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No Open Bond Market, No Problem: Futures Rise On Another Yen-Carry Levitation To Start The Week

Bond markets may be closed today for Veterans’ Day, but equities and far more importantly, FX, are certainly open and thanks to yet another overnight ramp in the ES leading EURJPY, we have seen one more levitation session to start off the week, and an implied stock market open which will be another record high. There was little overnight developed market data to digest, with just Italian Industrial Production coming in line with expectations at 0.2%, while the bulk of the attention fell on China which over the weekend reported stronger Industrial Production and retail sales, while CPI was just below expectations and additionally China new loans of CNY 506 billion (below est. of CNY 580bn) even as M2 in line, should give the Chinese government the all clear to reform absolutely nothing. That all this goldilocks and goalseeked data is taking place just as the Third Plenum (just as theatrical and just as meaningless as any session of Congress, because everyone knows that China will not initiate reforms until it has to at which point it will be too late) picks up pace was not lost on anyone.

Breakdown of China M2 and CNY loans:

And China’s total social financing for October:

Today’s session will be quiet with nothing on the US docket which means much more low volume levitation especially with no bond selloff to keep equities in some sort of pseudo check, while this week’s key event will be Yellen’s confirmation hearing on Thursday before the Senate Banking Committee. She has not discussed monetary policy since April so there will be an immense amount of interest. As DB notes, it may be a politicised hearing and one where Yellen may have to be more balanced than her natural dovish tendencies to broaden her appeal to the members.

Market Recap

Stocks in Europe recovered following a lacklustre open and edged into positive territory, although telecommunications sector underperformed throughout the session, with BSkyB trading lower by almost 10% after BT Group announced that it will pay USD 1.4bln for exclusive live broadcast rights for the UEFA Champions League tournaments. Deutsche Telekom shares also fell sharply after analysts at Goldman Sachs downgrade co. to sell and also lowered price target by 14%. Overall, the price action was relatively muted across various asset classes today, with trade volumes declining, as market participants observed Armistice Day in Europe and Veteran’s Day in the US. Looking elsewhere, EUR gained ground across the board, as market participants used the heavy selling pressure observed last week as a buying opportunity. As a result, consequent pressure on the Greenback ensured that USD/JPY was able to recover losses made during the overnight session in Asia and in turn move into positive territory. Going forward, there are no major economic releases set for the second half of the session

Overnight news bulletin

Trade volumes fell as market participants observed Armistice Day in Europe and Veteran’s Day in the US.

ECB’s Coeure said ECB can trim interest rates further and provide the banking systems with liquidity.

Short-sterling strip steepened this morning as market participants positioned for the release of the Quarterly Inflation Report by the BoE this week.

Asian Headlines

Chinese CPI (Oct) Y/Y 3.2% vs. Exp. 3.3% (Prev. 3.1%)
– PPI (Oct) Y/Y -1.5% vs. Exp. -1.4% (Prev. -1.3%)
– Industrial Production YTD (Oct) Y/Y 9.7% vs. Exp. 9.6% (Prev. 9.6%)
– Industrial Production (Oct) Y/Y 10.3% vs. Exp. 10.0% (Prev. 10.2%)
– Retail Sales YTD (Oct) Y/Y 13.0% vs. Exp. 13.0% (Prev. 12.9%)
– Retail Sales (Oct) Y/Y 13.3% vs. Exp. 13.4% (Prev. 13.3%)

As China’s Third Plenum party meeting continues, comments remain few and far between before the end of the meeting on Tuesday, however a brief statement has been released, with the Communist Party stating China needs a new engine of growth and reduce its reliance on “crude investments”.

EU & UK Headlines

ECB split stokes German backlash fears. (FT-More) Sources said divisions between northern and southern representatives on the ECB board have been mounting since market pressures on the eurozone relaxed, with council members freed up to revert to national interests.

ECB’s Coeure said ECB can trim interest rates further and provide the banking systems with liquidity.

Short-sterling strip steepened this morning as market participants positioned for the release of the Quarterly Inflation Report by the BoE this week. The central bank is widely expected to upgrade its growth forecasts for the UK economy this week and pave the way for an earlier interest rate rise.

