Too much money chasing too few assets

Outlook:

The bizarre dollar recovery yesterday can be laid at the feet of the bizarre behavior of US yields, rising to 2.06% from 1.989% at the close the day before, recovering all the ground lost on payrolls. Meanwhile, the US issued a 3-month bill at zero return, the first ever. Fixed income analysts are struggling to find a cause. As Market News notes, “No one knows for sure but there are a few plausible reasons and not all of them are comforting.”

First up is the equity market rally that siphons off demand and inspires sales. “Re-balancing” gets some blame/credit, although relative volumes in the two markets don’t really support that idea. Another idea is that if the Fed is on hold, risk appetite for higher-yielding corporates might be coming back. Among other stories we have the BoJ, BoE and maybe the ECB all possibly going deeper into QE, which makes the end of QE in the US look relatively nice, even if the hike is off the table, at least near-term.

Market News writes “There is just too much money chasing too few assets. Whether the Fed is able to hike this year or not, stocks cannot be totally ruled out as an investment and you can't have all your money in low yielding Treasuries…. There are those that suspect--and have suspected for some time-- that unless the central banks of the world are in "panic mode" no one knows how to trade these globally intertwined and interconnected markets. And most traders who are 30-years and younger have never seen a hiking cycle. Quantitative easing from now until end of time is all they know. If this all sounds a little disjointed, it's because we and many of the people we talk to are having a hard time making sense of the global financial markets in the last few months.” A lot of the confusion arises from “the Chinas, VWs, Greeces and Brazils of the world… causing daily wild emotional swings and irrational positions," says one analyst cited by Market News.

The implication embedded in that comment is that fixed income traders are unduly influenced by foreign events that they may or may not be properly equipped to interpret.

One thing the yield gyration might mean is correction of overreaction to the bad payrolls number. One number doesn’t wipe out the Yellen “this year” promise. Well, it’s not a promise—it’s an expectation on the Fed’s part. Some Fed presidents are saying Sept was a close call and Oct will be a close call, too. Until we get some clear communication from the Fed, and don’t hold your breath, it’s hard to see any-thing other than a return to the quest for yield.

This has been the theme for many years and it supports the idea of new risk-on trades, especially in equities but also in corporate bonds and emerging markets. The equity sell-off in the US adds a juicy additional justification for bottom-fishing, and some EM currencies are probably oversold. We are already close to a sell signal in dollar/peso.

Bloomberg reports that Franklin Templeton’s Michael Hasenstab, a contrarian, says “On a valuation basis, this is not a once-a-decade, this is a multi-decade opportunity to be buying very cheap assets.” He did well on Ireland and not so well on the Ukraine. Nowadays he is “buying the Mexican peso, Malaysian ringgit and Indonesian rupiah, while avoiding assets in Turkey, South Africa and Russia. He’s also betting on an increase in U.S. Treasury yields and sees the dollar strengthening against the euro, yen and the Australian currency.”

And we await the new Asia-US trade deal having a wonderful effect, with the FT reporting VietNam already feeling hopeful that its mighty export prowess will thrive. The implication is that it has no intention of allowing costs to rise because of the environmental and worker safety measures the Treaty is sup-posed to bring into existence. We might see some re-jiggering of sentiment toward the Treaty members, assuming the bill gets passed.

Let’s not neglect China just because it has been quiet on the financial front for a few days. While we were not looking, renminbi surpassed the yen to become the 4th most-used currency in international trade, according to the FT. “The renminbi accounted for 2.79 per cent of global payments in value terms in August, up from 2.34 per cent in July and higher than the yen’s 2.76 per cent share, according to Swift, the payments services provider.” Devaluation? What devaluation? “As recently as August 2012 the renminbi ranked number 12 with 0.84 per cent but has since surpassed the Hong Kong dollar, Swiss franc and Canadian dollar among others. It trails only the US dollar, euro and pound sterling.”

This is starting to pass the “So-What?” test and before year-end we will be talking about it all the time. Manufacturers who today pay China for semi-finished and finished goods alike will switch from dollars to renminbi. As we highlight in The FX Matrix, it’s the merchants who determine what becomes a re-serve currency. China is building the case correctly for the IMF to deliver approval. The implication for the longer term is that China will need lower dollar reserves in upcoming years. After all, countries need reserves in the first place to have the ability to buy food or armaments immediately, on no notice. If sellers of those critical goods see adequate liquidity for renminbi, they will accept it and not demand dollars or euros. This is about to become a Very Big Deal. It’s also a vindication of our confidence in Chinese sagacity. They botched the Shanghai crash, but they really do know what they are doing. Wither the dollar? We continue to see the Other Dollars plus the peso on the upswing, while the yen continues to wobble sideways as we await the BoJ (meeting starts today). Sterling is also a bit wobbly but likely returning to the upswing, while the dollar is likely toast against the euro and Swissie. In a general sentiment way, the eurozone seems to know what it’s doing and everyone adores Draghi. In contrast, the US is messy, with another government shutdown all too possible, and nobody much likes Congress (8% approval rating!), the Administration, the obsession with the election over a year away, or the Fed.