Month: May 2018

One week ago we warned that a major USD short squeeze is taking place, and that it has the potential to get much worse for dollar bears. Today, Nomura’s X-asset guru Charlie Mcelligott explains that, in his view, the reason why the dollar has so dramatically reversed direction in the past two weeks, in the process recoupling with rate differentials, is because the “fake narrative” of “synchronized global growth” is finally over, and with it, the “hawkish central bank pivot” thesis is breaking-down as well

More, as excerpted in his latest note below:

DOLLAR BREAKS-OUT, AS RECOUPLING WITH RATE DIFFS BLEEDING LEGACY MACRO POSITIONING

• Heard this one before?  DXY through 200DMA overnight is escalating the “performance bleed” from consensual macro positioning with implicit “short USD” components
• With the “synchronized global growth” narrative now being capitulated against, the Dollar has recoupled with rates differentials, as US is again viewed as the world’s leading growth-story
• In conjunction with R.O.W.’s “slower growth” trend, we have seen the “hawkish central bank pivot” thesis break-down as well—BoC, BoE, BoJ are collectively “regressing” with increasingly “dovish” rhetoric, while PBoC takes outright “easing”- / stimulus- actions
• Nomura Quant Strategies CTA model showing the “Dollar reversal” phenomenon in “real-time,” as WoW we see “short USD” positioning expressions beginning to reverse / pivot in not just FX but Equities and Commodities as well
• EM equities longs then in a dangerous position, as TFF data shows the Asset Manager “net long” position @ +2.5 z-scores, while Leveraged funds too remain high @ +0.8 z-scores
• Despite Dollar’s move, “long Crude” trade continues to hold via geopol w/ Iran decertification looking certain…yet is largely “priced-in” as a “known unknown”
• Crude holding higher is critical for the larger “bearish rates” / “re-inflation” themes
• On top of Crude “fatiguing” here, fixed-income “bears” seeing additional near-term / tactical “reversal” risks as well:
  • US Treasury’s quarterly refunding statement out last night showed a monster reduction in financing needs to “just” $75B from the original Jan est of $176B (!) as cash balances came in much higher than expected post taxes
  • The return of overseas demand for USTs, not just from ‘unhedged’ buyers (Japanese lifers recent investment plan releases) but also the future potential to see ‘hedged’ buyers return IF USD were to further rally going-forward (not just yet though), as the ‘punitive’ cost of xccy decreases, allowing attractive relative yields to dictate purchases
• Reiterating best “USD upside break-out” hedges: EEM / MESA PS, Nikkei CS (note: the EURUSD PS has already ‘realized’)
• Despite lower SPX yesterday, many were surprised by the outperformance of “1Y Momentum” factor (+0.7%) and broad HF L/S (-0.1%) vs SPX -0.8% / NDX -0.8% / RTY -0.9% / RIY -0.8%
• Not just the +++ forward seasonality I’ve been noting recently for “Momentum”- and “Buyback”- LONGS coming down the pipe in the months ahead—because yesterday was driven by the underperformance of “Momentum Shorts”
• “Momentum” SHORTS were pressed hard yesterday and contributed a massive +1.2% from a market-neutral perspective (vs “1Y Momentum Longs” -0.5%)
• As a reminder, the month of May can continue to “chop,” but the massive (negative) seasonal for “Momentum Shorts” that begins in earnest starting in June and running through September sees an average -3.7% drawdown (“positive” contribution from short book) since 1984 / -4.9% average return since ’00 / -3.8% median return since ‘00

DOLLAR RALLY HAVING MAJOR CROSS-ASSET IMPACTS:

New day, same story: the USD break-out is further accelerating, with the DXY taking-out its 200DMA to the upside overnight, stronger against all G10 and the entire EM universe tracked by Bloomberg.  

Feel free to punch me, but I’ll say it again—consensual macro longs accumulated over the past year + period under the “weak USD” regime (as DXY traded -14.2% between Dec ’16 and Feb ’18 despite ongoing Fed hikes) in the form of “longs” in Euro, Yen, EM Eq / EMFX, Nasdaq, Crude, Gold, Industrial Metals are all at various and diverse stages of “adjusting” to this new Dollar dynamic. 

The issue is the same I’ve noted in prior weeks–the “synchronized global growth” narrative is now being capitulated against, and as such, the Dollar has recoupled with rates differentials because the US is again viewed as the world’s leading growth-story.  The flipside of this of course is the “slowing growth” trend in rest-of-world too has driven the resumption of the widening in rates differentials.  

