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Sentiment towards the U.S. Dollar
The US dollar is still the global reserve currency, so in economic uncertainties people rush to dollars in a large degree considering it a safe-heaven. The dollar can also act as a funding currency- when times were good people would sell (borrow in) dollars and invest in higher yielding assets, but when global economy starts to fall apart those dollar short positions are unwounded, and the dollar rallies.
A strong currency increases the appeal of a country's bonds and stocks for foreigners. For an American investor, a weak dollar increases the appeal of foreign bonds and stocks. Currency markets play an important role in the intermarket picture because all asset prices have to be seen in relative terms not only in absolute terms. In FXStreet, we provide you Support and Resistance.
We are reminded of the 1975 OPEC agreement to accept only the dollar for its oil has slowly eroded at the hands of Venezuela and Iran. China is the world's largest importer of oil, in a world of excess supply, it is a buyers’ market. An oil contract priced in yuan that can be swapped for gold is a major blow for the dollar. Reports suggest that Saudi Arabia is considering yuan as payment for its oil. Some oil companies based in Russia, Iran, and Venezuela already accept yuan payments. [But] What stands behind the dollar is not oil. It is not that most commodities are still traded in dollars. It is not gold, for which the US has roughly four times more monetary gold than China. What stands behind the dollar is the deepest, most liquid and transparent debt market in the world. [...]Many of the same people who jump from one possible alternative to the dollar to the next have jumped upon China's intention to launch an oil futures contract as the new new thing. It is not.
Despite the boost to US interest rates and the possible US corporate repatriation flows back into the US, the impact on the USD has been rather limited. What is at play? Well first of all, the scale of repatriation flows may be constrained by two factors compared with 2005 when such a feature was in place. First, it is likely a significant portion of reinvested earnings held abroad for tax purposes is already denominated in USD to avoid balance sheet volatility given the substantial USD strength in recent years. In addition, the USD now also seems overvalued against EUR and GBP (see table below). This could further lower repatriation volumes. Finally, judging from history, the USD tends to perform relatively poorly when the US fiscal situation is weaker, as the current account weakens. Hence, we maintain our view that EUR/USD should move up to about 1.25 over the next year.
The Fed hiked the target range by 25bp to 1.25-1.50% as expected, while still signalling three hikes in 2018 and slightly more than two in 2019. This was interpreted dovishly by the markets, as Janet Yellen revealed that ‘most’ FOMC participants have included some fiscal stimuli from tax reform in their projections but still the dot signals were broadly unchanged. While, all else being equal, higher growth means the dot plot should have been revised higher, the persistent low inflation pulls in the other direction, netting each other out.
This essentially means the FX market has put a premium on USD in periods where the Board of Governors has consisted of members who have served over a long period and to whom markets have grown accustomed. This suggests that a ‘Fed inexperience risk premium’ could be discounted in the dollar next year as a result of a range of newcomers entering the Fed. As such, this is a caveat to the mechanical thinking that a Fed set to hike more than priced would necessarily support USD: mind the experience gap that Yellen and co leave behind and brace for USD weakness not least in the event of a shock, as the policy response may not be as swift – and hence USD positive – as in the previous decade.
President Trump nominated Goodfriend to the Fed's board of Governors. It is widely regarded as a solid choice and one that has been talked about for nearly six months. Goodfriend is a mainstream macro-economist who is sensitive to the international context. His past criticism of the Federal Reserve suggests he may be more sympathetic to hiking rates earlier in the cycle that has typically been the case. He also seems somewhat less interested in activist fiscal policy. He may be more interested in negative interest rates than Bernanke or Yellen.
Now I know I have made a strong and compelling argument for US Dollar strength. The thing is, we haven't seen any real follow through and until the stock market collapses, that argument won't even get a chance to prove itself. I have contended that the combination of Fed policy normalization and what should be a fall in stocks, will invite a massive way of safe haven flow that ultimately benefits the US Dollar. It still could happen, but at this point, I am concerned that there could be risk for a period where the US Dollar correlated with stocks on the way down.
[...] in negotiations to try and sweeten the bill, there are suggestions that there could be somewhat of a climb-down as the Republicans could delay the cuts to corporation tax by twelve months. This is hitting yields of longer dated Treasuries and as shorter dated yields hold up, is significantly flattening the yield curve further
With markets speculating that Trump may appoint Jerome Powell, who is seen as a dove, to become the next Fed head, bears could make an unwelcome appearance. It should be kept in mind that a dovish Fed Chair has the ability to weigh on the prospects of higher US interest rates in 2018, consequently pressuring the dollar.
Viraj Patel, Research Analyst at ING: “But from a market perspective, we're (arguably) already there when it comes to pricing in lower trend US inflation. It is true when the Sep Fed minutes note that market-based inflation expectations have remained stable recently. But equally, they have remained stable at a lower base relative to historic levels; the 5y5y US breakeven inflation rate remains around 70-75bps below its pre-2014 average, while even the Fed's latest Primary Dealers survey that participants on average are looking for US inflation to average around 1.78% over the next 10-years. The lack of inflation premia suggests that bond yields are set to stay structurally lower for longer. More importantly, we need some sort of catalyst to change this thinking and with the fiscal stimulus story looking a lost cause for now, we’ll need evidence in the US data to determine whether trend inflation is higher. But as we saw after last week’s wage growth data, complicating the picture is the fact that the next couple of inflation data prints may well be distorted by hurricane-related effects. So while US PPI (today) and CPI (tomorrow) will be of some importance, we may not be able to accurately assess trend US inflation dynamics until 1H18. Strategically, this points to a fairly benign bond market environment – one that favours EM FX and carry plays against the USD. Goldilocks is here to stay!”
Viraj Patel, Research Analyst at ING: "While on paper tax reforms may be great for the $ (though we have our reservations here now), the reality is that chasing this story has proved to be an unprofitable strategy this year. [...] We don’t expect this to change anytime soon and think the USD remains a sell-on-rallies. On the topic of Trump policies, worth noting that the President is reportedly set to unveil NAFTA proposals that may ‘throw the deal into peril’. We think this is a case in point for staying cautious over the $ in the medium-term.”
China announced the creation of an oil futures contract (open to international traders) that will be denominated in Yuan and convertible into gold. [...] The move amounts to a direct challenge to the dollar's privileged reserve status and could threaten U.S. dollar price erosion.
The resignation of the Fed Vice Chair, Stanley Fischer, is likely to be playing a significant role in keeping the dollar under pressure. His departure leaves four of the seven Board of Governors' seats vacant, meaning that Trump can reshape the Fed's policy, if he decided to bring more doves into the central bank. It's probably still too early to start speculating, and we will have to wait a little longer for clarity, when Trump nominates new governors. However, Fischer's resignation will remain a negative factor for the dollar in the weeks and months to come.
The figures for June and July were also revised lower, whilst the unemployment rate ticked higher. The softer reading on Friday was even more surprising given the strong ADP private payroll data and the solid reading to the jobs element in the ISM manufacturing report. Whilst one weak month by no means constitutes a trend, the softer figures have created more uncertainty surrounding any potential moves by the Federal Reserve regarding another interest rate rise by the end of the year. Reduced clarity of potential Fed action is doing little to abate the problem of runaway euro strength;
What explains DXY's drop and Queen Yellen's regulatory comments is seen in the rise of the money supply. Despite 3 raises since December 2015, M1 and M2 continues to climb. [...] Bank's deposits grew by 192 billion in 4 months. Rather than sit idle, monies were put to work in money markets. A few points in interest rates is all it takes to profit and grow more money.
The reason for the buck’s malaise are twofold, firstly the political backdrop; the dollar is being used as a hedge against the political risks associated with President Trump and the interminable delay with the application of the political promises he made prior to last year’s election. Secondly, could investors’ distaste for the dollar also be a sign that they are hedging their bets on the Fed, just in case they back down from their rate-hiking cycle on the back of Trump’s failure to implement his economic policies?
The US Treasury Q1 cash deluge has significantly eased USD liquidity in the USD money market. It has contributed to an around USD500bn increase in the US monetary base, which is a significant rise in USD liquidity. It is more than double the amount of USD the Federal Reserve added to the market on a quarterly basis during its recent stint of quantitative easing. One area where this is likely to have made an impact is on the EUR/USD XCCY basis swap. It has narrowed significantly since the start of the year, as USD has become cheaper due to increased supply of USD. This effect has mitigated the increase in interest rates on the back of the Federal Reserve preparing the market for a rate hike tomorrow. Consequently, carry in EUR/USD FX forwards is about unchanged. Hence, while the Federal Reserve has tightened monetary conditions in Q1, the US Treasury has eased monetary conditions.
So-called experts had predicted a 20% surge in the dollar based on the “border adjustment tax” in the GOP House tax plan. Except that surge hasn’t happened. Maybe the plan is dead. Maybe the plan’s market impact will be different. Our take is: if you introduce barriers to trade, we believe currencies of countries with current account deficits tend to suffer. The greenback qualifies, and the recent decline coincides with more protectionist talk coming from the Trump administration.
So is there reason to believe the U.S. may no longer be serving as the world's bank? At first blush, the answer would be no, as the U.S. has deep and mature financial markets. However, there are developments of concern: The first has already happened. [...] Due to regulatory changes in U.S. money market, it may now be no longer advantageous to issue debt in U.S. dollars, eliminating the downstream effects, including the holding of Treasuries as a reserve asset. A second change is under consideration: the House GOP tax proposal would eliminate the deductibility of net interest expense. If passed, it could have profound implications on how issuers around the globe get their funding...
Sustained expansion should expedite the termination of the current reinvestment policy. The Fed will have to choose between a gradual reduction in reinvestment or a complete termination. There are benefits to shrinking the balance sheet instead of raising the policy rate. Such an action might tend to weaken the dollar, which could spur exports and boost factory activity. In the global context, a depreciation of the dollar would reduce pressures on countries with fixed exchange rates and external debt.
The dollar doesn't need capital flows from China to contribute to its rally. It does need the second larg-est dollar reserve holder to maintain its holdings. One of those big sticks is the threat of selling a big chunk of those dollar reserves. The announcement effect would trash the dollar fast, and probably hard.
Since most times cycle balances themselves out, we could be poised for the next 3 year cycle to be a stretched 3 year cycle just as the dollar is ready to begin its 15 year super cycle decline.
When it is no longer attractive to borrow in U.S. dollar, the loan will be repaid, causing a dollar squeeze (higher). We think we have seen this dollar squeeze play out until the end of last year. The force may continue to play out, but other forces might be stronger. Some say that the dollar has to rise because U.S. rates may go up. In our analysis, real interest rates, i.e. those after inflation, may not go up as the Fed is at risk of falling further behind the curve; at the same time, interest rates in part of the rest of the world may have reached their lows. In this context, we see it is quite conceivable that the U.S. dollar could continue to weaken.
In the biggest tax changes in a generation, Trump, along with his republican party has introduced sweeping changes to the US tax system to make it one of the most competitive in the world which includes slashing the corporate tax rate to 20 percent as well as substantial personal income tax cuts The legislation in theory should lead to the repatriation of billions of dollars back to the US by companies who had previously sheltered their money off shore to avoid paying higher taxes. The changes are expected to create a huge demand for US dollar’s and provide support for the currency.
We do not think the widening of the cross-currency basis swap in the dollar's favor is much more than a particularly intense bout of year-end funding needs. It is particularly pronounced in Europe. Australian dollars, for example, can be swapped for dollars for three months at a premium to US dollars. The dollar premium over the yen is in the area it was at the end of last year. The dollar premium for euro swaps is at its most extreme since 2012, while the dollar premium for sterling swaps appears to be at a record extreme. EONIA jumped at the end of November, and it has spent the first half of December gradually returning to its longer-term averages near -36 bp. When the debt ceiling is lifted, the adjustment of the US Treasury cash holdings will drain around $400 bln of liquidity via mostly bill sales, and this may raise dollar premium on cross currency swaps next year. Regulatory incentives may also influence the availability of dollar funding.
So unless doves are nominated for the remaining posts, the central bank will have a more hawkish tilt in 2018. The market is only pricing in 1 full rate hike next year with a 65% chance of a second quarter point move over the next 12 months. This shows that investors are underpricing the possibility of tightening especially as policymakers have been talking about anywhere between 2 to 4 quarter point hikes. If the U.S. economy continues to expand like many expect next year, we could see the market adjust its rate hike expectations, which should be positive for the greenback.
With major tax overhaul due in 2018, some market analysts predict that the Fed will be more aggressive and it will increase the policy target range four times in 2018 as a fiscal policy will overtake the monetary policy in stimulating the US economy.
^...* repatriation - many U.S. corporations are expected to repatriate their earnings before the year closes to lower current tax obligations. This process creates demand for the dollar but the exact amount is difficult to tell as some foreign earnings could already be denominated in dollars.
Investors are hopeful that the tax reform plans could soon be implemented after the bill moved to the senate. Elsewhere, Fed nominee Jerome Powell's confirmation hearing got underway. The potential candidate indicated his preference for normalization of interest rates and maintaining that the Fed's balance sheet unwinding program.
Fed nominee Jerome Powell's confirmation hearing got underway. The potential candidate indicated his preference for normalization of interest rates and maintaining that the Fed's balance sheet unwinding program.
The US President Donald Trump is likely to pick Jerome Powell for the position of next Federal Reserve chairman this week with continuity being the most valuable feature of Powell’s nomination. With Jerome Powell getting the nomination for Fed chairman, Trump will have in place a Wall Street Fed chairman in line with his Wall Street Treasury secretary and Wall Street Council of Economic Advisers chairman, forming complete deregulatory trio and this is the reason why Wall Street keeps breaking all-time records and the US Dollar is back on the rise.
Richard Franulovich, Research Analyst at Westpac: “Beyond a near term stumble, USD remains in good shape. Accommodative financial conditions point to yet more upside surprises in coming months while yield spreads should gravitate in the USD’s favour as the Fed Funds rate extends its glacial ascent above other key cash rates and as the Fed’s balance sheet shrinks relative to the ECB and the BoJ’s balance sheets.”
[...] Yellen kept emphasising the importance of containing financial risks, suggesting the rate hikes will continue despite the below-target inflation data. As we know, rising interest rates would obstruct Trump’s economic plan in two crucial ways: higher interest to pay and collapse of the stock market. Do not let this mislead you. This is about economics, not politics. Our best guess is Trump’s economic reform agenda may gradually kick off in 2018, including the recent proposal of tax reform. If so, Fed will do its best to contain the financial risk, otherwise bubbles will be created in the various US financial sectors.
After Chinese yuan has stabilised this year, nation’s capital outflow pressure is mitigated. Two reasons may drive Chinese central bank to buy US Treasuries, which is equal to buy dollar in near term. First, PBOC looks keen to defend its FX reserves at USD 3 trillion level. Second, PBOC may not be comfortable with its currency rising too quickly.
[...] there is a second scenario whereby the complacency in the market that has seen the S&P 500 rally to all-time highs with historically low levels of volatility, becomes an unwind scenario that sees USD strengthen on safe-haven flows. The catalyst for this type of risk off scenario comes in the form of geopolitical uncertainty (North Korea and Trump), or even the QE reduction plan ready to be implemented by the FED.[...] Despite resilient U.S data CFTC non-commercial short USD positioning looks to be ‘overstretched’. Looking at the likes of AUD and GBP and we see net positions remain very long, putting both at risk of unwinding.
[...] if Spain continues to scare investors and money sloshes over to Bunds while at the same time the rate hike and Trump reflation trade get a stronger grip in the US, the US-Germany differential can only widen in the US favor. This is a solid reason to favor the dollar, re-gardless of payrolls or Fed chiefs.
We maintain our bullish on the US dollar as we believe the market hasn’t fully priced the upcoming rate hike together with the balance sheet reduction program, yet. However, we would stay cautious regarding further EUR weakness against the USD as another push, which can the take the form of a worsening of the Catalan situation, is needed.