US Headlines

Fed’s Williams (non-voter, soft dove) said US monetary medicine is working and evidence is in jobs gains and jobless rate. Williams said that he sees unemployment declining in 2014 and 2015.

Equities

Stocks recovered from a lower open and edged into positive territory, though telecommunications sector underperformed from the get-go, where BSkyB shares in London fell almost 10% after BT Group announced that it will pay USD 1.4bln for exclusive live broadcast rights for the UEFA Champions League tournaments. In addition to that, Deutsche Telekom shares also fell sharply after analysts at Goldman Sachs downgrade co. to sell and also lowered price target by 14%.

SocGen’s macro recap morning briefing

We finally have lift off. Or have we? Friday’s US employment report blew away many uncertainties and vindicated the Fed for not issuing a more dovish statement at it last meeting. The impact of the government shutdown on the economy has been trivial and we can now look forward to hopefully undistorted period data to form a judgement on underlying momentum and implications for the Fed. Although we still see the probability of Fed tapering as quite remote in December, the likelihood of the Fed reducing asset purchases has inevitably gone up sooner rather than later and that alone now means we should see some decent trends across markets until early December.

The strong US jobs data (overshadowed again by a lower participation rate) obviously puts the USD in a pole position to strengthen and US 10y yields to rise and the curve to steepen. It also argues for the US/EU 10y spread to keep widening towards 100bp given the contrasting picture for employment in the euro area and a dovish ECB. The rise in 10y US yields above 2.70% challenges our downward revised year-end forecast but adds support to our bearish EUR/USD call. A retest of last week‘s 1.3293 low is a distinct possibility as long EUR positions are chopped, but bears may not pause for breath until we reach 1.3200.

The focus in G10 for this week will be on eurozone Q3 GDP data from Thursday onwards. In the UK, the BoE inflation report is due this Wednesday. Upward revisions to near-term inflation and growth forecasts are highly likely and might result in the bank bringing forward a decline in the unemployment rate to 7% from late 2016. That will challenge the timing of a first rate hike and should boost GBP vs CHF, EUR and JPY.

Emerging markets were hit badly last week and the toxic combination of higher US 10y yields and a warning on Brazil’s credit rating by S&P
lifted USD/BRL above 2.3340. Investors will brace for a return to the summer highs above 2.40 if US data keep coming in strong. The focus this week is on the possible outcome of the 3rd Plenum of China and the guidelines for economic policy. Though expectations over announcements are limited, a focus

DB’s Jim Reid rounds out the overnight recap

The growth momentum in China appears to have improved over the past few months and the weekend’s October Chinese data provided further indication of this. Industrial production rose 10.3% YoY which was ahead of expectations of 10.0% and was slightly firmer than last month’s 10.2%. DB’s Jun Ma believes this adds some upside risk to Q4 GDP growth. Retail sales growth also accelerated in October (13.0% YoY vs 12.9% previous) which was in line with consensus, and fixed asset investments continued to grow at a 20%+ YoY rate. Jun describes the October CPI outcome of 3.2% YoY in October (3.3% expected) as remaining in the comfort zone, though it came in at an eight month high. PPI deflation widened to 1.5% YoY in October from 1.3%yoy in September but Jun expects that PPI inflation will recover to zero by the end Q1 next year.

Coming back to markets, the clear outperformer on Friday was DM equities where the S&P 500 (+1.3%) came back from early lows of 1747 following payrolls, before staging a remarkable recovery to close at a new all time high of 1770. The tone in emerging markets was in stark contrast, where it was a disappointing day across both equities and fixed income. The +15bp and 0.57% increase in UST yields and the Dollar index was clearly a problem. Brazilian and Mexican 10yr rates jumped by around 13bp and 7bp respectively, while the CDX EM index added 20bp in spread terms, in its weakest performance since June. The MSCI EM equity index (-1.5%) recorded its seventh straight loss which is the longest losing streak since March 2013. The weaker tone in EM on Friday is weighing on sentiment in Asia this morning including in Asian FX where a number of currencies are weaker including the KRW (-0.7%), THB (-0.7%) and IDR (-0.9%) against the USD. Asian EM sovereign credit has opened weaker particularly in Indonesia and Phillipines (both 5yr sovereign CDS are +5bp wider) but flows have been balanced in general. Despite the strong finish to DM equity markets last week, Asian equities are trading lower across most bourses with the exception of the TOPIX (+0.7%) following the payrolls-inspired gain in USDJPY. There is a fair bit of volatility in Chinese equities on the back of reports in domestic media including China Daily of potential reform plans filtering out from the Third Plenum meeting.

