Investing in Macro Tipping Points

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GLOBAL RISK - The Next "Peg" to Fall

THE NEXT "PEG" TO FALL

SINGAPORE DOLLAR PUTS ADDED PRESSURE ON CHINA

Singapore's MAS announced a surprise shift in the slope of their policy band - implicitly loosening policy and so the Singapore Dollar dumped over 160 pips against the USD, the biggest drop in almost 3 years, tumbling to its weakest since Mid 2010.

Interestingly, against the Japanese Yen this move merely roundtrips SGD strength from yesterday as one wonders who the real enemy in the competitive devaluation game is...

The Sing Dollar weakened to 1.35 against the USD - the biggest single-day drop since Feb 2011...

A big drop for the SGD...

But against the JPY, it's a small move...

Raising the question of just who the currency war is against...

Charts: Bloomberg

GLOBAL RISK - The Next "Peg" to Fall

THE NEXT "PEG" TO FALL

CHINA HAS ITS 'BACK TO THE WALL' WITH GLOBAL SLOWDOWN & COMPETITIVE DEVALUATIONS

CHINA IS FACING A COMPETITIVE CURRENCY DISADVANTAGE!

IF YOU WERE THE CHINESE WHAT WOULD YOU DO?

This has got to really p$%^ss off the Chinese!

HAVE THEY ALREADY STARTED?

Chinese Currency Plunges To Peg Limit Against USDollar, Strongest Against Euro In 14 Years 01-27-15 ZH

The drop in the Yuan over the past 2 days is the largest against the USDollar since Nov 2008 as USDCNY nears its highest (CNY weakest) since mid-2012. What is more critical is that for the first time since the new 2% CNY peg bands, USDCNY is trading at the extremes - 11.5 handles cheap to the fix. At the opposite end of the spectrum, the EURCNY just dropped below 7.00 for the first time since June 2001 with the biggest 2-day strengthening of the Chinese currency against the Euro in almost 4 years. It appears the consequences of ECB QE, SNB volatility, and now Greek concerns continue to ripple through the rest of the world.. and at a time when China faces its ubiquitous new year liquidity squeeze, that is not a good sign.

Biggest 2-day drop in the Yuan against the USDollar since 2008

With USDNCY puishing against its 2% peg band for the first time...

As the Yuan shifts to its strongest against the Euro since 2001 (almost 2000) - back below 7.000

Charts: Bloomberg

WILL THE HONG DOLLAR FOLLOW SWITZERLAND?

HONG KONG DOLLAR

THE STORY IS LIKELY NOT YET THE HONG KONG DOLLAR

"It will happen, but I keep thinking it will be after the [yuan] is completely convertible." Jimmy Rogers

Hong Kong Dollar Peg Doesn’t Fit in Swiss Hole 01-23-15 WSJ

The sudden death of the Swiss franc ceiling set off fears that other fixed exchange rates could be next. But Hong Kong’s storied peg with the U.S. dollar is as solid as ever.

Superficially, Hong Kong faces a similar situation to Switzerland. The Swiss National Bank was buying huge volumes of euros to hold down the franc, swelling reserves and leading to rapid money creation. There was little inflation, but worrying froth in the Swiss property market. Imminent quantitative easing by the European Central Bank added to the pressure.

Hong Kong’s peg to the U.S. dollar has similarly forced the territory to import ultra-loose monetary policy from the U.S. Rock bottom interest rates in Hong Kong fueled surging property values. Critics have gone so far as to blame the peg for youth dissatisfaction in the streets.

Some investors think Hong Kong could follow the Swiss. There was a surge in the volatility of Hong Kong dollar options the day after the SNB’s move and the spot price of the Hong Kong dollar has moved toward the strong side of its narrow trading band.

But comparing the franc to the Hong Kong dollar is like putting a square peg in a round hole. The SNB’s franc ceiling was a discretionary move undertaken for a few years by a central bank that viewed the policy as one of its tools among many.