US President Trump interviewed Fed´s Jerome Powell and Kevin Warsh as possible candidates to replace Janet Yellen as head of the FOMC, when her mandate ends later this year. Given that both candidates are seen as hawkish towards rate hikes, the greenback keeps finding support across the board.
The initial level of the caps are $6bn for Treasuries and $4bn for MBS, every three months they will be lifted until they peak at $30bn for Treasuries and $20bn for MBS. Considering the Fed’s balance sheet is more than $4.5 trillion, it will take a long time to shrink it back to its pre-financial crisis size, however, the pace of increasing the cap every three months is quite punchy, and may be more aggressive than some in the market had expected. This should be good news for the dollar and bad news for Treasury prices (good news for yields)
China’s central bank removed the reserve requirement of 20% for trading foreign currency forwards. This may slow the pace of yuan appreciation after its biggest two-week rally in more than 10 years. Yuan’s influence in the regional may slow the gains in Asian currencies, leading to a higher US dollar. [...] From now until further announcement, PBOC will stop requiring financial institutions to set aside cash when buying dollars for clients through currency forwards.
The marginal new lows were not confirmed by technical indicators. In the chart above, we added the MACDs. It made its lows near the middle of May. This is what technicians call a bullish divergence, and it is found with other technical indicators as well. In addition to the technical consideration, the two-year differential bottomed in late June a little above the April and May lows near 1.92%. It is now near 1.97% . A key level on the upside is 2.02%.
The US yield curve has steepened. Over the past week, the 10-year yield is up more than 14 bp, while the two-year yield is up 4. The 10-year breakeven has risen from 1.67% on June 20 to 1.76% on July 3. We have identified rising US interest rates (and premium over Germany and Japan) as a necessary condition of the dollar to resume what we think is the third significant dollar rally since the end of Bretton Woods.
What is most interesting is the disparity with the Fed's dot plot and the Fed funds futures market. The Fed's dot plot is expecting rates to rise to a touch over 2% by 2018, however, the Fed Funds Futures and the OIS market is looking for a much milder trajectory for US interest rates, looking for just one further hike in the next year. Is the market always right? Not always, but this disparity is odd, and could play havoc with asset prices if the market has been wrong-footed and needs to play catch up with the Fed, which could see a sharp turnaround for the dollar and US yields. However, it all depends on the inflation figures, if prices continue to fall in the US then rate hikes and balance sheet normalisation could be shelved for some time.
So if we do see something that gets equities rolling over, even in the face of a less hawkish Fed and weak US Dollar policy, the Buck could come roaring back in a furious kind of way. [...] Monetary policy is exhausted now so there is no more the Fed can really do to make things more attractive. This leaves the market vulnerable if the economy is cooling down again and if a recent run of softer data in the US is actually not transitory in the way the Fed had hoped. I hope this isn't the case but the more we move along the way we have been, the more I think this is where we could be headed. So while I won't be looking to buy the Buck right now, I still am holding onto that view we could see the Dollar rise again....only not for the best of reasons this time.
The dollar was at the center of Bretton Woods’ currency arrangement. It has also been the main reserve asset, one side of more than 90% of foreign exchange trades, and the currency that many commodities are priced and traded in the floating exchange rate era. There are two broad scenarios that can change this. The first is a clear, viable, and compelling alternative. It does not exist today. Some had thought the euro could be it. It is not. The euro is the second most important currency on various metrics, but in many, like use as reserve assets, or turnover in the foreign exchange market, the dollar is more than twice as large. Some talk as if the Chinese yuan can rival the dollar. Perhaps one day, but it is not just years but decades off. The second...
As per Citi, ultimately, the administration can say whatever it wants about a weaker Dollar, but if Trump goes ahead with sweeping tax reform and aggressive fiscal stimulus and if the Fed continues to move towards higher rates, while the rest of the developed economies stand still, nothing Trump says will do anything to stop the force of the US Dollar. These fundamentals can not be denied and the Dollar will not be able to ignore them if things move in this direction.
...we conclude that the currency impact of a repatriation holiday today could be of similar or perhaps greater significance than the effect of flows under the HIA in 2005. The absolute magnitude of any such support is difficult to quantify. However, to the extent that repatriation would be an overall supportive factor, however modest, for the U.S. dollar, it would only reinforce our core expectation of broad U.S. dollar strength in the coming quarters.
As a simple majority is sufficient in Congress to change the tax code, [...] And please disregard any analysis that focuses on the reduction in the number of tax brackets - the number of tax brackets are, in my view, completely irrelevant, as to the impact for investors. What is relevant is whether businesses will, as proposed, indeed be able to deduct 100% of their investments in the first year [...] What to look out for here is whether the U.S. tax system is shifting to a territorial one,[...] If so, it may remove the incentive for businesses to move their headquarters abroad. [...] whether any money that’s going to be repatriated will be used to create jobs, that discussion, in my humble opinion, misses the point: more important is whether artificial barriers to allocate capital are removed, allowing a more efficient allocation of capital.
...capital outflows from the eurozone are the biggest so far this year than any other time in 14 years. The WSJ reports "Eurozone investors bought €497.5 billion ($516.5 billion) of financial assets, ...such as stocks and bonds, outside the bloc in that period. Global investors, meanwhile, sold or let mature €31.3 billion of eurozone assets during the year. Together, that adds up to a net outflow of €528.8 billion, the most since the single currency was introduced in 1999."
The world is USD dollar starved and there is a shortage of offshore dollar funding -the Eurodollar maket-, and if Trump starts protectionist policies, means less dollars flow into the global system because they are doing less trade with the US, and that means there are not enought dollars around for all those people who borrowed dollars. That in it self is an extremely positive outcome for the dollar.
The dollar is rising because there is a perceived lack of dollars in the outside system, and we have seen this in the LIBOR market rising with US interest rates also rising. But the other reason the LIBOR is rising is because money is being taken out of that offshore funding market and being put onshore in the US. About a trillion dollars moved out of the traditional markets -away from money market funds- into the fed funds market.
There is likely going to be some repatriation of corporate profits, and the idea is that corporations can bring back all those profits they holded offshore, bring it into the U.S. for a small tax penalty. If companies have holdings in foreign currencies and they sell them and buy dollars and bring them back that automaticaly pushes the dollar yet up again. But the more important factor are companies like Apple: they have hundreds of billions of dollars in US dollars cash but in the European banking system. They start to take it to the U.S. banking system and that again takes hudreds of billions of dollars out of the eurodollar market so there is more sucking out of that market and all of these borrowers will be scrambling to find funding. The Fed will have to extend swap lines all over the world to allow some dollar liquidity but rates are going higher for this.
While most economists are focusing on either the higher US interest rates and a likelihood of a somewhat more aggressive Fed tightening cycle, or the possibility of a dramatically more stimulative fiscal stance. We see the combination (the policy mix) as an exceptionally potent force that will continue to propel the dollar higher. Interest rate differentials provide an incentive structure for investors. Investors are paid to be long the dollar against most major currencies. This also means that for any given level of volatility, it is cheap to hedge European or Japanese exposure.
Sentiment in the Euro Market
Bearish for the Euro
Germany continues to grapple with its political troubles as the SPD demands Merkel to form another grand coalition government. This is not an outcome that she favors.
The scale of the asset purchasing has been reduced during 2017 with the further reduction due for 2018. The volume of monthly asset purchases will be halved since January 2018 to EUR 30 billion with the program coming to an end in September 2018. With EUR/USD rallying to its 2017 high of $1.2092 on September 8, 2017, the scope for a further move higher is limited even with the asset purchasing approaching. Similarly to CAD, the Euro’s appreciation is likely to spur the policy response, most likely verbal intervention similar to the one from 2017 when ECB Governing Council members felt obliged to comment on euro being too strong at around $1.2000 level.
At the risk of oversimplifying, it is difficult to image German accepting the kind of integration that Macron and Schulz would like without countries returning to good standing vis a vis the Stability and Growth Pact, which involves debt levels as well as deficits. It might not be fully realized until early next year, but Germany will likely have a minority government, which Merkel has rejected, or face new elections in 2018.
Polls show a close race between the center-left PD, the Five-Star Movement and a center-right bloc of Berlusconi's Forza Italia and the Northern League. Since the Five-Star Movement rules out a coalition, the most likely outcome will be a grand coalition with the other two forces. The question is who leads it, and Berlusconi cannot be ruled out yet, in what would seem to be another blow to Merkel, who may have been instrumental in forcing him out previously.
Despite the cyclical recovery, core inflation still shows no sign of a convincing upward trend. For the recovery to enter its inflationary phase the economy has to improve further, until the point at which wages will tend to increase. The level of slack remains uncertain though. Broader measures of labor underutilization reach 18%, double the level of the current unemployment rate. The ECB is expected to remain cautious.
[...] political uncertainty is by no means over in Europe. Spain could be in turmoil for months. Italy will hold an election in March, too. Germany is calm and stable but also without a gov-ernment yet. Markets are not panicking about political disarray, but that can change.
Europe's problem is the ECB contained its interest rates far to long. Add QE in the mix then the exchange rate becomes misplaced and trades at incorrect levels. USD and the FED however are most off kilter as Fed Funds is miles overbought and it explains why daily interest rates trade on the floor.[...] What is seen overall is currency markets are in transition and EUR is the only pair to complete its mission. Markets still await USD/JPY, AUD, NZD and GBP. Until the transition completes, markets will continue ranges. When transition completes for all pairs and we are extremely close then a giant breakout will be seen.
The European Central Bank (ECB) has kept interest rates the same and is tapering the Quantitative Easing (QE) programme from £60 billion to £30 billion the New Year. However, concerns continue about inflation remaining below the target 2%, and ECB president, Mario Draghi, has not committed to reaching the inflation goal by the desired time, which points to a Eurozone economy that, while recovering and performing strongly, is not yet robust enough to wind down the programme altogether.
The divide between old core EU members and the more sceptical and newer members of the bloc will widen to an impassable chasm in 2018 and will shift the centre of gravity from the Franco-German axis to Visegrad-and-friends.The consequences for the euro will be severe. Looking for further weight to counter the Franco-German led “core EU”, Austria and the Visegrad 4 lobby to take the union in a pro-stimulus and anti-immigration direction. They successfully manage to gather a group of 13 EU countries, including Italy (once again led by Silvio Berlusconi) and Slovenia, to form a blocking minority at the European Council. For the first time since 1951, Europe’s political centre of gravity shifts from the Franco-German couple to CEE. The EU’s institutional blockage does not take long to worry financial markets. After spiking to new highs versus the G10 and many EM currencies by late in 2018, the euro rapidly weakens towards parity with USD.
We believe demand for investments will continue to undershoot demand for savings in the euro area (see Chart 2). Although public investment might rise due to favourable financing conditions and political uncertainty receding, the working age population is set to grow slowly and even decline in some countries, which will reduce the need to invest in more capital. Furthermore, life expectancy has risen more than the retirement age in many euro area countries (see Chart 3), which means that greater savings are needed to fund retirement. Unless the euro area experiences significant immigration of skilled workers or implements reforms to raise the retirement age, these structural factors will continue to depress potential growth and thereby the natural rate of interest. The outlook for a low natural rate of interest will limit the scope for ECB rate hikes over the coming years, in our view.
The ECB’s QE purchases and TLTRO loans have increased its balance sheet and the monetary base rapidly (see Chart 4). However, it has failed to lift broad euro money supply growth to pre-2008 levels (see Chart 5). The lack of pass-through to money supply growth may reflect an expectation that the increase in the monetary base is not permanent. Another likely cause is the impact of the new Basel III regulation on the money multiplier. Before 2008, the money multiplier was relatively constant. However, since 2008 it has been unstable and generally downward trending (see Chart 6). The regulation of banks’ capital and liquidity reserves has limited the effectiveness of monetary policy as seen in the falling money multiplier. [...] In our view, the ‘new normal’ for monetary policy in the euro area involves a large ECB balance sheet even if the economic situation normalises due to high demand for HQLA, which may rise even further when the required minimum LCR reaches 100% on 1 January 2018. Furthermore, the regulatory demand for HQLA, including deposits at ECB and disincentive to take on short-term funding, should also put downward pressure on short-term money market rates and thereby the ECB’s potential to raise rates.
Additional support for further reduction of monetary stimulus will come in the form of the reinvestments on maturing bonds, which will grow in size and importance over 2018, and we expect the ECB’s communication to be focused on the stock of QE rather than the flow. The ECB has stressed that reinvestments will be made ‘for an extended period of time’ after the end of the net QE purchases and ‘for as long as necessary’, which implies that the ECB’s balance sheet will remain large for some years to come. We think on a five-year horizon that discussions about quantitative tightening might start, but there is a need for a large ECB balance sheet even if the economy improves.
Investors may feel left behind empty-handed: although risk and uncertainty generate the extra return over and above the risk-free rate they strive for, they hate uncertainty so in their dreams guidance is clear and “close” and “well past” are precisely defined. However, such a dream could end up in a nightmare: the environment might change forcing the central bank to renege on its earlier guidance. Investors would wake up with a headache and volatility would increase structurally because everybody would understand that firmly stated guidance is of little value in a world which is rife with “known unknowns”. Out would go the credibility of the central bank. At the end of the day, guidance should be sufficiently clear whilst remaining…sufficiently vague. It's in the interest of the speaker (the central bank) and his audience (markets).
The still-low wage growth is also one of the main reasons why we do not expect core inflation to pick up significantly in 2018, despite the ECB arguing with its ‘super core inflation’ measure that underlying inflation pressures are building up. We expect wage growth to remain around 1.8% y/y in H2 17.
The unsatisfactory culmination of more than 5 weeks of coalition talks in Germany shouldn’t come as too great a surprise considering the large ideological differences between the Green and FDP party who, alongside Chancellor Merkel’s CDU, were seen as the most likely as forming a coalition following September’s elections. The proposed coalition had been dubbed as “Jamaica” given the respective party colours and the failure to reach an agreement has seen the political instability in the Eurozone’s most powerful country increase markedly.
Current period and Alignment informs EUR/USD is on a massive correction. From 1.0300's to current 1.1800's is 1500 pips. Allowable range in current period is right at 2500 pips in longs or shorts, 1/2 = 1200. Coincides to 12 1/2 Quadrant years. The next big line break is the 5 year average at current 1.2032. At 1.2032 is 1700 pips. If the current period holds and I see it will then EUR is ready for a big correction lower. See USD/JPY V EUR/USD and its informs if this is correct.
We initially expected a trimming to EUR 40 bln for 6 months, but it seems “less for longer” is gaining traction. A cut to EUR 20-30 bln a month and a duration of 9 months would open the way to a full phasing out of next asset purchases at the end of September next year. It seems likely though that Draghi won’t fully commit to a final end date yet, and deliver the net purchase reduction within a wider dovish framework of forward guidance that highlights again that rates won’t rise until well after the end of asset purchases, which would push the first rate hike out to 2019.
Spain’s government invoked Article 155 of the constitution over the weekend, in a move designed to weaken Catalonia president, Carles Puigdemont, and seize control of the region’s administration. Reports are circulating that officials in Catalonia would disobey orders from the Spanish government if Madrid enforced direct rule on the region, suggesting things could get messy. Anxiety is likely to heighten ahead of a vote by Spain’s upper house on Catalonia’s takeover this Friday, which may spell more pain for the Euro.
With political drama in Spain punishing the Euro, could Mario Draghi offer a lifeline to the currency on Thursday? Although expectations remain elevated over the European Central Bank QE tapering this month, investors still need clarity on how much the monthly purchases will be reduced by in 2018 and how long tapering will last. If Draghi adopts a cautious stance, and suggests that QE may be extended beyond 2018, the Euro is at risk of depreciating further as markets acknowledge this as a dovish taper.