EU/US REAL YIELDS DIFFERENTIALS AND EUR:

With the obviously slowing R.O.W. growth trend, the “hawkish central bank pivot” thesis is breaking-down as well: the BoC, BoE, BoJ are collectively “regressing” with increasingly “dovish” rhetoric, while the PBoC has recently taken outright “easing”- (RRR cuts) / stimulus- (tax cuts) action.

We continue to see this USD-positioning reversal develop “real-time” in the Nomura Quant Strategies CTA model, where the move higher in Dollar is having meaningful WoW impacts across macro-trend positions:

Gold from “max long” through “neutral” and now -10% “short” WoW

• EURUSD “max long” cut to +71%
• USDJPY “max short” cut to -71%
• USDSEK pivots to “max long” from -12% “short” last week
• USDCHF to “max long” from “neutral” last week
• Nikkei and Hang Seng “longs” jump from +33% to +62%
• Eurostoxx “max short” now being covered
• FTSE and CAC now both to “max long” from just +33% prior
• Copper now just +27% “long” from +43% last week
• Zinc now -10% “short” from +43% “long”

CRUDE/RATES

Despite the U.S. Dollar’s move, the “long Crude” trade continues to hold via geopolitics, w/ Iran decertification now looking utterly-certain after yesterday’s public dismemberment of Iran.  Yet, “decertification” of the Iran deal has already largely been “priced-in” as a “known unknown” over the past month +, with the Pompeo and Bolton additions to POTUS’ admin as well as the seemingly choreographed Trump tweet on OPEC and oil prices, which looked like a calculated effort to push the potential gas cost jump “blame” in front of Summer driving season elsewhere.  So is this ‘catalyst’ for Crude now tiring?

Today we are indeed seeing an almost “sell the news” in Crude on yesterday’s BiBi / Iran press conference, while the Dollar rally finally begins to hit as well.  A move lower in Crude is a very troubling dynamic for consensual macro positioning—both with regard to “bearish rates” and “re-inflation” themes.  To see the Dollar’s rally begin to crunch Crude is a problem if it were to gain ground.

Fixed-income bears are also seeing additional near-term tactical “reversal risks” as well after the recent run of weakness.  The US Treasury’s quarterly refunding statement out last night showed a massive reduction in Q2 financing needs to “just” $75B, which is down from the initial January Q2 estimate of $176B.  This estimate declined preciptiously as cash balances came in much higher than expected post taxes…and will again increase meaningfully in Q3…but some of that “deficit spending issuance” catalyst for the bears just lost its shine.

Another dynamic to keep an eye on going-forward will be the potential for a further USD squeeze to impact “hedged” buyers of USTs and possibly incentivize them to return to the mkt.  Recently with the release of Japanese Lifeco annual investment plans, we’ve seen numerous mentions that “unhedged” buyers are looking to increase their purchases of foreign bonds—obviously a (potentially) good sign for UST demand.

However, those investors who need to currency hedge their UST purchases have largely been absent from the UST market recently because of the punitive cost of said FX hedges (xccy) as the Dollar has been mired in its year + tailspin.  So despite the seeming optics of the rates differentials, the actual ‘take-home’ yield looks unattractive when adding back in the cost of the xccy, making EGBs and even JGB’s more attractive for respective foreign investors. 

Although currently we see USTs remaining still “unattractive” for these FX hedged investors, a sustained and further USD rally could stand to reverse this dynamic going-forward and in turn, create a new incremental buyer of USTs who has been absent from the market.  This is “one to watch.”

EQUITIES

Despite lower SPX yesterday, many were surprised by the outperformance of “1Y Momentum” factor (+0.7%) and thus, broad HF L/S (-0.1%), vs SPX -0.8% / NDX -0.8% / RTY -0.9% / RIY -0.8%.  This dynamic made the recent mentions of the +++ seasonality for “Momentum” (with the same for “Buybacks” as further ‘overlapping’ catalyst) look prescient.

But it’s not just the +++ forward seasonality I’ve been noting recently for “Momentum”- and “Buyback”- LONGS coming down the pipe in the months ahead—because yesterday was driven by the underperformance of “Momentum Shorts.” “Momentum” SHORTS were pressed hard yesterday and contributed a massive +1.2% from a market-neutral perspective (vs “1Y Momentum Longs” -0.5%).