Hong Kong’s currency board, by contrast, is an institutionalized, rules-based system in place since 1983, making it harder and even riskier to change on a whim.

What’s more, while the SNB was facing a coming flood of euro liquidity, Hong Kong is now likely to see a receding tide of dollars. The Federal Reserve has stopped asset purchases and will eventually raise interest rates, letting some air out of the Hong Kong property market.

If anything, pressure on the Hong Kong currency may soon turn in the opposite direction. If the Fed keeps tightening and the U.S. dollar continues to strengthen even as China’s economy slows, speculators could start betting on devaluation.

Not that they will succeed. Hong Kong authorities have been willing to take huge levels of pain to maintain the peg. They allowed GDP to contract by 5.9% in 1998 rather than succumb to depreciation pressure. And with the domestic political situation still unsettled, Hong Kong is unlikely to abandon a policy that has anchored the financial system for decades.

In the very long term, switching the peg from the greenback to the Chinese yuan is possible. But that can only happen once the Chinese currency is a freely convertible international one, which it won’t be for the foreseeable future. Traders buying call options on the Hong Kong dollar hoping for Swiss-like capitulation should find better uses for their money.

FLOWS - Liquidity, Credit & Debt

THE RIGHT WAY TO LOOK AT THE MARKET

"RATE OF CHANGE OF FLOWS"

RESULTS SINCE THE RATE OF CHANGE OF FLOWS "INFLECTION"

CHARTS: Annotated from Zero Hedge

CURRENCIES - USD Strength

Long USDJPY, aka the trade that is directly proportional to multiple expansion for the entire US stock market, and number of bankrupt Japanese corporations.

This is what BofA's technical strategist MacNeill Curry has to say:

Buy $/¥. It is about to break out from its week long range

For the past week, $/¥ has been caught in a 118.72/117.32 contracting range / Triangle formation. Now, that range is about to complete for a push towards 119.78/120.36. Perhaps most compelling is the risk to the trade. Price should not trade below the Jan-25 low at 117.27. Below here invalidates the bullish setup and results in a larger, choppier range than anticipated. Bigger Picture, we remain BULLISH. The long term uptrend remains incomplete for a push towards 124.16/124.59. Above the Dec-23 high at 120.83 says the long term bull trend has resumed. 

Buy $/¥ at market (now 117.80), risk 117.25, target 119.78, potentially120.36 

Click to Enlarge

GLOBAL RISK - How Financial Repression Leads to Mispriced Risk

HOW FINANCIAL REPRESSION LEADS TO

MISPRICED RISK

The Concept of "Real Risk Free" Total Returns

CULTURE OF RISK

The financial system is based on debt. US Treasuries, the benchmark for an allegedly “risk free” rate of return, is the asset against which all other assets are priced based on their relative riskiness. This “risk free” rate has been falling steadily for over 25 years.

The Wall Street Journal estimates that a third of traders have never witness a rate hike. However, the real problem is far greater than this. Bonds have been in a bull market for over 30 years. Forget rate hikes… an entire generation of investors and money managers (anyone under the age of 55) has been investing in an era in which risk has generally gotten cheaper and cheaper.

FINANCIALIZATION & RISE IN LEVERAGE

This, in turn, has driven the rise in leverage in the financial system. As the risk-free rate fell, so did all other rates of return. Thus:

investors turned to leverage or using borrowed money to try to gain greater rates of return on their capital.

The ultimate example of this is the derivatives market, which is now over $700 trillion in size. This entire mess is backstopped by about $100 trillion (at most) in bonds posted as collateral.

ASSETS CAN NO LONGER BE ALLOWED TO FALL - Deleveraging is Misinformation

This formula of ever increasing leverage works relatively well when the underlying asset backstopping a trade is rising in value (think of the housing bubble, which worked fine as long as housing prices rose). However, if the asset ever loses value, you very quickly run into trouble because you need to post more as collateral to backstop your trade. If you can’t do this easily, the margin calls start coming and you can find yourself having to unwind a massive position in a hurry. This is how crashes occur. This is what caused 2008.