Across the rest of the week, there will be a lot of focus on the Fed’s thoughts on the latest payrolls data and its implications for Fed policy. Indeed, apart
from Yellen’s confirmation meeting on Thursday, we’ll get further clues to the Fed’s thinking when Bernanke speaks on Wednesday. We also have a number of other Fed speakers scattered throughout this week beginning with Kocherlakota and Lockhart tomorrow. Today is Veteran’s Day in the US, so things will probably be on the quiet side, especially on the fixed income side where a number of markets are shut (equity markets will stay open). Staying Stateside, we get our usual post-Payrolls lull in data flow. The key releases over the week will be jobless claims on Thursday together with industrial production and the NY Empire Fed manufacturing survey on Friday.

Across the Atlantic, the week gets off to a similarly slow start before we reach what will likely be the highlight for the week in the form of first estimates of Q3 GDP for the Eurozone as well as individual GDP reports for Germany, France and Italy (Thursday). Our European economists expect a growth number of around 0.2% QoQ. A two day Eurogroup/ECOFIN finance ministers’ meeting is scheduled to commence on Thursday, as will a three day Germany’s SPD party convention where we may hear more about the party’s intentions with respect to a coalition agreement with Merkel’s conservatives.

Italian industrial production (Sep) is due later today, followed by German/Italian/UK inflation on Tuesday. We get Eurozone industrial production and UK employment stats on Wednesday. The BoE publishes its quarterly inflation report on Wednesday.

In China, we’ll probably start to get further reports of various reforms being considered by the government following the conclusion of the country’s Third Plenum of the 18th Party Congress of the Communist Party on Tuesday. In Japan, money supply (Tues) and 3Q GDP (Thurs) are scheduled during the week. Japan’s economy minister Amari delivers a speech on the country’s growth strategy to parliament on today.

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Record Levels of Currency Reserves Will Hit Hard

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When the US federal government was shutdown, China jumped in on the financial bandwagon and suggested that we build ‘a de-Americanized world’, which boils down to getting rid of the dollar as the international reserve currency. As the law-makers and the political parties were dragging their feet, the Chinese had their running shoes on to sneakily knock a dead man down again as he was trying to get up. Well, all is fair in love and war and we should expect nothing less.

The official Chinese state-run news agency (in mocking tone) stated: “As U.S. politicians of both political parties are still shuffling back and forth between the White House and the Capitol Hill without striking a viable deal to bring normality to the body politic they brag about, it is perhaps a good time for the befuddled world to start considering building a de-Americanized world”. But, has that dream come true? Has the shutdown affected the reserve currency of the world and is the dollar on its way out?

South Korea

It may not be on its way out just yet, but if the South Koreans are anything to go by, they are prepared to do quite a lot of damage if they have to in order to prevent their own currency the won.

Data released today by the Bank of Korea show that the country has been hording foreign exchange reserves (which currently stand at $343.23 billion at the end of October 2013).
This means that there has been an increase of $6.3 billion compared to September 2013.
You would have to go back at least two years to find that sort of figure.
This is primarily due to the fact that the won has risen by more than 9% over the past 4 months.
By buying up large quantities of dollars they have been able to preserve an even greater rise in their currency.
The South-Korean economy is dependent on exports for its economic-growth prospects and any increase in its currency means they are going to slow down.
South Korea’s growth (of Asia’s 4th largest economy) was lowered for 2014 from 4% to 3.8%.
Growth this year stands at 2.8%.
If and when stimulus stops, the South Koreans will have a huge stockpile of dollars to play with and to counterbalance an outflow of cash back to the US.

Reserves and the Fed

More than 60% of reserves at central banks around the world are in dollars today and that means that if those central banks need to (and they will!) protect their own currencies, then they will not hesitate for one moment about flooding the financial market when the time comes so that they don’t lose out on liquidity in tough times. But, flooding the market with dollars will be bad news for the US. International banks have roughly $850 billion in US dollars at the moment in their vaults and will be able to ride out a future storm.