As a reminder, the month of May can continue to “chop” for overall “Momentum” factor, but the massive (negative) seasonal for “Momentum Shorts” that begins in earnest starting in June and running through September sees an average -3.7% drawdown (“positive” contribution from short book) since 1984 / -4.9% average return since ’00 / -3.8% median return since ’00:

So the next logical question becomes “what currently screen as “1Y Momentum Shorts”?  Ask and ye shall receive…

Clearly, the “Energy” side of this “Momentum Short” seasonality trade (as well as the aforementioned Crude / re-inflation dynamic) stands in contrast to my larger “cyclical melt-up” thesis.  This is a real ‘short-term’ concern—HOWEVER, I do believe that ongoing trajectory of CPI / PPI / Prices Paid / Prices Received impact is having on future inflation expectations will continue in the medium-term and ‘win out’ vs this tactical seasonality ‘risk’ to the ongoing rally in inflation sensitive assets / plays / proxies.

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Mere minutes after we published a post speculating that President Trump’s latest denunciation of the Mueller probe could be part of a ploy to push him to spurn Mueller’s request for an interview, a CNN analyst named Michael Zeldin – who once worked as Mueller’s assistant – put forth a strikingly similar theory.

Zeldin pointed to the rash of typos in the document that was reportedly leaked to the New York Times as evidence that, instead of coming from the Mueller campaign like the Times insinuated, the leak might’ve come from inside Trump’s legal team. Zeldin said the questions were likely culled from notes being taken by the Trump team during the course of a discussion with Mueller and his team.

The reason? By leaking the questions, Trump’s team is trying to gently convince the president that he shouldn’t agree to an interview with Mueller – something he’s reportedly been feeling more apprehensive about

“I think these are notes taken by the recipients of a conversation with Mueller’s office where he outlined broad topics and these guys wrote down questions that they thought these topics may raise,” Zeldin said on CNN’s “New Day.”

“Because of the way these questions are written…lawyers wouldn’t write questions this way, in my estimation. Some of the grammar is not even proper,” he continued. “So, I don’t see this as a list of written questions that Mueller’s office gave to the president. I think these are more notes that the White House has taken and then they have expanded upon the conversation to write out these as questions.”

Zeldin worked as special counsel to Mueller in the 1990s when Mueller was the assistant attorney general of the Justice Department’s Criminal Division.

Here are the questions Mueller wants to ask Trump: https://t.co/SlQ3LloALL pic.twitter.com/rLMYTmRJZ7

— Amy Fiscus (@amyfiscus) May 1, 2018

Trump immediately seized on the questions as the latest evidence that Mueller is no longer actively pursuing collusion-related charges, which Trump said vindicates his claim that Trump is in the middle of a witch hunt. Trump slammed the leak as “disgraceful” and added that collusion “is a made up, phony crime.”

So what do you think? Did Mueller’s camp leak the questions to pressure Trump to hurry up and agree to an interview? Or did Trump’s team leak them to pressure their client to definitively turn the meeting down?

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South Korean President Moon Jae-in, who suggested on Monday that Donald Trump deserves the Nobel Peace Prize…

…has convinced North Korean leader Kim Jong Un to hold his historic meeting with US President Donald Trump at the demilitarized zone (DMZ) separating the two Koreas – a region Bill Clinton called the “scariest place on earth” in 1993, CNN reports.

Moon and Kim met last Friday at the same location in Panmunjom, as the historically significant event led to an agreement to denuclearize the Korean Peninsula and formally end the Korean War.

There is a “strong possibility” the summit will be held at the site, with some events possibly scheduled on the northern side of the military demarcation line separating the two countries, according to an official with deep knowledge of North Korea’s thinking on the matter. –CNN

The summit, thought to be held in “in late may,” will also mark a historically significant moment in US history – as the agreement between the two Koreas marks the first sitting US President to meet with a North Korean Leader, ending decades of failed US foreign policy as the multi-generational regime pursued its nuclear ambitions.

The idea to meet at the DMZ was on Trump’s mind all weekend – as he raised the possibility in a Sunday phone call with Moon, a senior US official and another person familiar with the conversation told CNN. 

“There’s something I like about it, because you’re there, if things work out, there’s a great celebration to be had on the site, not in a third party country,” said President Trump to reporters on Monday.

.@POTUS on the possibility of holding the North Korea summit at the DMZ: “There is something that I like about it because you’re there. You’re actually there. Where if things work out, there’s a great celebration to be had.” pic.twitter.com/XMZ44kheXa

— FOX Business (@FoxBusiness) April 30, 2018

On Friday Kim Jong Un and Moon Jae-in agreed to finally end a seven-decade war, signing a declaration to pursue the “complete denuclearization” of the Korean Peninsula, although they did not announce any concrete steps to dismantle the North’s nuclear programs..