We keep expecting the euro to benefit from the tapering announcement, but perhaps it is already fully priced in. In fact, perhaps it was over-priced in and the pullback we are getting now is a preliminary "sell on the news." That could mean that when the actual news comes out, we get one last push to the downside. In other words, the euro already overshot to the upside on the taper story and is now busily overshooting to the downside.
The widening rate differentials continue to weigh on the euro...
Undermining the common currency, were headlines indicating that ECB's officials are considering reducing QE to €30billion from current €60 billion per month, starting next January. Also, Estonian ECB's Governing Council member Ardo Hansson, said that monetary policy has to remain accommodative.
In June of 2011 and October 2013, these euro bullish extremes did a pretty good job of defining an intermediate-term bottom in the US dollar index. And interestingly, we are now at a bullish extreme in the euro not seen since 2011.
Let’s face one reality; USD weakness in earlier months was mainly driven by euro strength. Now there are less investors believing ECB is in a rush to tighten their monetary policy. Many of the traders started to close earlier “long euro” positions. After EUR/USD broke above 1.20 last month, the pair fell back quickly below 1.20. Such price reaction suggested there were not much interest in the market to purchase EUR/USD when it is above 1.20, before Mario Draghi makes clear the timeline of its QE tapering.
With the European Central Bank’s (ECB) October meeting looming, traders are starting to try to anticipate the impact of monetary tightening in the Eurozone. The ECB doesn’t meet until 26th October, but the markets are already worried that less cash in the European system will cause share market ructions that could offset any Euro gains.
The independence movement could also inspire other fracture across the region including in Italy where separatist forces have been gaining ground as well. One great unknown is the long-term impact of these events on the euro itself. The currency is actually uniquely structured to accommodate such adjustments, as it allows for political autonomy while maintaining economic unity. There is no doubt that the Catalan government will want to remain in the euro, but the question is whether Spain will try to veto its entry. If Catalonia, as an independent entity remains within the EZ, the economic impact will be minimal as it will have to abide by the current European law. If, on the other hand, Madrid vetoes its entry the region will be left stranded and will likely trigger a political crisis with the union itself as it challenges the very foundations of the Eurozone ideal.
Yes, growth has converged, but monetary policy has not. In fact, we argue peak divergence is still ahead. The divergence is on the respective balance sheets. The Fed's will shrink in Q4 by a modest $30 bln. The ECB's will expand by 180 bln euros. The Fed will likely raise rates, while the ECB's first hike is probably more than a year away.
There is a possibility that the EURUSD will transform into a battleground for bulls and bears in the last quarter of the year, as investors juggle with ECB taper speculations and mounting Fed rate hike expectations. Taking a look at the technical picture, prices are starting to look increasingly bearish on the daily and weekly charts. Sustained weakness below 1.1680 should signal an end to the weekly bullish trend, with the next level of interest at 1.1500.
[...] the ECB economic staff warns that "headline inflation could retreat to as low as 0.9 per cent in the first quarter of next year" because some of the components that had driv-en prices high (energy and food) are falling out of the annual comparison.
[...] "It may be time investors started paying more attention, said Angel Talavera, an economist at Oxford Economics in London. While Spain won't recognize the results of the referendum, the push for state-hood could eventually hurt the economy, discourage investment and raise questions about Rajoy's abil-ity to govern. Money doesn't like uncertainty.... At some point investors will wake up to the realization that there could be a longer-term impact.'"
Macroeconomic investors will be focused on Draghi’s decision on the CSPP which is the corporate sector purchase program where the ECB buys 60 billion euros per month in corporate bonds.[...] One of the keys to watch when figuring out what the ECB will do is the inflation projections.[...] higher inflation would cause the plan to be ended and lower inflation allows it to continue because policymakers believe the CSPP causes inflation. Europe has seen improved growth in 2017, so that’s the counterbalance for inflation which pushes policymakers towards ending the program.
ECB tightening could increase the borrowing costs for countries like Italy and Spain. Sustainability and the potential for a European breakup are in the heads of ECB policymakers. [...] The fact that the ECB does take politics into account makes the threshold for changing the CSPP more complicated to determine. One point where the political risk and the economic risk are coordinated is inflation because German economists at the Bundesbank are angry with the way the program has helped the periphery nations while potentially increasing inflation in Germany.
The Italian banking system collapse: there are 1 trillion euro of non-performing loans in Europe. A quarter of them or so are in Italy, another 15% in Greece, and another 15% in Spain - the entire European banking system is insolvent, is being propt up by QE from Mario Draghi. Then you have TARGET2 imbalances, the country to country funding [...] Germany owns something like 800 billion euros from peripheral Europe, how are these countries going to pay that back to Germany? It's not going to happen.
Market could be more cautious on buying Euro dollar due to rising uncertainties on ECB’s policy [...] f inflation is to stay tepid and far below ECB’s 2% target, ECB may delay the start of tapering until middle of next year, and this is seen as a dovish policy. Rising uncertainties of ECB’s upcoming QE policy may encourage some traders to square earlier EUR/USD long positions.
There is an election on Italy next year. [...] Each of the four main parties opposing the Democratic Party subscribe to the introduction of a parallel currency to rival the Euro despite the dire warnings emanating from Brussels and Frankfurt. It seems Rome is going to play Brussels at its own game of semantics and sticking to the letter of its treaties so beautifully illustrated by Brexit.There is a ban on any other legal tender than the Euro. The definition of legal tender is that is catties a guarantee of payment. So, those crafty Italian Politicians are going to introduce an alternative that does not carry an implicit guarantee. It has been mooted before in other countries and will be used purely domestically. All payments outside Italy will be in Euros as will payments made to visitors within Italy.
While the eurozone continues to grow at a pace that is above what is seen as trend growth (~1.3%), evidence continues to accumulate that the momentum has waned. This is evident in the PMIs. Germany has appeared fairly resilient. Much of its industry is competitive at stronger euro levels though the cost structure of other economies is not as favorable.
We had expected that the ECB would take advantage of the new staff forecasts to announce that it will extend the asset purchases next year but at a slower pace. However, the strength of the euro, which briefly traded above $1.20 last week (and approached the 50% retracement objective of the depreciation that began in mid-2014-~$1.2165), has increased the risk that the ECB waits a little longer to announce its decision. It must ultimately extend the purchases or make a potentially destabilizing hard stop (except for the reinvestment of maturing issues that are estimated to run at a little more than 10 bln euros a month).
The third-factor investors need to grapple with is the euro and market psychology. After moving above $1.20 on August 29, the euro could not sustain the momentum, and it has slipped lower. The disappointing US core PCE deflator and employment growth saw the euro make another run at $1.20 before the weekend (~$1.1980) before selling off on reports of the ECB's cautiousness next week. The euro finished just off session lows. At the start of this year, many were concerned about the extreme long dollar positioning. Dollar sentiment seems as extreme now but in the opposite direction, and the euro is the un-dollar of choice.
Greece is not a country that’s been “fixed”. Serious structural, fiscal and political problems remain and they will inevitably resurface in due course. Unless the country’s problems are comprehensively addressed, the exit scenario may resurface to haunt the Euro.
What is new is how fast the newly elected French President has lost support. Macron's standing in France is lower than Trump's in the US. This is important because it would seem to jeopardize his agenda, which is key to renewed vigor in the Franco-German relationship and addressing the simmering structural challenges in EMU.
Of course, a NPL crisis in Italy, should one occur, would likely lead to financial market volatility not only in Italy but probably across Europe. Growth rates in other large European economies, such as in France and Spain, could weaken, which could lead to a rise in NPLs in those countries. The lending capacity of the ESM could be tested in the event of another recession in the Eurozone.[...] In our view, Italy represents the most serious systemic risk to the European financial system given the high absolute amount of NPLs (about €250 billion) that infects the Italian banking system.
As of 30 June 2017, the Single Resolution Board (SRB) had collected €6.6 billion from 3,512 institutions in annual contributions to the Single Resolution Fund (SRF). In total, the SRF now holds an amount of €17.4 billion.[...] The SRF is being built-up over a period of eight years (2016-2023). The target size is intended to be at least 1% of covered deposits by end 2023. [...] At hand right now the SRF has €17.4 billion in the emergency safeguard. As noted last week, there are Over €1 Trillion Nonperforming EU Loans. [...] Simply put, the SRF is a complete joke. It’s only purpose is to pretend that something meaningful is taking place when clearly it’s not. On top of it, a quick check of the Bundesbank Target2 Balance shows peripheral Europe owes Germany a new record high €860 billion! [...] To prevent runs on banks the EU is investigating a scheme to freeze bank accounts. The next logical step is ban on cash altogether
[...] the EU wants to Freeze Accounts to Prevent Runs at Failing Banks.[...] Over €1 Trillion Nonperforming EU Loans [...] Italy, Greece, Spain, Portugal, and Ireland have a combined €606 billion in non-performing loans. The entire European banking system is over-leveraged, under-capitalized, and propped up by QE from the ECB. Simply put, the EU banking system is insolvent.
If the 10 year US note stays in bearish mode then we can expect an important bearish turn for the EURUSD as well, since we notice the positive relationship between the 10 year US note and the EURUSD since the start of July.
But there may be more bank resolutions to come in Italy, and they could be quite expensive. Public support would further burden the Italian government, already one of the most indebted in Europe. And allowing national authorities to circumvent European standards undermines efforts to reinforce a fragmented financial system across the continent. It is certainly unrealistic to expect the public sector to be a bystander if private buyers are not forthcoming. But recent actions do little to diminish moral hazard for poorly-run banks. Nine years after the onset of the financial crisis, Europe still has not found a consistent way to clean its dirty financial laundry.
Amplifying Global FX Capital: “In a low yield environment globally, capital appears to have been drawn more to equities in general, and investors have paid less attention to interest rate differentials and hedging costs.” “EUR has probably benefitted from unhedged equity inflow and is vulnerable to a correction in equities. The market is also net long EUR and, in a risk-off environment, position squaring and deleveraging is likely to see EUR selling.”
The Target2 system is designed to adjust accounts automatically between the branches of the ECB's family of central banks, self-correcting with each ebb and flow. In reality, it has become a cloak for chronic one-way capital outflows. Private investors sell their holdings of Italian or Portuguese sovereign debt to the ECB at a profit, and rotate the proceeds into mutual funds Germany or Luxembourg. "What it basically shows is that monetary union is slowly disintegrating despite the best efforts of Mario Draghi," said a former ECB governor.
[...] Greece's debt crisis returning with a vengeance could encourage bearish traders to attack the EURUSD incessantly. The International Monetary Fund has warned that Greece may not achieve the required target to qualify for a cash bailout with discussions already on the rise of a potential Grexit. This terrible cocktail of uncertainty and political risk could ensure the parity dream on the EURUSD becomes a reality in the longer term.
Bullish for the Euro
We are concerned that around the middle of next year, a factor outside the direct control of the ECB may cause the balance sheet to shrink. What we have in mind is that when the ECB is crafting its guidance for September, the banks will be able to pay back their borrowings under the targeted long-term repo operations (TLTROs). Given the negative rates offered by the ECB and the short-end of the curve, ample liquidity, favorable deposit-to-loan ratios, and lukewarm demand for credit from households and non-financial businesses, we suspect some will opt to repay early. This would have the effect of reducing the central bank’s balance sheet. The return of a modest portion of the more than 700 bln euros borrowed under the facility could offset months of ECB purchases.
While relative rates are often regarded as a key driver of FX, rates could become of second order in an environment where the potential for central banks to hike rates is limited. As the ECB and the Riksbank embark on a path to ‘normalisation’ of policy, we see potential for portfolio flows to become a key source of EUR support (see Special Report – The EuroScandi exit and what it implies for markets, 30 November). Eurozone capital flows should eventually reverse from currently large outflows to become inflows. While such flows may be partly hedged, our integrated rate-flow framework suggests that in the past these have been a significant driver of EUR/USD.
While speculative currency flows should merely be regarded as a timely indicator on how the market perceives fundamentals and not a longer-term driver in their own right, portfolio flows may prove a persistent driver in their own right, as these are inherently related to the ‘natural flow’ via the balance of payments (which is ultimately a EUR positive due to euro balance-of-payments surplus). We note that not least portfolio outflows related to debt securities could fade as: - Euro residents’ search for yield abroad due to negative rates at home fade. - Foreigners buy less from the ECB as QE is phased out. Furthermore, that debt portfolio flows could possibly reverse (i.e. become inflows) as: - Euro residents possibly repatriate funds as rates appeal rise. -Foreigners (e.g. Japanese investors) may eventually start to buy euro debt. [...] Our rate strategists suggest that the EUR-USD 2Y swap spread could be back at -150bp and -100bp on a 3Y and 5Y horizon (from currently around -200bp), respectively. At the same time, we assume that cumulated portfolio inflows over the next five years approximately equals cumulated outflows since 2014-15. Also, we let speculative positioning edge back to zero. In combination, these assumptions (see Chart 22-24) used for a 5Y projection of the model suggests that a normalisation in rates and flows in combination has the potential to send the cross some 15 big figures higher, everything else (e.g. valuation) being equal.
The optimism of euro zone economic outlook is getting more obvious. Various economic indicators showed the region’s growing speed has reached the fastest in past 10 years.
Economic Data: A synchronized upswing appears to be gathering steam. Laggards like France and Italy are fully participating. Spain also appears to be re-strengthening, like Germany. Despite political challenges in several countries, including Ireland, where the minority government faces a trying few days, the economic momentum continues unabated.
What do I like about the long side of this trade? TWO DRIVERS - Well...there are two driving forces here. The first is the fact that this is where the big money is positioned and this is where it seems the US government is aligned. There has been so much talk about a weaker US Dollar over at the White House, that I believe this could be a difference maker if it continues and if the larger players keep with this trade as they have been for many months now. Even the appointment of Powell as the next Fed Chair is one of those things that lets you know the focus isn't exactly on promoting a stronger US Dollar. But perhaps it's the second reason that is even more compelling to me. When you look at the chart, it becomes very easy to see the breakout in the Euro this year and the formation of what looks to be a longer term base. Certainly there are fundamentals I could, and have presented that make the US Dollar attractive, but the added insight from the charts tell me maybe a little US Dollar strength, but not a whole lot more before another big slide.
Viraj Patel, Research Analyst at ING: "If one was to assume that euro area markets are in a ‘normal’ environment – as the evidence suggests – then Praet's speech is the clearest signal yet that the ECB later this month will announce a lower for longer QE taper schedule in line with our house view (ie, asset purchases cut to EUR 20-25bn from January over 12 months). [...] While theoretically different QE options may not change the equilibrium levels for asset prices, we certainly think the signal of an initial aggressive cut to monthly QE purchases will be positive for the EUR (at least in the short-term). We see EUR/$ at 1.25 as testing the ECB’s pain threshold."
As per Reuters report, risk reversals reflect their highest EUR call bias across the curve since 2009. Three-month and 1-year risk reversals show highest EUR call bias since 2009 at 0.5 and 0.15. The one-month 25-delta risk reversals jumped to 0.5 on Wednesday.
Analysts at Scotiabank: "The ECB is edging closer to the end of its asset purchase programme, however, and we expect the eventual normalization of monetary policy to allow investors to refocus on one of the EUR’s key structural supports—its large current account surplus relative to the US.[...] We also note that global central banks retain a low relative and absolute exposure to the EUR in reserve asset holdings and large, institutional investors may have to adjust exposure to the EUR as growth strengthens and the ECB exits from extra-ordinary policy accommodation. We look for modest strength in the EUR next year and more obvious gains into 2019 as a result.