Despite the pig debt oinking over the EU and the troika today meeting with the Greek Finance Minister over the bailout program (there is a fear over the return of the creditor into Greece due to differences regarding the Greek funding gap) there is one big difference today in comparison with the financial crisis of the subprimes.

That difference is that the central banks were not prepared for it.
Today, they have reserves of cash, largely due to buying up huge quantities of Quantitative Easing.
The EU bought $74 billion in Q1 and $52 billion in Q2.
In fact, the real beneficiary of Quantitative Easing is the financial system and the US Federal Reserve has been filling the coffers of central banks around the world, rather than giving it to its own economy.
That’s another reason to criticize easy, loose monetary policies (at least from one side of the Atlantic).

Large reserves of the dollar around the world are just waiting there to be used when the economies need it. The central banks are stockpiling dollars in a bid to make their currencies go down against the dollar and at the same time make the dollar scarce so that it is in demand and rises. If it comes to the crunch, then they will have liquidity still even if their economies go downhill and it will be all thanks to Quantitative Easing and the Federal Reserve. The US stock market is on a high, the chapagne corks are popping and the fizz is being drunk down. But, the paradise is fool’s one and nothing more. It’s an unreal one that will run into problems sooner or later. The fact that the USA is the biggets debotor in the history of the world right now means that it will have little recourse to counter any economic trouble lurking around the corner (except continue printing money?).

There have been slowdowns in the US economy on cycles of roughly six years. Each time they have got progressively bigger and stronger. The next one will hit then in about 2014-2015, just in time for Quantitative Easing to be a real problem.

But, it will have done one thing: allowed foreign central banks to artificially maintain their currencies lower than they should be and to therefore appear to be more competitive. It will also enable those same economies to have greater financial independence than the US when the trouble knocks on the door.

The US saved the world after all! Only trouble is: it forgot to save itself!

Originally posted: Record Levels of Currency Reserves Will Hit Hard

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The United States Of Hypocrisy (In One Cartoon)

…because it’s always what’s not said that matters…

(via Sunday Funnies)

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The Biggest Difference Between QE3 And QE2

Back in 2011, in an exclusive analysis, Zero Hedge showed how virtually all the reserves created as a result of QE2 ended up as cash on the balance sheets of foreign (mostly European) banks operating in the US. Some suggested that this was due to a change in FDIC rules which was being arbed by foreign banks which were able to engage in a mini carry trade affecting the Fed’s excess reserves. We disagreed, and suggested that this was nothing short of yet another way in which foreign banks abused the Fed’s “Bernanke Put” to bail themselves out at a time when the Eurozone and its currency seemed like they would implode any second.

QE2 came and went, and was replaced by QE3. And, having lasted nearly a year now, it has allowed us to observe the main way in which the Fed’s open-ended QE3 has so far differed from the QE2 of 2011.

Recall that while the Fed’s Quantiative Easing programs are largely determined by what securities the Fed monetizes: i.e. the sources of funds, what is always left unspoken is where the Fed’s created reserves end up, or the “uses” of funds, or rather, reserves. Luckily, as the chart below shows and as tracked by the Fed’s H.8 statement, there is a perfect correlation, and causation, between the Fed’s newly created reserves parked at banks, and the corresponding change in cash held on the books of either domestic (large and small) and foreign commercial banks operating in the US.

What may not be quite visible in the chart above is that during QE 2, virtually all the newly created cash ended up at foreign banks. This is shown far more clearly in the chart below showing the change in cash balances at large domestic commercial banks and foreign banks between the start and end of QE 2.

So while the Fed was explicitly pumping the deposit base of foreign banks in 2011 – and thanks to JPM and the entire deposit collateral pathway we now know that this cash was used to satisfy collateral requirements needed when purchasing risk assets, even if the banks never explicitly used the Fed’s cash to buy up risk – what has it been doing so far in 2013? The answer is shown below.