The two leaders embraced after signing the deal during a historic meeting on their shared border, the first time a North Korean leader has set foot on the southern side. They announced plans to formally declare a resolution to the war and replace 1953 armistice that ended open hostilities into a peace treaty by year’s end.

“We solemnly declare to our 80m Koreans and the world that there will no more war on the Korean peninsula and a new era of peace has begun,” North Korean leader Kim Jong Un and South Korean president Moon Jae-in said in a joint statement. “It is our urgent historic assignment to put an end to this current abnormal state of ceasefire and establish a peace regime.”

#BREAKING: North Korean leader Kim Jong-un makes history with a brief walk into South Korea for an ice-breaking #KoreaSummit pic.twitter.com/hsa4IM7O2v

— Jeffs (@jeffs_araujo35) April 27, 2018

“We have agreed to share a firm determination to open a new era in which all Korean people enjoy prosperity and happiness on a peaceful land without wars,” Kim said, in his first remarks in front of the global press since taking power in 2011.

No Wall, No War, No hate
Today, We are all KOREANS #interkoreansummit #남북정상회담 #KoreaSummit pic.twitter.com/iziTIIEGmW

— JaeKwon Son 손재권 (@gjack) April 27, 2018

The two sides “confirmed the common goal of realizing, through complete denuclearization, a nuclear-free Korean Peninsula.”

Trump loved the images from the inter-Korean summit and the fact the entire meeting was televised, those sources said. –CNN

CNN reports that some in the Trump administration have concerns, however, that a meeting at the DMZ would appear conciliatory towards Kim, and are arguing towards Singapore as an alternate location for the summit. 

The wealthy and glamorous city-state sits on the end of the Malay Peninsula and has often been seen as a gateway between Asia and the West.

A close ally to the United States during the Cold War and currently host to a US military presence, Singapore also has a diplomatic relationship with North Korea. It is one of only 47 countries to feature a North Korean embassy. –CNN

That said, Kim Jong Un is said to be reluctant to travel long distances by plane, due in part to security concerns, so Singapore may be off the table. 

A third location the leaders could meet is the previously suggested is the Mongolian capital of Ulaanbaatar – leveraging diplomatic ties between both Pyongyang and Washington and serving as neutral ground for the summit. It would also allow Kim to travel to the meeting using his father’s armored train. 

“Mongolia is very eager to host this summit, they have come out and said they will host it … They want to be the Switzerland of Asia, they want to be seen as a partner that can have good ties with everybody,” said Jenna Gibson, director of communications at the Korea Economic Institute.

On Monday, South Korean leader Moon Jae-in said U.S. President Donald Trump deserves a Nobel Peace Prize for his efforts to end the standoff with North Korea over its nuclear weapons program, a South Korean official said on Monday.

Just a few short hours after the historic first crossing south of the border by Kim to meet Moon pledging to end hostilities between the two countries and work towards the “complete denuclearization” of the Korean peninsula, Reuters reports that Moon told a meeting of senior secretaries, according to a presidential Blue House official who briefed media:

“President Trump should win the Nobel Peace Prize. What we need is only peace.”

This follows Moon’s comments in January that Trump “deserves big credit for bringing about the inter-Korean talks. It could be a resulting work of the U.S.-led sanctions and pressure.”

Perhaps the most important question of all; will Dennis Rodman be at the signing?

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Via Global Macro Monitor,

Watch Brazilian surfer Rodrigo Koxa ride an 80-foot wave in Portugal last November. Koxa was recently recognized for the feat at the Big Wave Awards in Santa Monica, California.

Please view the video above and respond by choosing the best answer which most closely represents your perception of the ink blots big wave surfer video.  Free association is welcome.

We will run the algorithm to analyze your personality.

Q:   What do you see in the big wave surfing video?

1. Investors riding the coming breakout rally in the S&P500

2. Traders long stocks about to be rushed by a vicious bear market

3. “Blue Wave” November election where Democrats take the House and Senate

4. President Trump surfing opinion polls to a 50 plus percent approval rating

5. Bernie Sanders about to get crushed politically

6. The inflation wave about to break on the U.S. economy

7. The deflation wave about to break on the U.S. economy

8. Google recording your internet surfing

9. FX traders riding the coming dollar rally

10. Gold traders riding the coming rally

11. Bitcoin traders about to get candy crushed

12. The Clintons finally going down in the Whitewater

13. Bitcoin traders riding the price up to $1 million

14. Bond investors about to be destroyed by a U.S. debt crisis

15. A Brazilian surfer killing it

16. Other

17. All of the above (WTF?)

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The Dow is down over 250 points (at the lows of the day) back at one-week lows, Nasdaq is surging (at the highs of the day) as the dollar index just keeps on running higher, breaking key technical resistance on the way amid a low liquidity trading day.