Despite all of the rhetoric, the world has not deleveraged in any meaningful way. The only industrialized country to deleverage since 2008 is Germany.

This is not unique to sovereign nations either. As McKinsey recently noted, there has been no meaningful deleveraging in any sector of the global economy (the best we’ve got is households and financial firms which have basically flat-lined since 2008).

In the simplest of terms, the 2008 collapse occurred because of too much leverage fueled by cheap debt. This worked fine until the assets backstopping the leveraged trades fell in value, which brought about margin calls and a selling panic.

REHYPOTHECATION

The practice by banks and brokers of using, for their own purposes, assets that have been posted as collateral by their clients.

In rehypothecation, securities that have been posted with a prime brokerage as collateral by a hedge fund are used by the brokerage to back its own transactions and trades. While rehypothecation was a common practice until 2007, hedge funds became much more wary about it in the wake of the Lehman Brothers collapse and subsequent credit crunch in 2008-09. That has all changed as has the re-emergence of Cov-Lite, PIK Loans et al.

Since the Financial Crisis everyone has become even MORE leveraged than they were in 2008. And they did this against an ever-smaller pool of quality assets (the Fed and other Central Banks’ QE programs have actually removed high grade collateral from the financial markets).

Thus, we now have a financial system that is even more leveraged than in 2007… backstopped by even less high quality collateral. And this time around, most industrialized sovereign nations themselves are bankrupt, meaning that when the bond bubble pops, the selling panic and liquidations will be even more extreme.

Excerpts above taken from a note from Graham Summers, Phoenix Capital Research

THE CONCEPT OF "RISK FREE"

DEFINITION: Risk-free interest rate is the theoretical rate of return of an investment with no risk of financial loss. One interpretation is that the risk-free rate represents the interest that an investor would expect from an absolutely risk-free investment over a given period of time.[1] Since the risk free rate can be obtained with no risk, any other investment will have additional risk. In practice to work out the risk-free interest rate in a particular situation, a risk-free bond is usually chosen that is issued by a government or agency where the risks of default are so low as to be negligible.

As my MACRO Co-Host writes in The Surprising Consequences Of The Global Frenzy For Positive Yield

As the dollar soars, so does the real yield on bonds denominated in dollars.

REAL RISK FREE TOTAL RETURN

This is THE trick of FINANCIAL REPRESSION in financing the US Government Debt

Savers lose but the US Government & International Banks win.

FINANCIAL REPRESSION - Negative Real Rates Coming

Get Ready For Negative Interest Rates In The US 01-24-15 ZH

With Fed mouthpiece Jon Hilsenrath warning - in no lesser status-quo narrative-deliverer than The Wall Street Journal - that The ECB's actions (and pre-emptive collapse in the EUR) means the U.S. economy must deal with a rapidly strengthening dollar that will make American goods more expensive abroad, potentially slowing both U.S. growth and inflation; and Treasury Secretary Lew coming out his crypt to mention "unfair FX moves," it appears The Fed (and powers that be) are worrying about King Dollar. This suggests, as Mises Canada's Patrick Barron predicts, the Fed will start charging negative interest rates on bank reserve accounts as the final tool in the war on savings and wealth in order to spur the Keynesian goal of increasing “aggregate demand”. If savers won’t spend their money, the government will take it from them.

As The Wall Street Journal explains,

The European Central Bank’s launch of an aggressive program this week to buy more than €1 trillion in bonds poses important tests for the U.S. economy and the Federal Reserve.

Europe’s new program of money printing—and the resulting fall in the euro—means the U.S. economy must deal with a rapidly strengthening dollar that will make American goods more expensive abroad.

The stronger dollar could slow both U.S. growth and inflation, giving the Fed some incentive to hold off on its plan to raise short-term interest rates later this year from near zero.

...

A stronger dollar has three important implications for the U.S. economy, markets and policy makers. 