Surprisingly – if only to all those who claimed our assertion that the Fed was bailing out Europe’s banks was bunk due to “regulatory arbitrage” – entirely unlike during QE 2, this time around, virtually every dollar newly created by the Fed has landed on an equal basis at both large domestic commercial banks, and foreign banks operating in the US. But… but… whatever happened to the regulatory arbitrage of QE2?

To those still confused, here is the best visualization of the cash change in domestic vs foreign banks under the two QE regimes:

Indeed – a pretty clear summary of what the Fed’s deisgnated bailout audiences was under QE 2 (European banks) and QE 3 (everyone on an equal, pro rata basis).

The above, far more importantly than what the Fed is monetizing in order to build up its reserves, gives us a clear snapshot of the other part of the equation – where the Fed’s reserves end up.

All of this should perhaps once again spark the debate over just why has the Fed parked a record $1.3 trillion in cash not with US-based banks, but foreign ones, and just for whose benefit – since by now it is quite clear that QE is solely for the benefit of the 0.1% of the population and, of course, the banks – was QE designed.

Because it is one thing to bail out the rich, at least they are America’s rich. But when more than half of the proceeds of QE to date…

…have ended up at foreign banks, perhaps at least a theatrical congressional hearing is in order?

Source: H.8

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Ray Dalio's Bridgewater On The Fed's Dilemma: "We're Worried That There's No Gas Left In The QE Tank"

“The Fed’s real dilemma is that its policy is creating a financial market bubble that is large relative to the pickup in the economy that it is producing,” Bridgewater notes as the relationship between US equity markets and the Fed’s balance sheet (here and here for example) and “disconcerting disconnects” (here and here) indicate how the Fed is “trapped.” However, as the incoming Yellen faces up to her ‘tough’ decisions to taper or not, Ray Dalio’s team is concerned about something else – “we’re not worried about whether the Fed is going to hit or release the gas pedal, we’re worried about whether there’s much gas left in the tank and what will happen if there isn’t.”

Via Bridgewater,

In the old days central banks moved interest rates to run monetary policy. By watching the flows, we could see how lowering interest rates stimulated the economy by 1) reducing debt service burdens which improved cash flows and spending, 2) making it easier to buy items marked on credit because the monthly payments declined, which raised demand (initially for interest rate sensitive items like durable goods and housing) and 3) producing a positive wealth effect because the lower interest rate would raise the present value of most investment assets (and we saw how raising interest rates has had the opposite effect).

All that changed when interest rates hit 0%; “printing money” (QE) replaced interest-rate changes. Because central banks can only buy financial assets, quantitative easing drove up the prices of financial assets and did not have as broad of an effect on the economy. The Fed’s ability to stimulate the economy became increasingly reliant on those who experience the increased wealth trickling it down to spending and incomes, which happened in decreasing degrees (for logical reasons, given who owned the assets and their decreasing marginal propensities to consume).

As shown in the charts below, the marginal effects of wealth increases on economic activity have been declining significantly. The Fed’s dilemma is that its policy is creating a financial market bubble that is large relative to the pickup in the economy that it is producing. If it were targeting asset prices, it would tighten monetary policy to curtail the emerging bubble, whereas if it were targeting economic conditions, it would have a slight easing bias. In other words, 1) the Fed is faced with a difficult choice, and 2) it is losing its effectiveness.

We expect this limit to worsen. As the Fed pushes asset prices higher and prospective asset returns lower, and cash yields can’t decline, the spread between the prospective returns of risky assets and those of safe assets (i.e. risk premia) will shrink at the same time as the riskiness of risky assets will not decline, changing the reward-to-risk ratio in a way that will make it more difficult to push asset prices higher and create a wealth effect.

Said differently, at higher prices and lower expected returns the compensation for taking risk will be too small to get investors to bid prices up and drive prospective returns down further. If that were to happen, it would become difficult for the Fed to produce much more of a wealth effect. If that were the case at the same time as the trickling down of the wealth effect to spending continues to diminish, which seems likely, the Fed’s power to affect the economy would be greatly reduced.

…

…we think that US monetary policy is nearing a new test that will require wisdom and creativity along the lines of that which was required to deal with those problems.