With Europe on May Day holiday, the dollar is untethered…

And Treasury yields are spiking along with the dollar…

And as the dollar spikes, Dow is tumbling…

But Nasdaq is surging…

Meanwhile, Gold is getting monkeyhammered back towards $1300 – the lowest level of the year…

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Confirming that what Jeff Gundlach predicted last December, when the DoubleLine CEO said his favorite trade for 2018 is to be long commodities, has been spot on…

.. this morning Goldman’s head commodity strategist Jeff Currie writes that commodities are the best performing asset class of 2018, and echoes the bank’s recent enthusiasm on the asset class, saying “the strategic case for owning commodities has rarely been stronger.” The reasons for Currie’s enthusiasm, as we discussed previously, are straightforward:

Robust late-cycle growth is depleting global supply chains, creating increasing positive carry. As inflationary concerns push interest rates higher, cross-asset correlations with commodities decline, and the diversification benefits rise with higher rates. Rising geopolitical and trade policy risks only add to the inflationary mix in commodities.

And yet, perhaps in light of the recent sharp move higher in oil prices, Goldman admits that investors remain skeptical of commodity investments “even though Brent carry pays 15% pa and the supermajors are paying dividends north of 4%.” As Goldman lays out, concerns stem from:

• a decade of underperformance with E&Ps destroying 23 cents on a dollar invested,
• fear of buying the top of an ‘artificial’ rally from supply cuts, and
• the lack of a structural catalyst like China in the 2000s.

To boost investor morale, Currie lays out three bullish catalysts, first noting that the weak returns of the past decade are (likely) behind us:

1. The weak returns of the past decade are behind us. The global economy was operating below capacity in the ‘recession/recovery’ phase for over a decade and any early-cycle playbook warns of the poor returns in commodities when the global economy has slack in the system. Today it is operating near or above capacity.

2. The structural story is a lack of long-cycle investment. Short-cycle investments in sectors such as technology and even shale oil and gas have attracted capital over the past decade at the expense of long-cycle investments in oil and commodities. Going forward, short-cycle projects are not sufficient to balance demand and commodity prices need to incent long-cycle investment.

3. Prices are high because inventories are depleted. While supply cuts pulled forward market tightness, inventories are now low and demand levels significantly exceed supply levels.

This in turn leads to the most compelling observation by Goldman, namely that there is no precedent of supply from OPEC or any other producer overtaking demand this late in the business cycle to replenish inventories before a recession occurs.

In other words, the current dynamic may continue until such time as the negative feedback loops from surging oil prices send the world into a freefalling “cost-push” recession, a repeat of what happened in the summer of 2008, when $150 oil was one of the catalyst to unleash the financial crisis.

* * *

And while a recession will clearly end the party, Goldman admits other risks are also present, chief among which is China, arguably the driving catalyst behind the 2015/2016 global recession. The recent Caterpillar warning only underscores these concerns. Here’s Goldman:

To be sure, this does not mean that commodities outperform in every quarter in this stage of the business cycle. For example, China metals demand was weak in Q1 owing to the late Lunar New Year and the uncertainties created by this year’s National People’s Congress in March. Inventories of steel, copper, and aluminum climbed sharply in the first quarter. Machinery sales were strong but mainly driven by replacement demand. Other indicators such as cement production and excavator hours point to weak construction activity. Through its strong trade linkages with other countries like Europe and Japan, it also contributed to the softness in global growth.

However, one important lesson we learned about China during the past year is that the overall growth target is still important to the government and policies are likely to remain flexible to counterbalance perceived risks domestically or from abroad. In fact, the PBOC recently announced an RRR cut to offset risks of trade tensions with the US. The politburo meeting in late April also signaled an easing bias while the country continues to pursue structural reforms. Higher frequency data have already shown demand picking up in China. Taken together, we think the Q1 weakness is temporary and continue to hold a constructive view on metals for the rest of 2018.

China aside, a bigger paradox in Goldman’s overall view is that, as Currie notes, the bank – like Gundlach – is pushing for a more aggressive ‘tilt’ just as growth is slowing, which “seems counterintuitive.”