European interest rates are low, artificial, contained and should be far higher. European money supplies are far overbought and should be much lower. [...] But Draghi wants more QE to add to an already overbought money supply. It doesn't matter how much Draghi purchases because overall it means a drop in EUR and all EUR pairs. Not an ounce of bullishness exists to Draghi's QE policies as all economic indicators from GDP to confidence will drop dramatically over time. Draghi's dilemma is not in the fantasy QE will bring economc prosperity but he risks interest rates traveling much higher. The greatest risk in higher interest rates is EUR pairs higher. One mistake by Draghi then interest rates and EUR skyrocket. Then Draghi and Europe are finished. Draghi will be looking for the next Marshall Plan.
The downside risks to the economy have disappeared in the wake of persistently high growth at levels that are sufficient to absorb excess capacity. The risk of deflation has disappeared. This has been an important factor driving the euro and interest rates higher.
When the UK voted to leave the European Union, there was uncertainty on both sides of the equation. As Brexit negotiations began, it’s become evident that the UK government is on the back foot. Risks exist on both sides but it seems that the EU is in control of the negotiations at this point.
ECB's Mersch (Luxembourg): Reiterates Council view that Monetary accommodation is still required as cost pressures remain subdued- German IFO Economists noted that sentiment among business was euphoric and never more satisfied with situation. EUR exchange rate was no impediment to economy
“As the economy continues to recover, a constant policy stance will become more accommodative, and the central bank can accompany the recovery by adjusting the parameters of its policy instruments – not in order to tighten the policy stance, but to keep it broadly unchanged.” ECB speech by ECB President Mario Draghi, June 27, 2017. Not surprisingly, the euro has rallied quite a bit as part of this ECB induced mini taper tantrum. [...] the ECB will remove accommodation, but it won’t really and it won’t call it tightening. [...] Except the market didn’t take Draghi’s bluff and German Bunds sold off. Less than a year ago, Bunds traded at negative yields; in the aftermath of Draghi’s comments, they surged from roughly 0.25% to over 0.50%. A big jump for those that watch those markets. In contrast, U.S. Treasuries are yielding 2.37% as of this writing. [...] Historically, the spread between U.S. Treasuries and German Bunds are highly correlated to the exchange rate between the Euro and the U.S. dollar. As German Bunds are falling (yields rise), the euro has had a tendency to rise when U.S. long-term rates don’t move much. Not surprisingly, the euro has rallied quite a bit as part of this ECB induced mini taper tantrum. [...] I’m not suggesting reform in the Eurozone will be perfect – it never is; but I am suggesting that real rates have room to move higher, especially relative to U.S. rates, as progress is being made.
"The contrasting treatment of Banco Popular Espanol, which was put into resolution, and Veneto Banca and Banca Popolare di Vicenza, which were liquidated, raises questions about the application of the EU's Bank Recovery and Resolution Directive (BRRD) We believe the treatment of troubled banks will be clearer once the EU's minimum requirement for own funds and eligible liabilities (MREL) is in place", Fitch Ratings said
Europe (or at least Germany) has far more momentum than the US, as we saw in yesterday's IFO data. So, the FX traders are not looking at a static comparison of the two economies, but rather the rate of change in each economy. US yields seem to have little or no reason to rise back to the previous highs around 2.62%. They may not fall much more, but they are not rising. In contrast, European yields have nowhere to go but up. A single word from Draghi today, "transitory," drove yields up not only in the Bund, but elsewhere in Europe, too. So rising European yields are the latest shiny thing that traders can see. Granted, it hasn't happened in full, yet. But traders buy on the rumor, far in advance of conditions materializing.
Even before Macron dispatched Le Pen, many investment houses and journalists were talking up European equities and the euro. Sometimes it was offered as the counterpart to the unwind of the Trump trade. The apparent chaos of the White House, the clumsy and disorganized efforts to replace the Affordable Care Act, and the prevarications, increased the skepticism over the Administration's larger economic agenda.[...] Ideas that the rising eurozone inflation and continued above-trend growth would prompt the ECB to begin preparing the market for an exit from the unorthodox policies seems as much if not a larger part of the story as the sluggish US growth.
A political triumph for Angela Merkel’s party in the Saarland state election and the popularity of Emmanuel Macron in France both suggest 2017 may not repeat the populist uprising of 2016. The perception of diminishing election risk in France and Germany coupled with dollar-weakness has come to the rescue of the euro.
[...] we believe the euro has increasingly become a so-called funding currency. Amongst others because rates are so low, speculators are borrowing in euros to buy higher yielding assets. If we have a risk off event, e.g. a sharper decline in stocks, those speculators might have to reduce their bets and, as part of that, buy back the euro. Short covering may not lead to sustainable rallies in the euro, but it’s a piece of the puzzle worth watching.
The dollar started to surge at the first talk of tapering, even as the first actual rate hike was far, far, off. Similarly, the euro may well start appreciating well before rates will actually go up again in the Eurozone[...] Then the rumor came up that the ECB may hike rates before ending the purchases of securities; this rumor was given credence as the Austrian ECB member of the governing counsel suggested that there are many different rates and, yes, some could be raised before the bond purchases are done.`
...eurozone data improving far more and far faster than we have come to expect from this region. It's a battle for the hearts and minds of traders between all the squishy stuff that goes into "sentiment" vs. the fundamentals.[...] the Eurozone is hardly sclerotic—it's getting the same boost the US got from QE. It's just getting it a few years later.[...] If we are looking for a hard reason to prefer the euro over the dollar, this is it.
In today's world, though, a European bank is no longer able to tap into U.S. dollar funding at the same favorable terms, as evidenced by the higher LIBOR rates. That means their clients won't have access to the same embellished terms, either. Such clients may well decide to no longer seek a U.S. dollar loan, but instead a euro-denominated loan, or a loan denominated in their home country's currency. This trend might be accelerated by the fact that interest rates in the Eurozone are lower than in the U.S. As much as we love to hate the euro, this trend may let the euro rise as a formidable competitor to the U.S. dollar as a reserve currency.
We expect further USD strength in the short term, as markets continue to reprice and put in more risk premium into the money-market curve. However, we maintain our call for a turn higher in EUR/USD later in 2017, as the majority of the strengthening USD move tends to be up to and at the beginning of a hiking cycle. At the same time, current account flows, valuation and positioning are supportive of the euro.
Sentiment in the GBP Markets
Bearish FOR GBP
With four interest rate hikes in the US and the only one coming conditionally in the UK in 2018, the interest rate differential, as well as the growth rate differential, plays in favor of the US Dollar.
The government continues to increase the funds set aside for costs Brexit and is reportedly on the verge of doubling its offer to the EU. The budget put aside GBP3 bln for administrative costs associated with Brexit and earmarked GBP2.8 bln for the National Health Service. The OBR forecasts are sobering and reinforce our sense that the UK will be smaller and poorer on the other side of Brexit.
The British pound has shown a sharp decline after the Bank of England increased the interest rate by 0.25% to 0.50% and lowered the economic outlook of the UK economy. GDP is now growing at 1.5% compared to 1.75% in August. The economic growth in 2018 is forecasted at 1.7% compared to 1.8% anticipated earlier. The GBP/USD remains under pressure thanks to negative sentiment around the influence of Brexit on the state of the national economy.
Sterling, we have noted, is particularly sensitive to high frequency data because the Bank of England is thought to be as well. According to Bloomberg, the OIS curve is implying a high degree of confidence of a rate hike (77% chance for the November meeting and 81.5% chance of a hike before year-end). However, as has been the case in recent years (leaving aside last year), threats by Carney and the BOE to hike rates have diminished in the face of disappointing data. This time may not be different, and that makes sterling vulnerable.
The Bank of England policymakers may be commended on their ability to breathe life back into Sterling by stimulating expectations of higher UK interest rates. But this could end tragically for Sterling if this year concludes without a tightened monetary policy. While there is a strong argument for higher rates taming inflation, this may end up impacting business confidence and punishing the fragile UK economy
The U.K. current account position alone is not enough of a reason to be bearish the pound, however, it’s a risk that leaves the UK dependent on ‘the kindness of strangers’ according to the BoE to fund its twin deficits.
Some reports over the weekend suggested that UK Prime Minister May was privately conceding that it may cost the GBP50 to leave the EU. It was denied by Brexit Secretary Davis, but the eventual amount may be near this figure. Consider that from the EU's vantage point, the UK is responsible for the 14% of its budget that it had pledged until 2020. Without putting too fine a point on it, assume the EU budget is about 1% of members GDP (~$16.5 trillion) or $165 bln. Assume the UK is responsible for 14% of that (or $23 bln) for 2018, 2019 and 2020 or a cumulative amount of around $69 bln or GBP54 bln.
Real wages in the U.K. continue to contract, due largely to high inflation (largely exchange rate induced). At the same time, the British unemployment rate continues to fall to new lows and total employment continues to climb to new highs. Low productivity likely explains the coincidence of wage stagnation and a seemingly tight labor market. In the light of this, we expect the Bank of England to continue with its accommodative stance.
What gets us really negative about the sterling, though, is their fiscal situation. Sure, there may well be a short squeeze at some point because others don’t like the currency but medium to long-term, we believe the Brits may well go down what we call the “Italian road.” That is, we believe they’ll finance substantial deficits with monetary policy that’s too loose, leading to a currency that will cascade lower over time. That’s because we don’t see how the Brits can finance their budgets
Bullish for GBP
We believe the BoE will stay on hold in 2018 and not hike before Q1 19, as, in our view, it is too optimistic on wage growth and hence underlying inflation pressure and is reluctant to tighten too much relative to the ECB. Economists are divided on whether the BoE will hike in Q4 18 or Q1 19, while markets have priced in the first hike in Q4 18.
I'm also holding the long exposure in the Pound and love this one as well. Perhaps we get some dips on US Dollar demand and Brexit worry, but all I heard from the Bank of England governor last week was a message of 'I'm going to scare you all into making sure you get a deal done sooner or later.' That is why I believe Carney went to such lengths...more to accelerate the process than to show real worry of a disastrous outcome. We have to keep reminding ourselves the worst case Brexit scenario is well out of the way. That was back when we were trading in the 1.1800s. And so now with the Pound around 1.3000 (still looking very cheap longer term) after trading up towards 1.4000, I believe the opportunity is presenting.
Analysts at Nomura: “The UK flow picture is not pretty, it was not before the referendum and it has worsened. FDI and portfolio inflows have slowed and domestic investor outflows have weighed on sterling with two quarters of net financial outflows. But this year’s Q3 flow tracking is on a better track and is in line with our more optimistic view for GBP.
Sentiment towards the Japanese Yen
Bearish FOR THE YEN (USD/JPY up)
There is nothing in the economic substance for the Bank of Japan to end its asset purchasing program at the moment. The Bank of Japan acknowledged the progress in Japan’s economy, but the inflation rate is still far away from the target leaving the Bank of Japan inactive for 2017 and it is also expected to stand pat on rates in 2018.
With inflation rising and global bond yields (led by US Treasuries) surging, the BoJ nevertheless digs in its heels on the 10-year yield peg and even tries to make a show of moving the peg slightly to accommodate market pressures. The JPY is crushed all the way to 150 versus USD in an aggravated spike to absorb the pressure of higher yields. USDJPY hits 150 before the BoJ capitulates, after which it rapidly devalues to 100. John J Hardy / Head of FX strategy.
From a macroeconomic standpoint, the divergence between the Fed and the Bank of Japan (BoJ) policy outlook is supportive of a stronger USDJPY and the geopolitical risks may cause lower safe-haven inflows toward the yen, which is not the ideal harbour for investors willing to avoid the N. Korean tensions. Hence, the Swiss franc could be an interesting safe-haven alternative to the yen.
The BoJ is going to continue its all-in monetary policy by buying assets at around Yen 80 trillion a year. This can definitely not end well. Some BoJ members believe that the inflation target of 2% is too high for the current monetary policy which is, in definite, not loose enough. For the time being, the BoJ maintains its 10-year government bond target around 0 percent.
The Bank of Japan kept monetary settings steady on Thursday, but a board newcomer argued against the central bank's view that current policy was sufficient to boost inflation to its 2% target in a sobering assessment of the outlook. Goushi Kataoka, a vocal advocate of aggressive easing who joined the board in late July, dissented in an 8-1 vote - potentially exposing a fresh rift in the board that could further delay any plan by the BOJ to dial back its massive stimulus. The BOJ decided to keep its short-term interest rate target at minus 0.1% and a pledge to guide 10-year government bond yields around zero percent under its yield curve control policy. The BOJ also maintained a loose pledge to keep buying bonds so its holdings increase at an annual pace of 80 trillion JPY, diverting from the U.S. Federal Reserve's plan to steadily pull back from crisis-era measures.
The Bank of Japan (BoJ) maintained the status quo as widely expected. One of the two new board members voted against the yield-curve control policy, citing that the ongoing policy easing may not be enough to push the inflation toward the BoJ's 2% target. This was an unexpected dovish surprise. The divergence between the Fed and the BoJ policy outlook is supportive of a further rise in USDJPY [bearish JPY].
Japanese PM Shinzo Abe’s LDP failed big in Tokyo elections. The party secured the fewest seats ever in the city assembly and the popularity of Mr. Abe is questioned before next year’s national election. The disheartening outcome of Tokyo elections could encourage Abe to reshuffle his cabinet and boost the fiscal stimulus. The latter move is negative for the yen, at least in the short-term. Combined to the improvement in the US yields, the USDJPY could be catapulted toward the 115.00 level.
The yen has slightly strengthened against the US dollar because of a risk-off sentiment in the market over the past few weeks. But we consider the economy in Japan is still struggling to recover. The sad reality is Japan has not succeeded in boosting private consumption, which accounts for 60% of the GDP.
The dollar's performance against the yen seems to be driven more by US yields and equities than the news stream from Japan, which has been light. If US Treasuring can stabilize as we expect, then the dollar can begin recovering against the yen.
...a continued expectation of strong policy divergence between the Fed and the Bank of Japan which will drive interest rate differentials sharply in the US dollars favour. That's something both Fed chair Janet Yellen and BoJ governor Kuroda highlighted last week. Kuroda then again reiterated that he will keep the policy in Japan accommodative even though he has a more upbeat outlook on the economy and inflation in the year ahead.
Bullish FOR THE YEN (USD/JPY down)
... after the release of Bank of Japan meeting minutes. Some members are considering tightening monetary policy, if the economy continues to improve next year. This would be a significant shift in strategy for a Central Bank thought to be the last to exit the unconventional stimulus packages.
Following the MOF's decision to cut the initial target issuance of 40-year bonds, after having previously cut the amount 30-year bonds it planned to issues, the BOJ announced the reduction of the number of long bonds (25 year-plus) by JPY10 bln to JPY90 bln. The curve at the long-end steepened, as a result.
For many years, the Nikkei and Japanese yen (JPY) has had a very strong correlation. As the Nikkei would go higher, investors would sell JPY to fund those domestic purchases, and visa versa. But what we have seen in the recent months is that correlation break stride. And this is a problem for the JPY vs most major currencies. This poses a problem with FX traders, JPY dealers and institutions who thought this long time correlation would eventually lead to JPY weakness. What has happened in recent months, is the JPY has been quite range bound against many currencies. And if the Nikkei decides to make a more prominent pullback, we may see the JPY bounce higher and put the XXX/JPY pairs back down into their range or range lows.
In Japan, the PM Abe’s Liberal Democratic Party won big as expected, they retained two-thirds majority in Sunday’s general election. Abe’s win makes the reappointment of Kuroda, and hence the continuation of ultra-easy monetary policy, significantly more likely. Yesterday’s victory sent the Nikkei to the longest winning streak on record and the yen to a new three month low outright.
The big additions in open positions (open interest) in JPY/USD November expiry call options only adds credence to the bearish view on the USD/JPY pair. The open positions in JPY/USD calls increased by 385 contracts on Thursday. Over the last three trading days, the open positions in JPY calls have gone up by 1144 contracts. On the other hand, open positions in JPY puts fell by 260 contracts in the previous three trading days. The changes in open positions clearly show a bullish bias on the Japanese Yen (indicates investors are expecting a sell-off in the USD/JPY pair).
