times as likely as winning the Powerball jackpot.”

Voters get the same utility from imagining a glorious America running the world as they get from fanta-sizing about winning a vast sum of money. It’s unrealistic, it’s childish, and it’s not going to happen. They know it, but it’s fun for a few minutes to play pretend. Even so, according to experts, Trump actu-ally does have a chance to get the nomination, which will make the election a re-run of the 1964 election in which Goldwater lost 44 states to Johnson.

In the meanwhile, the Trump ascendancy is giving writers their chance to produce rants. You have to love a good rant. Esquire magazine (which has excellent recipes, by the way) has one by a former aide to Senator McCain, one Mark Salter. He writes Trump is “a cartoon villain, a fake, a cheat, a liar, a creep, a buying, bragging, bullshitting, blowhard kind of asshole.” Trump is a “xenophobic bigot” whose “ridiculous boasts demand derision.” At bottom, Trump sees the voters as suckers. Salter wants to punch him in the face.

Separately, another self-aggrandizing fruitcake is Ann Coulter, who says we should forget whether Trump is a fiscal conservative (he’s not). Trump’s appeal was launched with making illegal immigration from Mexico the number one priority and that theme continues to hold the voter. And we all await some-thing, anything, that will trump this theme. It won’t be civility and decency and a presidential demean-or—it has to be something totally vile about the man himself. How hard can that be to find? Turns out that Trump’s father building a steel mill for Hitler isn’t it. But it’s out there. Look at the guy—it must be.

One observation about the State of the Union speech: look at the expression on the face of Speaker Ryan—dripping with envy at the President. This guy wants the job in the worst way.

Note to Readers: Next Monday, Jan 18, is a national holiday in the US and markets are closed. We will produce reports as usual for the benefit of non-US readers but note that the FX market should be thin.