Advocating for a more aggressive allocation just when economic growth is beginning to slow might sound somewhat counterintuitive. The reason for this is simple. Financial markets depend upon expectations and hence on expected growth rates in economic activity, which are showing signs of slowing.

In contrast to financial markets, however, commodities depend upon activity levels, not growth. So even if
growth slows, as long as demand levels are above supply levels – which creates market tightness – commodities can still generate positive returns. Some more details on this key thesis of a “scarcity premium”:

This observation is at the core of the late-cycle playbook for owning commodities and why commodities typically perform the best when other asset classes perform their worst, particularly in relation to inflation. When demand levels exceed the capacity to produce, i.e. a positive output gap, commodities inventories drawdown. The resulting inflationary pressure slows expected growth rates via higher interest rates, which hurts financial assets. In contrast, even if the growth rate of commodity demand slows, the high level of commodity demand continues to deplete supplies, which maintains the scarcity premium in commodity prices, i.e. spot prices trade a premium to forward prices.

The scarcity premium creates the positive carry in commodities as the investor buys forward at a discount. Think of oxygen: if it became scarce we would pay an enormous premium today for it as we don’t need it tomorrow if we don’t have it today. Financial markets cannot possess this characteristic which is why gold cannot go backwardated since it is not consumed like oxygen, energy or grains. But it is this scarcity premium that creates the late-cycle diversification benefits of commodities, particularly in relation to inflation.

In oil, the current scarcity premium is 14.7% pa, which means oil prices could drop by $10/bbl in and the investor still breaks even. It is important to point out that the scarcity premium is always larger the closer you are to physical spot prices, which means the investor would prefer to roll the front end of the curve 12 times as opposed to buying 12 months out. For example, the second month contract trades at a 1.1% discount to the spot versus the 12-month contract at a 9.2% discount, which means that rolling 1.1% 12 times creates a 14.7% return which is greater than a 9.2% return. This is the essence of scarcity.

The key to this scarcity premium in commodities is the high levels of demand usually associated with a late cycle economy. Underscoring that this commodity market is not artificially driven by supply cuts from China and OPEC/Russia is the increasing number of commodities developing a scarcity premium. Currently we calculate that 13 out of 24 commodities are in backwardation. As Exhibit 19 shows, as the business cycle deepens the number of commodity markets creating a scarcity premium has increased significantly as supply chains are depleted.

In conclusion, Goldman also reverts to another point it popularized last year, namely that while higher oil prices may sap consumer demand, they end up easing financial conditions, as “they lead to more global excess savings.”

And indeed, there is increasing evidence of an improving trend in the international dollar liquidity. BIS data shows that global banks’ cross-border claims and liabilities have been on the rise, indicating easier accessibility of dollar credit. Dollar credit to EM economies has rebounded particularly strongly in 2017. Higher frequency measures such as dollar liquidity of European banks, measured by their dollar claims on the US banks, has been on the rise as well. European banks are at the center of global trade finance/cross-border credit and their dollar claims on US located banks can be seen as liquid reserves which support their dollar balance sheets (Exhibit 22).

Meanwhile, as one would expect in a world of rising commodity prices, EM FX reserves have begun to build again as a result of higher commodity prices and improvement in net capital flows (see Exhibit 23).

As the events of late 2015 taught us, EM FX reserves are significant providers of dollar liquidity to the euro-dollar market, and European banks specifically, both by direct cash lending and indirect lending through the derivatives such as cross currency basis swaps as well as lending out of other dollar assets such as US treasuries. (just ignore the blow-out of the LIBOR OIS spread, which while showing some modest signs of normalizing is still a long way away from “normal.”)

Summarizing the above, the liquidity released due to rising commodity prices, sits at the center of the self-reinforcing loop between the 3Rs, a concept also popularized by Goldman one year ago, one in which higher commodity prices (reflation) and stronger demand growth in EM through credit expansion (releveraging), which reinforces global synchronous growth (reconvergence in growth): these are the 3R’s and they are central to Goldman’s bullish view by creating a positive feedback loop that supports higher commodity prices.

And while all of the above makes sense, even with the troubling implication that the surge in oil will only end with the next recession/depression, things would be much easier if the dollar wasn’t surging in parallel with oil, making any incremental gains for commodities that much more difficult, as the most important driver of easy financial conditions around the globe continues to tighten with every passing day in what may be an extremely painful short squeeze…

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