Markets do not see the current situation escalating to a war, however, there is a feeling of unease and that could keep the Yen bid. What if things escalate to military conflict? The resulting repatriation of overseas profits by Japanese individuals/ corporate could yield sharp gains in the Yen.
Unsurprisingly, the yen has a negative correlation to both the Brent and WTI oil price in the longer term. However, since the start of this year the correlation has dwindled back to zero, possibly reflecting the yen’s status as a safe haven that has been tested by a number of geopolitical events in recent months.
In short, while markets remain placid and calm about the current chain of events, there is considerable risk that the Russia probe could uncover criminal activity in the White House which would trigger risk aversion flows back into yen, despite Governor Kuroda's best efforts to expand QE. For now, the assumption of the FX markets is that the primary driver of trade in USDJPY is economic growth.
Sentiment in the Commodities Market
A bull market in commodities normally corresponds with bull markets in other currencies than the US dollar because the dollar and commodities are expected to trend in opposite direction (note commodities are priced in USD). Nevertheless, there can be periods when the sentiment is very negative toward bonds, so that safe-heaven currencies like the USD and assets considered an hedge against political uncertainty, like gold, rise together.
Tradicionally, the sentiment towards commodities goes opposite to equities, except during late stage expansion and contraction in the business cycle.
The negative influence of rising commodities on stocks holds true during inflationary and disinflationary periods- but not necessarily during a deflation! In a deflation, rising commodity prices are generally positive for stocks.
Commodities usually trend in opposite direction of bond prices, that is, in the same direction as interest rates. when inflation is expected or experienced, sentiment in the commodity sphere becomes bullish. Positive sentiment in both markets, commodities and bonds, is also good but not for a prolonged time because it's considered inflationary.
Bearish FOR THE COMMODITIES
[...] gold prices will depend how the tax reform will shape the expectations. If the markets focus on the rising national debt (due to the tax cuts), the price of gold should rise. On the other hand, if Trump’s success restores the Trump trade and shifts the traders’ attention to the spending bill, the yellow metal will struggle. We believe that the second scenario is a bit more probable.
[...] the shale output is set to rise at a faster rate next year. This might explain the signs of bull market exhaustion in oil prices post-OPEC decision to extend the output accord until end 2018. [...] Focus on OPEC compliance and exit strategy: Oil above $60 could entice OPEC members and Russia to produce more than what they have pledged under the output cut accord. Noncompliance would derail oil market rebalancing and could lead to oil price sell-off.
Bad signs, meanwhile, continue to mount in gold. We have no doubt that many gold investors or would-be investors have turned to crypto. At the margins, that means less excitement and buying in precious metals. Anything could change in crypto at a moment's notice but for now, the outflows from gold are considerable and speculative net longs are at 4-month lows.
Fears are that the institutional are going to enter short Bitcoin position and that futures will artificially increase the Bitcoin supply as what is happening for Gold. It is also important to note that the settlement will be cash and not in Bitcoin. We firmly believe that futures may weigh in a longer run on the Bitcoin price. Yet, the Bitcoin price has not reached its top yet and we may see insane prices within the next couple of years.
The latest survey on oil markets, conducted by consultancy Deloitte Services, showed that a majority of the US oil executives expect crude oil prices to stay below $60 per barrel (bbl) through 2018. [...] Half of executives polled said they expect capital spending to drop next year, and nearly 60 percent said they expect a decline in the number of drilling rigs active across the United States
In its World Economic Outlook report published on Tuesday, the International Monetary Fund (IMF) revised lower its oil price forecasts for 2017-18. Key Points: Expects global oil prices at around $50 per barrel, down from its April projection of $55 per barrel; In 2016, the average oil price amounted to $42.84 per barrel. The IMF expects it to reach $50.28 in 2017, and $50.17 in 2018
Gold Risk reversals gauge fell into the negative territory earlier this month and has extended the drop to -0.65; the lowest level since July 14. The negative print indicates increased demand for Put options, i.e. downside bets. Unless there is a notable pick up in the risk reversals, the metal looks set to fade the technical rallies.
On a daily basis, silver may seem to respond to the action in the USD Index, but from the bigger point of view, the link is much more bearish – the USD Index is about 10 index points lower than it was at the beginning of this year and silver is more or less at the same price level (more or less the same is the case with silver stocks). If silver was able to ignore such a huge slide in the USD, then it’s very likely to respond to the USD’s rebound. In fact, it seems that even a stop in the USD’s decline would be enough to trigger a decline in silver.
Extension of the cut in the oil output was expected for a long time. Traders used that reason to but Oil and because of that, the price climbed sharply in the first half of May. When the rumour becomes a truth, you sell - that what usually happens. That is why traders often repeat: buy the rumours and sell the facts. Current situation on the Oil is just another example of this old school quote. Second thing is the cut itself. We said that before and we will repeat that again. If some countries cut the output, other will increase it in order to close the gap and gain market shares. Shale producers, non-OPEC countries, they all are happy with the cuts as it helps their business and the overall supply-demand situation stays the same.
[...] the cartel members have set themselves up for almost certain failure. Whether production rises because they can’t stick to their agreement, the U.S. and others produce a lot more, or some combination of the two, the outcome will be OPEC’s inability to control the markets, sending prices lower.
Higher interest rates and a higher $ are bearish for gold over the longer-term. In addition, the decline from the September 2011 high has retraced a large proportion of the price rise from the 1933 low. Tony Plummer of London (Helmsman Economics) points out that the 2011-2015 decline retraced more than 38% of the rally from 1933 to 2011. The violation of the 38% level suggests that there has been a shift in the underlying fundamentals. I think that this price move is telling us that the ability of governments to boost the economy by having central banks inflate the currency is failing.
We expect a pro-growth agenda under Donald Trump and a limited global impact from the UK’s Brexit plans to put gold back under pressure soon. However, if the UK opts for a hard Brexit and Donald Trump spends his first days in the Oval office adding trade tariffs rather than unleashing ‘animals spirits’, gold stands to gain further.
As I’ve said all along, the next major target in gold is its 2008 low of around $700. To get technical with Elliott Wave Theory, that would retest the 4th-wave correction before the largest 5th-wave bubble run into $1,934. I still see gold landing somewhere between $650 and $750 in the next year or so, likely by the end of 2017.
Gold falls: This is the year we’ll see gold sink to $650-$750 per ounce, likely by late 2017 or shortly there after. I still see it dropping to as low as $400 (if not lower) before this down 30-year commodity cycle is over between early 2020 and early 2023. Oil rises a bit more and then crashes again: Oil will likely rise to as high as $60 at first, and then fall back to $26 or lower by late 2017. Ultimately, I expect we’ll see oil prices between $8 and $18 a barrel by early 2020.
A global push higher in yields, which began stateside following Trump's victory shows little signs of ending anytime soon and this makes non-yielding assets such as gold relatively less attractive.
Gold has done exactly what I said it would. It peaked shortly after my sell signal in late April 2011 and crashed after breaking major support at $1,525. It rallied to near $1,400, as I predicted it would, in late 2015 and has recently fallen $200 towards my target of $700 in the next year or so.
With further strength in equity markets and the dollar, along with continued expectations of higher interest rates, gold could have substantially further to retreat.
Back in early 2013, silver topped after [...] Moving above its 10-week moving average [...] Correcting a bit more than half of the preceding short-term downswing [...] The RSI moved a bit above the 50 level. This time, we have already seen these signals and consequently, silver appears to be ready for the next part of the pattern – a huge decline.
The gold and the stock markets have different drivers. The stock market tends to rise year after year due to population growth, technological developments, and currency inflation. The commodity markets do not benefit from all three. Thus, the stock market tends to rally and then retrace part of its prior advance such as 38% or 50% of the previous bull market. Due to the lack of support from the same drivers, commodity markets can retrace 100% of their prior advance.
Bullish FOR THE COMMODITIES
[...] copper futures hit the highest level since 2014. Encouraging data showed that China imported 19% more copper on a year on year basis in November. The metal has rallied 25% since the beginning of June, with this in mind Dr Cooper is telling us we could be in for a strong 2018. Copper is often referred to as a good leading indicator for economic growth, which has earnt it the name Dr Cooper or the metal with a PhD.
GDP is in a funk because of debt overhang. Consumers struggle to pay down debt. Many can't because they are overleveraged to their homes. This is all very inflationary until the bubble bursts once again. And when it does, faith in central banks will take a big hit. I expect gold will be the beneficiary.
I think that there is plenty of room for further Bitcoin appreciation. There are actually several reasons. Firstly, although institutional investors already have a foot in the crypto space, the inflow of money if far from over as many big players haven’t move yet. The arrival of CME and CBOE derivatives will just make BTC investing much easier and will encourage skittish investors to take the leap. Secondly, several key projects, such as Rootstock or Lightning Network, which are built on the top of Bitcoin, that aim as improving Bitcoin’s scalability will be released soon. Finally, people are claiming that Bitcoin and crypto assets in general are in a massive bubble. Just before the dot-com bubble popped in March 2000, the market capitalization of Nasdaq hit $6.7 trillion. AS of this morning, the total market capitalization of crypto assets stands at $330 billions…
A combination of the OPEC and non-OPEC restraint, some political issues, such as in Libya, and "normal" pipeline problems have helped lift prices.
There are rumors spreading that the prime minister of Spain is going to take over the government in Catalonia as early as tomorrow as the latter has refused to cancel an attempt to become independent and break off from Spain. Its pretty amazing that just on the rumors the gold price isn’t higher as if this event happens, it will throw the Eurozone into turmoil and you can be sure investors will be looking for safe haven assets.
What the central bankers do then remains to be seen, but history suggests they will keep doubling down as they did when Long term Capital Management blew up, when the dotcom bubble blew up, and when the housing bubble blew up. But this time the central banks will be starting with negative interest rates in Japan and Europe,low interest rates in the US, and imploding junk bond bubbles everywhere. Got Gold?
As OBOR invests and builds heavily in infrastructure, there will be a huge demand for commodities, resources, energy, service, and technology. OBOR will mean pouring a lot of cement for roads and a lot of steel for railways. Steel needs iron ore, energy and coal, while electricity infrastructure will help support the demand for copper. OBOR can also increase shipping demand as infrastructure investment improve ports and open new markets for commerce.
[...] it is important to keep an eye on the geopolitical risks. There is a back-and-forth threatening between the US and North Korea. If this leads to any nuclear/military action as suspected, gold could abruptly reverse losses and extend gains above the $1’300 level.
The Fed taper - realization that balance sheet expansion has ended - in 2013 also added to the bearish pressure around Gold. If balance sheet expansion led to asset price inflation [bearish for gold], balance sheet taper could lead to asset price deflation [positive for gold].
What I’m arguing here is that QT will increase risk premia.[...] With rates rising, should the price of gold decline? I can see Eurozone based investors getting less enthusiastic about gold as the euro has been rising. That said, rising risk premia may be a positive for the price of gold. Because gold does not have cash flow, there’s also no greater discounting of future cash flows as risk premia rise.
Dry weather in the US and Europe has been a cause for concern recently in the world wheat market. On Friday, a report from USDA added to those concerns, providing additional fuel to the recent rally in world grain prices. Overall, world food prices are up about 10% since the beginning of May – something that could also potentially come to the at tention of major global central banks if it starts to pass through to inflation.
The IEA warns that in order to offset recent declines and meet rising global demand, the oil industry needs to develop 18 billion new barrels every year between 2017 and 2025. Oil’s recent price range in the mid $40s to mid $50s per barrel doesn’t seem to be incentivizing the necessary new production capacity. Higher prices appear to be in store over the next few years.
... why this correlation [gold - USD] can be most ephemeral over the short- and intermediate-term time frames is the fact both the US dollar and gold can act as safe havens at the same time. We saw this during the credit crunch. We will likely see it again at some point in this cycle.
After the election, we believe the price of gold came down as the market priced in higher real interest rates in anticipation of lower regulations. We indicated that this euphoria will cede to realism, meaning that regulations might not be cut quite as much. We also suggested that any fiscal stimulus on the backdrop of low employment may be inflationary. That is, expectations of higher real rates might be replaced with expectations of higher nominal rates; net, bonds might not change all that much, but the price of gold may well rise in that environment.
Gold does not necessarily rise and fall with interest rates, jewelry demand in India, or any other widely believed nonsense. Rather, gold has moved in conjunction with perceptions as to whether or not the Fed and central banks have everything under control. If you think everything is under control, and do not want insurance against a currency crisis or another debt crisis, then dump your gold. If you believe as I do, that everything is not under control, or if you want some insurance, then take a position in gold. the ab
Gold could drop on massive tax cuts and fiscal spending program in the US, however, the dip could prove to be short lived as rising inflation expectations are likely to pull up the yellow metal in the long run. Furthermore, record rally in stock markets could also force investors to allocate a small portion of their money to gold (hedge demand).
One reason why I am optimistic on gold is that I haven’t seen any proposal to get long term entitlement spending under control which is, in my view, key to long-term fiscal sustainability. The link to gold is that a lack of long-term fiscal sustainability may lead to negative long-term real rates which, in turn, would be a positive for gold which has a cost of holding and doesn’t pay interest.
...the widely expected higher inflation would increase nominal interest rates, but not real interest rates, which are crucial for the gold market. [...]
The rise in Bitcoin is attributed to several factors. The recent currency policy by India’s Modi and Venezuela’s Maduro are credited as one of the factors, as the leader of these two countries tried to replace the old currency notes. Although there are valid reasons for the policies, it creates obvious side effects with public confidence in the national currencies taking a hit. Another driver for Bitcoin is the strict capital controls in some countries like China which may drive capital into bitcoin to circumvent the control, as well as the steady devaluation of Chinese Yuan. Most bitcoin trading takes place in China so financial conditions in the country can have a huge impact on Bitcoin’s price.
Sentiment in the Equity Markets
The appetite for stocks is believed to manifest the people's expectations about the economy. But they can also be perceived as a good investment in a deteriorated economic environment.
Here at FXStreet, we are more concerned about the relative return of stocks, which can be positive even in a declining market in absolute terms. That is why a strong currency also increases the appeal of a country's stocks (and also bonds) to foreigners, because the relative return, when translated back to their home currencies is greater than the absolute nominal return.
The opposite is also true when a currency falls, its stock market becomes less attractive to foreigners.
In the same way, if the stock market in one country starts performing better than the stock market in another country, you should be aware that this could lead to a rise in value of the currency for the country with the stronger stock market, while the value of the currency could depreciate for the country with the weaker stock market.
Bearish FOR THE STOCK MARKETS
The WSJ notes that a new study by the Bank for International Settlements covering data from 18 coun-tries from 1870 finds "no clear link between rates and factors like demographics and productivity—it is mostly central-bank policy that matters." Rates can still creep up on investors when central banks raise rates solely to contain optimism. "Central banks in Canada, Sweden, Norway and Thailand are thinking along these lines, analysts said. The point is that central banks can raise rates to squash bubbles instead of trying to fine-tune inflation.
The combination of rather strong US economic growth and a further boost from tax reform underscores our overweight US equities. However, the additional growth effects of the US tax cuts for the US economy may be more limited than normal. First, the income tax cuts are targeted mainly at high income earners, who have a low marginal propensity to consume. Second, investments may not increase significantly despite the possibility of deducting investment costs, as credit has been cheap and easy in recent years. Third, fiscal multipliers (i.e. how much additional economic growth can fiscal expansion generate?) tend to be low when the output gap is almost closed, as is the case in the US right now.