The basic issue is that quantitative easing is a much less effective tool when asset prices are high and thus have low expected returns than it is for managing financial crises. That’s because QE stimulates the economy by (1) offsetting a panic by providing cash to the financial system when there’s a need for cash, and (2) by raising asset prices, and driving money from the assets they buy into demand and investment, creating a higher level of future economic activity. So, the policy was particularly wise and most effective (in the sense of impact per dollar) at the height of the financial crisis when there was both a desperate need for cash and when extremely depressed asset prices were heavily weighing on demand and investment.

Now, there is a flood of liquidity and asset prices are high relative to underlying fundamentals. So the impact of additional asset price increases on demand is much less (as high asset prices and low future returns make assets more interchangeable with cash).

Quantitative easing today is driving asset prices to unsustainable levels, without stimulating much additional activity. That leaves a much clearer tradeoff between driving up asset prices today and lowering future returns (the price of which will be paid in the future). During the crisis period, that was much less the case, because pulling forward returns from the future (i.e., raising prices) was then also creating future earnings growth (by helping to normalize the economy).

The dilemma the Fed faces now is that the tools currently at its disposal are pretty much used up, in that interest rates are at zero and US asset prices have been driven up to levels that imply very low levels of returns relative to the risk, so there is very little ability to stimulate from here if needed. So the Fed will either need to accept that outcome, or come up with new ideas to stimulate conditions.

We think the question around the effectiveness of continued QE (and not the tapering, which gets all the headlines) is the big deal. Given the way the Fed has said it will act, any tapering will be in response to changes in US conditions, and any deterioration that occurs because of the Fed pulling back would just be met by a reacceleration of that stimulation. So the degree and pace of tapering will for the most part be a reflection and not a driver of conditions, and won’t matter that much. What will matter much more is the efficacy of Fed stimulation going forward.

In other words, we’re not worried about whether the Fed is going to hit or release the gas pedal, we’re worried about whether there’s much gas left in the tank and what will happen if there isn’t.

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Ray Dalio’s Bridgewater On The Fed’s Dilemma: “We’re Worried That There’s No Gas Left In The QE Tank”

Via Bridgewater,

…

…we think that US monetary policy is nearing a new test that will require wisdom and creativity along the lines of that which was required to deal with those problems.

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There's A Liquidity Crunch Developing

Submitted by Alasdair Macleod of GoldMoney.com,

This week an article in Euromoney points out that liquidity in bond markets is drying up. The blame is laid at the door of regulations designed to increase banks’ capital relative to their balance sheets. Furthermore, the article informs us, new regulations restricting the gearing on repo transactions are likely to make things worse, not only reducing bond market liquidity further, but also affecting credit markets. The reason this will be so is that in a repurchase agreement a bank supplies credit to non-banks for the period of the repo.

One could take another equally valid point of view: the reason for deteriorating liquidity in bond markets is due in part to yields being unnaturally low. If you price bonds too highly, which amounts to the same thing, few investors want to buy them without the unconditional support of the central bank as a ready buyer. This, after all, is why just the hint of tapering recently was enough to derail the markets. So here again we come up against the same choice: if the Fed insists on mispricing the market with its interventions and zero interest rate policy it must fully support the market with both QE and also twist applied to the yield curve to maintain market liquidity.

For the investment analysts and commentators that still expect tapering this must come as something of a surprise. The underlying point they have missed is that once a central bank embarks on a policy of printing money as a cure-all, it is impossible to stop, or even to just taper without risking a liquidity crisis. Increasingly illiquid markets are now telling us that QE should be increased.

The point was rammed home this week by the ECB’s decision to lower interest rates. The move was sold to the financial press as designed to stimulate inflation and reduce the risk of deflation. However, central to the deflation argument is the need to stimulate liquidity in the secondary markets, which according to the Euromoney article “are now close to breakdown”.

At least the ECB rate cut should defuse tapering expectations in US markets, making it easier for the Fed to back down from its failed experiment. The Fed now needs to plant the suggestion that QE will have to be increased, or a similar mechanism designed to boost liquidity introduced.

This will not be difficult in the prevailing economic conditions. Even though GDP remains a positive figure, concerns over deflation abound and are preoccupying more and more analysts. These are concerns which analysts can readily accept as an immediate and greater risk than inflation.