1. First, it tamps down inflation just as the Fed is trying to raise inflation closer to 2%.
2. Second, it hurts exports and therefore economic growth.
3. Lastly, the attraction of U.S. financial assets could heat up markets just as regulators keep watch for dangerous asset bubbles.

...

U.S. officials have been playing down that scenario, and, more broadly, resisting talk of a global currency war—competitive devaluations by countries eager to keep their currencies as low as possible to protect exports; but “The Fed faces a challenge having to navigate some pretty intense cross currents,” said Bruce Kasman, chief economist for J.P. Morgan Chase.

The U.S., in effect, is importing some of the world’s downward inflation pressure through currency movements.

Treasury Secretray Lew pipes in...

• *LEW SAYS UNFAIR FX MOVES TO DRAW SCRUTINY FROM U.S.
• *LEW SAYS STRONG DOLLAR IS GOOD FOR AMERICA

*  *  *

And Patrick Barron predicts (via Mises Canada)...

I predict that the Fed will start charging negative interest rates on bank reserve accounts, which will ripple through the markets and result in negative interest rates on savings at banks.

I make this prediction only because it is the logical action of the Keynesian managers of our economy and monetary policy.

Our exporters will scream that they can’t sell goods overseas, due to the stronger dollar.

So, what is the Fed’s option? Follow the lead of Switzerland and Denmark and impose negative interest rates in order to drive down the foreign exchange rate of the dollar.

It is the final tool in the war on savings and wealth in order to spur the Keynesian goal of increasing “aggregate demand”.

If savers won’t spend their money, the government will take it from them

JAPANESE 2 YEAR GOES NEGATIVE

GERMAN 2 YEAR GOES NEGATIVE

30 YEAR HEADING STEADILY SOUTH

FLOWS - Liqudity, Credit & Debt

EU equities tracked the Fed Balance Sheet. GaveKal shows however they are negatively correlated to the ECB's own B/S

The ECB’s QE May Lead To Further Declines In Euro Equities Excerpted from Lance Roberts

There is much hope that the ECB’s newly minted QE program of €60 billion a month will be the spark that creates inflation in the Eurozone, sparks economic growth and boosts asset prices.  It is a lofty objective to say the least considering there is very little evidence that QE programs either create inflation or economic growth.  A quick look at Japan and the U.S. suggests that the ECB will likely be disappointed on both counts.

However, when it came to asset growth, the Federal Reserve was very successful as the liquidity that was pumped into the system was recycled into the financial markets.  As I have shown many times in the past, there was a high degree of correlation between the expansion of the Fed’s balance sheet and the S&P 500 index.

The reason this worked in the U.S. was because the excess reserves created by the quantitative easing program yielded a positive interest carry. This is not the case in the Eurozone where the reserves created by the bond buying program with the ECB are held with a negative interest rate.  This makes the program much less attractive to sellers of the bonds.

However, there is another issue that was recently pointed out by the very smart gentlemen at GaveKal Research:

“When we overlay the MSCI Europe, we find a somewhat surprising relationship-- equities have risen as the central banks' assets have contracted over the last several years, implying that asset purchases (inverted on the following chart) could actually be negative for stocks:”

“We have no way of knowing for sure whether or not this pattern will hold, but this chart would seem to suggest that MSCI Europe equities could decline ~30% by the end of 2016.”

Given that the majority of the Eurozone is either near or in recession, there is little reason to hope that a QE program the size that is being suggested by the ECB will be effective. However, there is currently little evidence that investors should be betting heavily on a resurgence of international asset prices. As shown in the chart below the correlation between domestic and international equities has been quite high and more correlated to the Federal Reserve’s repetitive QE programs. 

With the domestic markets now struggling due to lack of liquidity, it is unlikely that international equities will provide any safety net for investors. Of course, while the mainstream media may be telling you to keep investing in stocks, it is clear that the “smart money” has been heading into the safety of bonds.