As we approach the end of 2017, investors are likely to reassess their portfolios. Few may disagree that stocks are very expensive, but expectations of tax reforms, synchronized economic growth, accommodative monetary policies and robust earnings, were all factors that helped shares surge this year. Given that the tax bill passed the Senate Budget Committee on Wednesday, it looks like we are getting closer to a deal, but this does not necessarily mean that bulls will get overly excited. I think much of the premium for tax reforms has already been priced in, and I won’t be surprised to see the scenario of “buy the rumors and sell the news” when we get the deal done. Monetary policies can only get tighter at the current stage which is another negative factor for risk assets. This leaves us with few factors that may justify further upside in stocks in 2018, so investors might start considering protecting their portfolios from any potential pullback.
If this rally had been based on a booming economy that would be one thing, but the truth is that the U.S. economy has not seen 3 percent yearly growth since the middle of the Bush administration. Instead, this insane bubble has been almost entirely fuelled by central bank manipulation, and as the economy begins to heat up, the central banks will likely lean against the economy by implementing a faster hiking cycle than currently projected, which will ultimately spark the next market Fall.
The reason why the S&P is now making hard work of maintaining the same velocity is because, since early-October, it is engaged in a corresponding series of 4-5’s which are approaching upside completion that ends the entire impulse from August’s low.
The two classic lead indicators for US stocks include the Dow Jones Transport Average and the small cap Russell 2000. The Dow Jones Transport index peaked on 13th October and has been falling since then, it fell through its 50-day moving average on Tuesday, which is a bearish sign and could signal further losses ahead. The decline in the Russell 2000 hasn’t been as steep, but it peaked on October 5th and sold off sharply on Tuesday as investors seemed to rush to ditch small cap stocks after yet another record high was reached.
US stocks and US bonds are both extremely overvalued according to historical measures. In fact, the US bond market has never been more overvalued, and according to the median price to sales ratio of the S&P 500, neither have stocks. This does not mean that stocks and bonds are going to crash tomorrow. Valuations are not a timing tool, but a key element to a multifaceted portfolio construction method. That being said, the extreme optimism apparent in the drastic departure from fair value in financial assets presents a difficult task for portfolio managers and investors going forward.
As the broader market indexes continue to push to new highs (even with more nuclear-level brinksmanship between Trump and North Korea), aggressive short-sellers keep adding to their positions. Another 2.3% of assets was plowed into leveraged short funds not too long ago. Until they get wiped out, the markets could push higher. (These speculators are a contrary indicator.) The bad news for the markets is that corporate buybacks have touched an eight-year low this quarter. Buybacks have been a key driver of stock returns in this bull market since 2009. The slowdown in corporate activity ultimately will make it very difficult for the market to sustain recent gains.
[...] the lower the earnings yield, the lower the future returns. You would expect this relationship to be consistent, but it isn’t. In the 1940s, the earnings yield was low and the appreciation was high. There was also a gap in the 1980s where the yield was low and appreciation was high. If the basic trend in the stock market and yields continues, there will be another one of those periods starting in 2019 because the bull market started in 2009. That would be a strong sell signal. The green line is about to drop in the next 12-24 months as it starts to include the financial crisis.[...] The stock market has been in one of its best streak ever all year. The latest ramp has been catalyzed by the potential for a $5 trillion tax cut. The only problem is how the $3.5 trillion gap is filled. This rally has caused the market to have above average valuations which likely imply stocks won’t repeat the past 8 years of performance in the next 8 years.
The money pouring into index-based ETFs dwarfs anything seen over the last 10 years. This has been a huge factor driving virtually all stocks higher because index funds are indiscriminate.
[...] Many market sectors are valued at 50% or more above their 30-year peaks. That’s a cause for concern, because if selling pressure really starts on the indexes, there’s more room to fall than in prior market cycles across all stocks. There’s going to be virtually nowhere to hide, unlike in 2002 when technology stocks took most of the pain.
The forward yield curve is anticipating a recession in about 5-7 years while the auto sales and housing permits index is anticipating a recession this year. I think the truth lies in between. Even with strong economic growth and earnings growth, it doesn’t mean stocks are bound to rally. The non-financial EBIT is just catching up to 2011 levels while the stock market rallies at hyper speed. At some point, multiples will compress meaning great earnings in 2018 don’t mean stocks will do great.
[...] many are worried about the price performance of the FANG stocks being too good. The reality is the tech stocks aren’t the ones you should be worried about. Stock performance doesn’t equate to how it’s being valued. The best argument against tech is that margins will compress, but that argument applies to other sectors. At the worst tech should perform as the market does in a correction. However, that may be optimistic thinking because tech is traditionally a risk on trade, so it may get irrationally sold.
There’s really no good reason to look at Treasuries and mortgage-backed securities (MBS) in isolation; as such, the balance sheet reduction would be $50 billion a month if the program were to be fully deployed [...] Basically, the Fed can reduce its balance sheet until excess reserves have been eliminated (this level varies on economic activity) [...] If printing money is quantitative easing (QE), then balance sheet reduction is quantitative tightening (QT) [...] If the Fed tells you, rates rather than QT is the primary tool to set rates, it must be true, right? Please just look at the rates, ignore everything else. [...] I am in the camp that believes QE has been all about compressing risk premia, i.e. the spreads between risky and so-called safe assets. With QE, junk bonds trade at less of a premium over bonds [...] What I’m arguing here is that QT will increase risk premia.[...] Stocks are historically correlated to junk bonds, not because they are junk, but because they are both so-called risk assets. Just as their volatility has been compressed with QE, we believe their volatility should rise with QT.
[...] if the S&P falls more than 15% from its high the turn in Fed policy from hawkish to dovish is virtually assured. From there it will turn to panic as the economy and stock market meltdown. [...] And, most importantly, the coming market crash and recession will occur with the balance sheets of the Treasury and Fed already extremely stretched.
Looking between the lines, for the Feds at least, it appears there’s a gradual transition afoot beyond data dependence to a greater concern about the adverse financial market impact from elevated asset prices.
Commentators and policymaker are starting to view low inflation outcomes as structural. Some central banks are shifting their focus surreptitiously from inflation targets to real interest rates and financial conditions. The RBA has accepted a lower glide path back to its inflation target, the Bank of Canada shifted to a tightening bias despite a slump in inflation readings, and the Fed is now more cognizant of financial conditions. A traditional focus on inflation targets may have boosted asset prices and built-in financial stability risks; recalibrating policy may see asset prices correct lower.
The handful of stocks that we have been talking about for weeks that are propping up the market are becoming unhinged. Some heavy stock are displaying odd amounts of volatility. Some 30 point unforeseen moves on a minute candle out of nohere are a dire warning that all the risk right now is to the downside on the Nasdaq. Microsoft, one of the largest caps in the entire marketplace with 8 bn shares outstanding, lost 50 cent in a matter of seconds. There is no bid when volatility starts to hit and we could see an incredible down day. Will you find a seat when the music stops?
The bounce in Treasury yields witnessed after the election of Donald Trump is now decaying in the D.C. swamp. If the Fed continues to ignore this slow growth and deflationary signal from the bond market and continues along its current rate hiking path, the yield curve will invert by the end of this year and an equity market plunge and a recession is sure to follow. [...] the only rational way to avoid an inverted yield curve, market chaos and a recession is if long-term Treasury yields reverse their long-term trend lower due to a rapid increase in GDP growth. This would only occur if Trump’s agenda of repatriation of foreign earnings, tax cuts and infrastructure spending is imminently adopted. But the probability of this happening very soon is getting lower by the day.
Only a handful of industry traders are talking about this: the danger that lurks inside the ETF products. [In this example] It started with the Russel futures and reverberated into the IWM, but what I want to explain by looking at this is how fragile markets happen to be and the instability that exists in today's ETF markets. What have ETFs to do? They have to buy and sell all the constituents of the ETF, and if someone comes and starts to selll, let's say the IWM like there is no tomorrow, the IWM managers have to go out there and sell the Russel's shares. What that would in effect do is create an monstrosity of volatility. But when you look at the stocks in the ETF, they are not trading any volume. So volumes are concentrated in products like the IWM. What's the issue then? If you come in and sell this product, there is not enough liquidity to turn around and sell the stocks. So what happens to the individual stocks? Their price would drop drastically. Not to mention less liquid products like junk bonds ETFs, which are really hard to unload...
[...] Janet appears to be optimistic that it will happen and then explained how they plan to shrink the balance sheet, saying that the Fed 'would gradually limit the central bank purchases of Treasury and agency securities, letting portfolio securities mature and not reinvesting them'. Now understand something here.....The Fed holds a massive amount of mortgage backed securities (as a result of the GFC and the 10 yr QE - Quantitative easing they launched) and those securities generate a' monthly income' for the FED (think about your monthly mortgage payment - it includes principal AND INTEREST) - and up to this point, the Fed has been reinvesting this interest income providing extra liquidity for the mkts....well sports fans - this is about to slow down come the fall.......as the Fed acknowledged that their help has now caused asset values to become stretched....saying: “vulnerabilities appeared to have increased for asset valuation pressures”. Do you think???
[...] a little-known valuation indicator invented by Norman Fosback – which has called major market tops and bottoms – is the average price of the 25 cheapest stocks in the S&P 500. When stock prices were completed decimated like they were in 2002 and 2009, this indicator was flashing major buy signals. Now, it’s as high as it was during the Internet Bubble and much higher than the Housing Bubble.
Another way to look at the reckless speculation in stocks is the bull to bear ratio. The chart below has a red line through the S&P 500 when the bull to bear ratio is above 3.0. The optimism is much greater than the beginning of the last bull market in 2003 as there are more red lines.
When looking at S&P 500 Shiller’s cyclically adjusted price-to-earnings ratio (CAPE) which is currently trading at 29.5 x earnings.This takes us back to April 2002;from April to October 2002, S&P 500 dropped from a high of 1,174 to a low of 768, a total of 34.5%.Since then, the Shiller’s CAPE never re-visited these levels until just this week.
Here are some cautionary sentiment developments: The amount of money in inverse index funds has fallen by 75%, one of the lowest levels in 20 years. [...] The average strategist expects the S&P to end 2017 at 2356, a gain of about 4%. That would be their least-bullish outlook since 2003 [...] The latest survey of active money managers from NAAIM shows bullish sentiment with low standard deviation [...]
A growing divergence between large and small caps will be an important sign of such a top. Small caps have grown the most irrationally since the Trump win after lagging and could disappoint increasingly in the continued rally from here.
Everyone is so focused on interest rates. Too focused. The thing is, they’re focused on the wrong interest rate. While the federal funds rate has seen little movement and may not budge much for the rest of the year, three-month LIBOR is at multi-year highs! [...] The problem is, as interest rates creep up and more portfolios have been used as collateral to finance asset purchases, it could create a huge storm if stocks and bonds take even a minor dip.
Bullish FOR THE STOCK MARKETS
The tech sector had a wobble in the final month of the year. After a super strong 2017, which saw the sector rally 37%, December saw the sector gain an anaemic 1%. This sector could potentially be an initial loser of the tax bill, given the amount of money that tech companies hold overseas and the global nature of their business. However, we could expect to see a repatriation of a significant amount of these funds held overseas in order to reduce a new levy payable, which could then see these stocks prepare to take another step higher.
Financials have already benefited from the optimism of the tax bill and we could expect to see that continue as the bill is implemented. The tax bill could enhance inflation and enhance borrowing, both of which are supportive to financials, not to mention the lower tax bill. Furthermore, financials tend to benefit in higher interest rate environments and given the Fed’s desire to continue hiking, potentially three times, the future still looks rosy for this sector. We expect financials to outperform the broader market and deregulation of the sector could also provide a tailwind for financial companies.
Several respected market analysts are projecting gains of 10% or more in U.S. equity prices for 2018 now. They could be right, for Jupiter (optimistic) in Scorpio (taxes) will continue to trine Neptune (euphoria and profits) through August 2018. Furthermore, the Saturn/Uranus trine returns to an almost exact aspect in August-September 2018 too.
My sense also is that if there aren't fundamental underpinnings to the strength in equities after a near 9 year bull market, then the bond market is warning us that equity strength is part of widening, speculative disconnect between stock price appreciation and the underlying drivers. In other words, TINA has created a year end panic into equities.
Technology’s outperformance is creating interesting performance gaps. Any index which has a lot of techs is doing well, and an index which doesn’t have much tech is underperforming. The most noteworthy index which doesn’t have a lot of tech is the MSCI Europe index which has a less than 5% tech weighting which is below the MSCI World index which has a 17% weighting, the MSCI USA index which has a 25% weighting, and the MSCI Asia index which has a 28% weighting. Many tech stocks in Europe are expensive because investors want to buy tech, but there aren’t many stocks which meet investors’ needs. MSCI Europe underperformed MSCI World from 2013 to 2016. This year MSCI Europe is doing 3.64% better than MSCI World as of October 31st.
Supporting the notion that the economy is ‘perfect’ is the Gallup poll below. As you can see, the mentions of economic issues being the most important are near the lows seen before the financial crisis and the bursting of the dot-com bubble. It’s especially interesting to see this issue so low on the totem poll because America isn’t at war. One of the reasons for this low concern is the low U6 unemployment rate. The current U6 rate is at 7.9%. The trough before the financial crisis was 7.9%, and the trough before the recession in 2001 was 6.8%. This line up well with optimism. Americans aren’t economic experts. If they have a job, then the economy is great; if they are jobless, the economy is a top issue.
With over 70% of the market up in 2017, it has great breadth, signalling a crash isn’t near. Everything could change suddenly, but the action isn’t like the other tops in that regard.
Shares in Tokyo recorded a 15th consecutive day of gains overnight following the news that incumbent Prime Minister, Shinzo Abe, has won a landslide victory in the Japanese elections. The victory marks the third successful campaign for Mr. Abe who signalled he wants to push ahead with further large scale economic stimulus dubbed “Abenomics” and with the ruling coalition now retaining a super majority with more than two-thirds of the seats in parliament, the decision to call a snap election has been well and truly vindicated.The Nikkei 225 closed higher by more than 1% to post its highest end of day price of the year and you have to go back more than two decades for the benchmark to have traded at a higher level.
The appointment of Randal Quarles to the Fed board of governors with responsibility of financial regulat ion also supported sentiment especially for financial stocks. Quarles is in general seen in favour of ruling back US regulation.
U.S. stock indices did not fall on a hawkish Fed. I believe lowering the estimated long-term neutral interest rates from 3% to 2.8%, prevented stocks from falling as overstretched valuations will continue to look acceptable, every time long-term interest rates are dragged lower. Back in 2012 longer run interest rates were seen around 4.25% and if they remained close to this level, it would have been tough to justify a PE ratio of 24 on S&P 500. However, it does make sense now.
Either way, it will be difficult to dampen the stock traders' appetite. As mentioned in our earlier reports, both dovish and hawkish Fed expectations attract enough buyers to sustain the bull market. While a dovish Fed hints at a longer period of low-cost liquidity, a hawkish Fed revive the optimism on better growth prospects. This way of reasoning has been ongoing since Donald Trump's election and has been positive for the stock valuations regardless of the news. Finally, the expectation of tax reforms is still a last resort.
I looked at each instance when the percentage of S&P 500 stocks trading above their 200-day moving average fell below 60% (the condition we’re experiencing now). [...] As you can see, S&P 500 breadth falling below 60% is not a death knell each and every time. Most of the time, the broad market tends to recover following these cleansing periods.
Sterling hasn't had a strong reaction to "good" political news since June 2016, suggesting that the FX market is still expecting Brexit to be a shambles. However, a weak pound is good for the FTSE 100, so we could see some of last week's downward pressure on the FTSE 100 bluechips lift in the next few weeks if we continue to see GBP declines as we expect.
[...] who could take over the helm at the Fed? Some had thought Gary Cohn [...] However, even though Cohn is not a trained economist he would be a good pick for Fed chair if Trump wants support to roll back on post-financial crisis regulation.
[...] the Elliott Wave Principle suggests there will be more upside potential before the DJUA signals an end to the secular-bull uptrend for the DJIA, S&P 500 and Nasdaq100 [...] This double ‘golden-ratio’ level is the markets ‘harmonic’, it is attracting the price towards it which means the current advance cannot collapse into a secular-bear downtrend until reached sometime over the next few years.
In Q1, there was nearly $90.1 billion worth of new foreign direct investment (FDI) in the United States, a marked increase from the $17.6 billion figure registered in Q4 2016 (bottom chart). Likewise, purchases of U.S. stocks and bonds by private foreign investors, represented by portfolio investments, continued to strengthen, rising $128.6 billion on the quarter. The recent bull market run in U.S. equities is continuing to attract foreign investment.
The BAI cycles projected a flat 8 years that is now ending and the cycles are rising in 2017. The cycles were picking up the election of a business-friendly administration as well as the cycles did when they were flat, preceding the election of a business-unfriendly administration. This event has led to a rise in optimism which will bring investment in new business. This has overwritten all other considerations. And, tax cuts are bullish. We have not had cuts in so long that I think that most have forgotten the beneficial effect.
What’s even more interesting is markets now consider a tighter monetary policy a sign of confidence in economic growth and thus a reason to continue purchasing stocks, when for years post 2008 crisis it had been considered the most significant motive to dump stocks.
The changes to Dodd Frank are likely to be small to begin with but Trump is shifting the direction of travel from more regulation to less regulation. That’s a good thing for the financial sector, and less red tape is good for corporate America as a whole. Trump turning his attention to deregulation could be just the boost Wall Street needs to send the Dow back above the 20,000 mark.
Technically speaking - Despite another surge we continue to have breadth indicators that diverge greatly from index prices.......During January the percentage of issues that continue to trend above their 50-day moving averages has drifted from way overbought (near 100%) to near 65% at the end of last week. The other indicator that continues to show weak breadth is the McClellan Oscillator for the Nasdaq indexes. Since late December this Nasdaq indicator has barely moved into the positive breadth area - In fact, it continues to remain weaker suggesting that only a handful of issues is carrying the load....The enduring sideways correction will have to break out or break down at some point.....depending on what you think will dictate your next move...
With regards to stocks, we don’t have a crystal ball, but are concerned about high valuations. Without giving a specific investment recommendation, we would not be surprised if small caps (as expressed in the Russell 2000) outperform large caps (as expressed in the Nasdaq). The reasons include:...
The macro forces we identified, reflation and nationalism that were expressed most clearly in the US election, but were evident before too, is spurring a dramatic shift in asset preferences. The dollar, core equities, and financials are broadly in favor. Bonds, emerging markets, gold, have broadly fallen out of favor.
...as long as banks continue to outperform, and REITs continue to underperform, the overall stock market, the path of least resistance for interest rates will remain higher.
Sentiment in the Bond Markets
It is important to note that bond yields and bond prices go opposite. Furthermore, bonds have several maturities ranging from very short-term 1 week up to 30 years or even more. These two opposite ends of the yield curve may see different supply-demand imbalances, but general sentiment towards government bonds will provide the trader or investor with a general sense for the appetite for that particular asset class. Bonds are the focal point of the intermarket chain and the deepest market compared to equities and commodities.
Any capital flows out of the bond market, is prone to create a sharp move in other asset classes. Market participants are therefore sensitive to changing inter-market relationships involving bonds. Bonds are traditionally considered risk-free investments but demand for government bonds from the public can dry up if other assets are perceived as carrying lesser risk of default. Also central banks can reduce or increase their holdings of domestic or foreign bonds.
Bearish for the Bond Markets
In theory, the combination of looser fiscal and tighter monetary policies (which will be the case with the Fed hiking rates and reducing its balance sheet next year) should push up US interest rates, which in turn should aide the USD. Indeed, we have seen short-term interest rates in the US move higher as the likelihood of the tax reform increased. The impact on the long-end of the US curve has been more limited but 10-year US yields did jump around 11bp over the past week. However, we do not expect a major sell-off in fixed income, such as after the election of Donald Trump. Given the rather limited growth impact and the still muted inflation pressures (which we see continuing in 2018), we maintain our call that the Fed will hike rates only two to three times next year. However, there may be slight upside risk to our forecast for 10-year US yields of 2.7% in 2018.
[...] should tax cut legislation come into force, one of the ways how to avoid overheating of the economy is to introduce the tighter monetary policy. So, in fact, we might see abrupt swing from ultra-easy policy of near-zero interest rates to monetary tightening with interest rates above equilibrium rate of 2.5%-3.0%
The takeaway from this long term analysis is that when the trend ends, rates skyrocket quickly. The average return after these depressive periods are over is 315 basis points in the first 24 months. It’s important to not get confused between nominal rates and real rates. Regardless where inflation goes in the next few years, real rates will shoot higher if we are near the end of the cycle. It’s critical to pay close attention to the changes in real rates over the next few months as the Fed is pushing up short term rates by raising the Fed funds rate.
Analysts at Scotiabank: "...the speech about two years ago by retiring Vice Chairman Stanley Fischer was specifically on the very topic of exchange rate effects on growth and inflation. Fischer stated that Fed models indicate that for every 10% trade weighted appreciation in the dollar, core PCE inflation is reduced by 0.5% in the two quarters following the dollar’s move and the four-quarter effect is to reduce core PCE inflation by about 0.3%. Note that the broad dollar index appreciated by about 9% from the spring of 2016 until early 2017 and has since depreciated by a similar amount. It is therefore conceivable that much of the deceleration in core PCE inflation from 1.9% at the start of this year to 1.4% as of August was due to the dollar’s prior appreciation. By corollary, dollar depreciation since earlier this year may well have the Fed much closer to its inflation target as soon as 2018H1.”
Francesco Garzarelli, Research Analyst at Goldman Sachs: "Large scale purchases of government bonds by the major central banks have further contributed to inﬂating bond prices, pushing the term premium below what can be justiﬁed by historical relationships with macro factors. On our estimates, which attempt to control for these factors, QE policies have cumulatively subtracted around 50bp from 10-year US Treasuries and about the same amount from German Bunds.”
[...] let’s not overlook the above-trend amplification of the US economy which has contrarians coming out of the woodwork now thinking FED -ECB policy divergence as opposed to convergence. US Treasury yields continue firming, and the inflationary expectations from the US tax reform are expected to provoke a further rise. While EURUSD should remain under pressure given this scenario, the EURO bulls are unlikely to give up the plot preferring to hold on for the October ECB
The original reflation scenario immediately after the election was based on deregulation, tax reform and infrastructure spending that would goose GDP and employment, and inflation along with it.[...] A quick review of the inflation outlook indicates the bond market can easily become fickle and lose its moxie.[...] This is not to say that the Fed will not hike this year. And this is the week the Fed stops reinvesting in maturing issues. But it is to say that the US is not seeing inflation and unless oil blows up, there is no real prospect of inflation. That leaves the weak—very weak—hope of tax cuts and infrastructure yet to come to do the job. It's the scenario we have but it's not a trustworthy one.
The implied yield on the December Fed funds futures contract rose five basis points this month to 1.25%. Bloomberg and the CME differ on its significance. At the end of August, their interpolations from the pricing of the futures contract were nearly the same. Bloomberg calculated the odds of a hike by the end of the year near 34%, and the CME was near 33%. Now Bloomberg sees the odds at 66%, and the CME is at 76%.
[...] 10 year YIELD should pivot to the upside into a powerful new upleg that takes out heavy, consequential resistance lodged between 2.30% and 2.40%, triggering upside projections to 3.25%-3.50% thereafter.
After the FOMC meeting, we concluded that US Treasuries re-entered a sell-on-upticks phase after the Fed confirmed his view on 2017/2018 interest rate policy. A December rate hike isn't fully discounted yet. Short term though, we expect some correction higher. We hold a sell-on-upticks view in the Bund as well as the ECB's normalisation process slowly takes off. From a technical point of view, both the Bund and the US Note future fell below uptrend lines (early September) since the start of summer, making the picture neutral from bullish.
The two-day meeting of the Fed resulted in an overall agreement to keep interest rates unchanged at 1.25%, as widely anticipated. Despite lowered inflation forecasts, the FOMC still forecasted one more rate increase by the end of 2017 to sustain the US economic growth. The Central Bank also noted that it will start unwinding its balance sheet in October, while the market wanted it to wait and see how September’s hurricanes affected the economy.
For a couple of years, economists have been predicting the end of the three decades bull bond market, but this has never occurred due to investors pessimistic long-term inflation outlook. It is yet to be seen whether the reversal in yields will resume towards the end of the year.
Even though the Fed recognises that there is room for improving regulation and that we should evaluate effects in greater depth, it has shown its commitment to prudent regulation and, above all, is warning not to take current macroeconomic or financial stability for granted. Draghi goes one step further and underscores the interplay between monetary policy and financial regulation. In a situation like the present one, with very lax policies, relaxing regulation is not an option and would be particularly “ill-timed”. Put differently, if the central banks sense imminent deregulation, they will be less inclined to continue with such expansionary monetary policy.
There are lots of good rationales for being long bonds: the US economy is slowing as seen in the 2s vs 10s yield spread tightening; inflation expectations are tumbling; and the Fed cannot afford to be aggressive with the US and global economy still sluggish and at the same time reduce the size of their balance sheet. But, there are other rationales that suggest betting against his one-way bet may be worth the risk: wave chart analysis; reports of the death of Trump tax and regulatory reform may be greatly exaggerated; the Fed makes it clear they will be doing “at least” two more hikes this year, and begin to trim their balance sheet at the same time; China decides it no longer needs to prop up its currency by holding such a huge supply of dollar reserves in the form of Treasuries and gets even busier selling them.
Despite the belief voiced by many commentators the Trump reflation trade was, or is, over, we maintained confidence in our Wave view for long yields, as seen below. At least a modicum of confidence here is critical to maintaining a dollar bullish view. That's because over time interest rates, or more importantly, relative yield spread (e.g. United States yield versus Eurozone yield) is probably the most important indicator of the intermediateterm direction of currency value (the major exception to this rule is the Japanese yen).
This difference in real yields is particularly striking in Germany. An inflation rate of 2% isn't just a target...it's a reality. The 10-Year Bund currently yields 0.43%, and the February year-overyear rate of Consumer Price Inflation (CPI) is 2.2%. Therefore, real interest rates are currently a negative 1.77%. If the ECB were to seriously commit to ending its QE program, fixed income investors and speculators would panic to get ahead of the removal of Draghi's bids; and Bund yields could surge well above the rate of inflation in a very short period of time. Therefore, it is a very credible assumption that the free market will rush to front run the offers from Draghi and Kuroda, and cause chaos in global bond markets.
Bonds should prove interesting in 2017. My personal opinion is that we saw historic lows in 2016. However, if stocks were to tumble, wouldn’t bonds rally? Possibly. What I’m concerned about is that bonds will fall for different reasons than in 2016: in late 2016, more real growth was priced in; I happen to believe that some of those higher real growth expectations will be replaced with higher inflation expectations. If that happens, bonds can lose money even if stocks fall.
There is still more reason for bond yields to be rising rather than falling. [...] Market-based measures of inflation expectations have been rising globally, consistent with stronger global growth indicators and stronger commodity prices in recent months. These factors are likely to reassert upward pressure on global bond yields, and rising relative real interest rates in the USA, where rate hikes are more likely to be implemented, supporting the USD.
Bill Gross grabbed headlines Tuesday by casting aside all other markets and economic indicators and saying the future of global markets hinges on one chart – the 10-year yield. The T-note yield has been trending down for 30 years but is testing the upper limit of that channel. Gross says a break above 2.60% would signal a new paradigm of growth and inflation that would be the start of a bear market in bonds. He didn't predict it was coming but said it would have to come with 3% real growth. Gross' rival for the bond crown – Jeff Gundlach had a similar take but with 10-year yields at 2.37%, he allows for more leeway before declaring a new paradigm. He said it won't be a bear market in bonds until 3% yields.
The rise in US yields since the election is not so much an increase inflation expectations but real yields. An increase in real yields could be a reflection of an increase in the demand for capital (which could come from the private and/or public sector). It could reflect anticipated changes to supply-side factors (tax cuts and regulation) that boost profitability.
... regulations combined with reductions in the trading desks at the banks have greatly reduced the volume of bonds that can be liquidated quickly and easily. The entrance was large but the exit has been shrunk. Thus, the bond market appears very risky from a longer-term perspective.
Despite significant purchases by the ECB and the BOJ, bond yields appear to have bottomed. Deflationary forces in most countries have been arrested. Bond yields have been falling since the early-1980s. This trend may be over. That is what is at stake. We may have entered a new paradigm.
The end of the 35-year-old bond bull market is upon us. Trump’s trade policies, along with his avowed love of debt, is putting significant upward pressure on borrowing costs. The Donald will now try to convince Janet Yellen to reverse her incipient tightening policy and bring rates back to zero—and eventually even to launch QE IV. [...] what Yellen and Trump don’t understand is that our nation is both debt-disabled and asset-bubble addicted, which requires interest rates to be near zero percent or the whole ersatz economy will implode. The devastating bond bubble’s collapse will bring Trump to that reality very soon.
Nicole Elliott, Private Investor and Technical Analys says the yields on the Treasury bills are far lower than the Fed funds rate, while the interbank lending rates are at least 50 bps above the Fed funds rate. She calls this as the failure of the Fed policy. Elliott then goes on to detail the dynamics of overnight offshore Yuan lending rates.
Bullish for the Bond Markets
The US two-year yield rose 5.5 basis points to almost 1.78%, its highest level in nine years on Tuesday and retreated in North American on Wednesday. It settled a little below 1.73% on Wednesday, largely unchanged on the week. Neither Yellen nor the FOMC minutes changed market expectations. It continues to price a hike next month and the little more than one hike next year.
After Chinese yuan has stabilised this year, nation’s capital outflow pressure is mitigated. Two reasons may drive Chinese central bank to buy US Treasuries, which is equal to buy dollar in near term. First, PBOC looks keen to defend its FX reserves at USD 3 trillion level. Second, PBOC may not be comfortable with its currency rising too quickly.
Greenspan is correct in that there is a bond market bubble, but he is looking in the wrong place. He is looking at US Treasuries. Junk bond yields in Europe are at record lows and in the US they are at near record lows. You have the average junk bond in Europe trading at a less yield than AAA-rated corporations in the US. That's a bubble! When the junk bubble busts we are going to see even lower yields in Treasuries [Treasury prices higher] . It's also likely the junk bond market is propping up the equity market.
The chart below is evidence of the large increase in corporate debt buying from the European central bank which mostly goes into large caps. It’s a remarkable trend which goes up and to the right perfectly. Looking at this chart makes the prospects of this policy ending seem ludicrous. However, the chance of it ending isn’t ludicrous because the ECB is running out of bonds to buy, so this program will be winding down in 2018.
Traders can front run the unwind of the balance sheet when it starts. The difficulty is determining whether increased supply of bonds raises or lowers prices. You’d think it would lower prices based on the rule of supply and demand, but the market is more dynamic than that. In the long-term I am very certain that the balance sheet will go up. Any short-term decline is a pitstop. Maybe that thought process is why bonds don’t selloff on the news of an unwind.
[...] the Fed is unwilling to allow the balance sheet to diminish. This means economic conditions years in the future will underperform as the FED can't have it both ways. Accomodative policy informs this will be the case. Improved economic conditions and Fed raises runs counter to Accomodative and money in abundance as policy. Current Primary credit at 1.50 hardly allows consumers to purchase houses and autos nor can Loan growth be expected to rise.
Ask how many times the implied probability calculators used by many failed over X amount of meetings. I see the Fed's desire to raise by placing Fed Funds above the Natural Rate but Fed Funds is not ready to rise and actually has a long way to go before a raise should be considered.
If inflation remains at a more moderate pace than some are currently projecting–perhaps reflecting continued seller competition, dollar appreciation, and/or more modest energy price increases–then the FOMC will not need to be as aggressive in raising the funds rate. Moreover, estimates of the neutral fed funds rate indicate that the rate remains below its historical average of prior cycles. The recent policy proposals aimed at increasing the repatriation of capital held abroad, which would boost the cash position of domestic firms as a source of funds and thus reduce business loan demand, may also support the case for lower interest rates going forward than otherwise might be the case.
10-Year Treasurys could rise to near 3.0% before reversing down on falling inflation and slowing economic trends again. Once they’ve started to fall, they could go as low as 1.0%, or lower, and then stay near there for years, creating the fixed income opportunity of the decade for buying 30-year Treasurys and 20-year AAA corporate bonds.
Sentiment in Emerging Markets
Emerging markets reflect foreign currency exposure, which could explain correlations between EMs and Dollar Index. It's also important to know that many EM countries depend on commodity exports. For example, a side effect of a rising dollar and thereby weakening commodity prices, is that EM currencies such as the Brazilian Real and Russian Rubble suffer. That's important because weaker EM currencies have a negative impact on EM stocks making these look less attractive for global investors.
Also rising Treasury yields (often associated with a stronger dollar) also reduce the appeal of higher yielding (and riskier) EM assets.
Inversely, they do better when yields are dropping along with the dollar. Look above to the sentiment in the US dollar as it is is part of the reason for money flows into and out emerging assets.
When considering a particular asset class or financial market, instead of versus analyzing the subject in isolation, intermarket analysis includes all related asset classes. It is important to remember that these relationships are dynamic which makes trading applications even more difficult. This page's contents try to go beyond traditional historical intermarket relationships, and to be representative of the current relationships.
Bearish FOR EMERGING MARKETS
On US tax reform, we think it could be a mixed bag for emerging markets. While they generally thrive on higher US and global growth given their export dependence, the impact of the tax reform should be fairly limited. However, if the tax reform should push US interest rates materially higher (which is not our base case), it would be likely to ignite capital outflows from emerging markets and put pressure on countries with large current account deficits or USD debt, such as Turkey. However, overall we still see general good prospects for emerging markets in 2018, although there are clearly some risks to watch out for.
The high indebtedness increases the risk of a financial turmoil or significantly slower growth in the future at least. And slower growth may spur a debt crisis as troubles set in when people borrow money expecting an average 7 percent annual growth but get only half of that. Such a scenario could spur some safe-haven demand for gold, but the currency channel should be negative for the yellow metal. Unless there is a serious contagion effect, investors would probably pull into the U.S. dollar. At least, this is what they used to do during financial crises (especially in emerging markets), as the greenback has been viewed as the safe-haven currency for nearly a century.
The Turkish Lira was under intense selling pressure during early trading on Monday following an escalation of diplomatic tensions between Turkey and the United States. A mutual suspension for visa services for non-immigrants remains the key culprit behind the Lira’s startling 6.6% depreciation against the Dollar. Although the Lira has clawed back recent losses since the sharp depreciation, increased political tensions may continue to impact the Turkish currency this week.
In July 2017, the African National Congress, South Africa’s ruling party, proposed that the South African Reserve Bank (SARB) be nationalised. As soon as the news hit, the Rand predictably fell, by around 1.5%, to R13.45 against the USD. While Finance Minister Malusi Gigaba keeps saying all the right things aimed at protecting the independence of the Reserve Bank, a sinister undertone may be implied. Nationalisation will, by its very nature, give the government more influence over policies.
What risks are facing EMs at the moment? The Fed's reduction of the balance sheet, higher rates and the stronger USD would clearly cool down EM.
The rand may be the so-called "canary in a coal mine" for EM and needs to be watched closely. The rand has been the second worst performer (-3% vs. USD) in H2 after being amongst the top performers (+5% vs. USD) in H1. We focus on ZAR because we think it has been one of the biggest beneficiaries of the quest for yield by investors. ZAR has always been one of our least favorite EM currencies. South Africa comes with terrible fundamentals, as well as heightened political risk and downgrade risk. Though the high yields have attracted hot money flows, the SARB is now cutting rates. This will ultimately weigh on the rand’s attractiveness.
The most interesting and lasting conflict was the G20 meeting in Seoul at which the Brazilian finance minister accused the US of a currency war by embracing policies that drove too much yield-seeking capital into emerging markets, stressing their currencies and forming the conditions for a crash.
Regarding the state of the Russian economy, Elvira Nabiullina, head of Russia’s Central Bank, said the economy has been resilient regarding international sanctions. As a result she hinted that interest rates may go even lower. The key rate is standing at 9%
Henrik Gullberg, Research Analyst at Nomura: “Russia’s recent revised budget for 2017 came with a very small upward revision to the oil output number and a higher oil price assumption for the year, with the oil price in RUB terms revised up by more than 8% to RUBOIL2,928 from RUBOIL2,700 previously. The small upward revision in oil output, coupled with the upward revision in RUBOIL, means the budget is reliant on higher RUB oil revenues. This in turn means Russia needs the OPEC production cuts to be adhered to; if not, RUB needs to weaken to protect the fiscal position. This suggests correlation with crude will become increasingly asymmetrical, rising when crude is trading around $50 or below, while moderating at higher levels.” At current levels RUBOIL is hovering just below the 2,928 budget minimum, suggesting that unless the oil price rises, RUB needs to weaken, with the fiscal 8.00-58.25. Also, over the past six months RUBOIL has averaged around 12% above the 2,700 minimum for the old budget. Simply as a comparison, assuming a similar cushion under the new budget would imply a RUBOIL rate around 3,270 and an equilibrium USD/RUB exchange rate around 64-65.”
Hot money inflows intensified as higher Czech inflation brings CNB‘s exit closer. The Czech central bank has to intervene heavily to defend the EUR/CZK 27.0 floor, while liquidity in the Czech banking system (sitting in the CNB accounts) has spiked in 2017.
The 6-month EUR/CZK forward is pricing in a 256 point drop, one of the largest declines since the financial crisis. This suggests that the market believes that there is a very real possibility that the Czech authorities will disband with the peg in the first half of this year.
... we expect China to continue tightening capital controls gradually because if the PBoC continues to dissipate its FX reserves, this may enhance downside pressure on the yuan.
Longer-term outlooks will not change due to the short squeeze [in the Yuan]. More powerful fundamental drivers include the broader trajectory of the dollar and interest rate differentials. Still, capital controls and the willingness of officials to facilitate such a powerful squeeze demonstrates their resolve and ability to manage the challenges.
a change in the calculating factors for the Yuan. As we reported last week the calculation continues to move away from the expensive US Dollar and will now be measured against an increased basket of currencies. This move has the potential to make Chinese exports cheaper and imports more expensive. However, the obvious impact will weaken the currency core and therefore be supportive for the Shanghai index which will be helpful as money leaves the country seeking a safe-haven
Of course, supporting the rotating carousel of real estate, commodity, and stock bubbles, while also trying to stem bond defaults, comes at a cost. All of that debt and money creation usually results in a decimated currency. However, China uses its currency reserves (held mostly in dollar denominated Treasuries) to keep the value of the yuan from falling too quickly. But what had once been China’s get out of financial crisis free card--their immense foreign exchange reserves--is dwindling at an alarming rate.
... the Chinese authorities have not made much of an attempt to halt the post-election decline in the YUAN, as if to say to Trump that his ascendancy has triggered a natural reaction in the currency markets, a far different situation than orchestrated currency management.
My view is that China’s US bond dump is about demand for US Dollars, which highlights growing concerns about financial stability in the mainland, amidst inflating asset bubbles and burdening bad loan provision.
...onshore to offshore flows do not appear be causing severe liquidity problems for Chinese capital markets or wider global risk aversion, but they do point to underlying weakness in Chinese economic confidence and may be contributing to strength in the USD against other currencies.
Bullish FOR EMERGING MARKETS
Czech National Bank increased the policy rates twice in 2017 in August and in November with another rate increases likely in 2018. This should support CZK against EUR in a move towards 25.000 EUR/CZK.
With global expansion set to continue in coming years, the cyclical environment is likely to remain supportive for risk markets. This year has generally been a very good year for FX carry trades and implied FX volatility has declined significantly. From a risk/reward perspective, FX carry trades still look attractive, with high yielding currencies, such as RUB, TRY and ZAR, offering very attractive risk-adjusted carry and the currencies are not significantly overvalued from a fundamental point of view (see chart). Moreover, we expect growth momentum to pick up in some of the major emerging economies with, for example, Brazil, South Africa and Russia continuing to show a modest economic recovery after years of subpar economic growth.
Turkey's central bank (CBRT) took steps to support price and financial stability, after TRY's ($3.8561 -0.53%) recent slump. In a statement on its website, the CBRT, said it has tweaked its reserve option mechanism, lowering the upper limit for the FX maintenance facility to +55% from +60% – their aim is to draw liquidity from the market and support the currency.
Turkish Central Bank’s move to boost foreign-exchange liquidity and support the lira by reducing the amount of foreign currencies banks can park as reserves helped ease the pressure. Turkish lira was among the worst performing emerging market currencies last week. With this decision more than 5 billion liras are estimated to be withdrawn from the market.
According to Fed study, emerging markets are more vulnerable to shifts in US policy. As uncertainty over the next Fed chief was quelled last week with the announcement of Powell as next Fed Chairman, emerging market currencies came under increased pressure towards the end of the week.
Rob Carnell, Chief Economist at ING: "Zhou’s comments that FX reforms and reduced capital curbs would happen when the time was right, and just ahead of the 19th Congress, have been taken by some as a sign that China could widen its current 2% CNY trading range soon after the end of the Congress. Although the current trading band is not much of a binding constraint on the CNY, the Governor’s remarks indicate policy confidence in the currency, and the success of the recent strategy to reduce currency outflows.”
the Chinese reserves for September showed that they increased to $3.1 Trillion VS $3.092 in August... I do believe that most of that increase came vis-à-vis an increase in the value of the currencies that China hold as reserves... But it's still important to think about how all the Chicken Littles were pointing to the Chinese reserves as a sign of China's collapse... And once again, they were wrong...
[...] this does not mean that EM investors are dismissing the Fed’s intensions to tighten policy, but rather that at this stage its doesn’t see coordinated central bank action triggering a spike in volatility.
...the race to the bottom in the G10 FX space has triggered a wave of money into emerging market FX, which is why the Mexican peso, Czech Koruna, Serbian dinar and Mozambique New Metical are the top five best performing currencies vs. the USD so far in 2017.
Anyone that that traded ZAR for an extended period of time should be numb to political and social instability. While the headlines of No Confidence vote against Zuma might have made splash news, we suspect most traders will thinking around the event risk. In our view the current political instability is a binary event both ending with higher ZAR. Should Zuma get impeached, a new and potentially better president will be elected, ZAR positive. If Zuma stay in power, then its business as usual and low volatility and higher interest rates environment will drive speculators back into ZAR.
Measures of US investor bullishness are running close to their highest levels in more than two years. Emerging market equities and US small cap stocks seem to be particular in vogue at the moment. Investors seem to be expecting stronger global growth and inflation this year and rising interest rates. I would agree with the economic diagnosis.
Taper Tantrum, these yield curve dynamics remain negative for EM bonds and EM FX. EM equities are a different matter, supported in part by the continued post-election rally in DM equity markets. Higher commodity should also help insulate some EM countries from the selling pressure.
Once the Yuan stabilises against the U.S. currency, there is an argument for a measured investment, banking on the longer-term strength of the Chinese currency. [...] Will we see a true level of support for the currency, or will the Chinese Central Bank step in to prop up its currency [...]?[...] Should the Chinese step in to support the currency before markets feel its price has been fully corrected, a mid-term rally is unlikely to be in the offing. Market sentiment may, however, be influenced by this and the PBOC may find that its intervention point mirrors expected base-levels of support.
Sentiment concerning Volatility
Bearish FOR VOLATILITY
A more convincing argument I hear as to why low volatility is structural may be that information nowadays gets absorbed more quickly. On the one hand, we have computers scan the news in milliseconds, often trading without human intervention. And we have more computing power, allowing for a more efficient implementation of any investment process. Market makers in exchange traded funds also help in the execution efficiency of markets, possibly exerting downward pressure on volatility. However, let's not forget that volatility lowered in this fashion may have the same implication as low volatility in the building up of any bubble: it is the perceived risk that is lower, not actual risk. It is said forec
The current EU/US differential runs 53 basis points. This figure is light from a trading / volatility perspective yet its not terrible. If Yellen raises again and the ECB refrains then the differential climbs to 65 and volatility will be good, not great as the old days but good enough. A Yellen raise however might force the ECB higher in which case the differential remains the same as today at 53. An ECB raise and Yellen on hold means the differential closes to 41 and volatility literally disintegrates. The old days of EU/US differentials was right at 75 to offer a perspective of 53.
...what is an exchange rate, what is DXY and EUR/USD. Both are interest rates transformed to an exchange rate. Exchange rate and interest rate are synonomous terms. Fed Funds rates are contained therefore DXY is restricted from movements. Fed Funds is not only the supreme USD interest and overnight rate but regulate Fed Funds is to stifle all USD interest rate movements. To understand this concept is to conquer perfect market knowledge, become a currency trader rather than a person who trades currencies and realization the amount of pablum written is astounding.
Bullish FOR VOLATILITY
The S&P 500 suffers a flash crash of 25% (peak-to-trough) in a spectacular, one-off move reminiscent of 1987. A whole swathe of short volatility funds are completely wiped out and a formerly unknown long volatility trader realises a 1000% gain and instantly becomes a legend.
Hence, while risk assets are likely to perform going into 2018, we could see downside risks increasing, as positioning and risk premiums become even more stretched. Implied FX volatility is very low and volatility curves are generally flat as the FX option market prices a continuation of the low volatility environment. In the G10 space, our FX volatility valuation monitor indicates that buying volatility at longer-dated tenors in USD crosses in general looks attractive from a risk/reward perspective. Thus, we see value in building in a long vega exposure in FX positions with a +6M expiry given the generally low risk premia priced in FX options.
Axel Merk: "And the reason I say that is that when something is not sustainable, odds are it will stop. In my view, it is not sustainable that volatility will continue to be that low. In my experience, and I've been doing this for a few decades now, the best bubble indicator there is, is low volatility which is an expression of the complacency. Be that in the tech bubble. Be that in the housing bubble, or be that in the current environment."
There will be unprecedented volatility between inflation and deflation cycles in the future due to these factors. This represents a huge opportunity for those that can identify these inflexions points and know where to invest.
Only a handful of industry traders are talking about this: the danger that lurks inside the ETF products. [In this example] It started with the Russel futures and reverberated into the IWM, but what I want to explain by looking at this is how fragile markets happen to be and the instability that exists in today's ETF markets. What have ETFs to do? They have to buy and sell all the constituents of the ETF, and if someone comes and starts to selll, let's say the IWM like there is no tomorrow, the IWM managers have to go out there and sell the Russel's shares.
Market sentiment is defined as the net amount of any group of market player's optimism or pessimism reflected in any asset or market price at a particular time, a kind of collective emotion. The goal of understanding sentiment is to discern when a trend has reached an extreme point and is prone to reverse its direction.
Among sentiment indicators there is the VIX, the CoT Report, Put-Call Ratios, the Ted Spread, Mutual Funds statistics, Margin Balances and Investor Polls- such as FXStreet's weekly FX Forecast Poll.
The Forex Forecast Poll
The Forex Forecast is a currency sentiment tool that highlights our selected experts' near and medium term mood and calculates trends according to Friday's 15:00 GMT price. The #FXpoll is not to be taken as signal or as final target, but as an exchange rates heat map of where sentiment and expectations are going.
The CoT Report
The COT provides up-to-date information about the trend and the strength of the commitment traders have towards that trend by detailing the positioning of speculative and commercial traders in the various futures markets. The Commodity Futures Trading Commission (CFTC) releases a new COT report each Friday.