USD REPORT - TRIGGER$

US DOLLAR SHORTAGE - A USD Liquidity Problem

On Wednesday afternoon, just after the close of the market, the US Dollar, the world's reserve currency flash crashed. This is how the WSJ described the move:

In the latest episode Wednesday, a message from the U.S. Federal Reserve that it is in no hurry to raise interest rates caused a big slump in the dollar, which has run up a huge rally so far this year. The euro surged more than 4% against the buck, its biggest jump in a single day in 15 years, according to Deutsche Bank. Early on Thursday, the European currency resumed its slide.

The sheer speed of the round trip in the euro-dollar exchange rate—the world’s most heavily traded currency pair—left traders and investors reeling.

We profiled the staggering move in real-time as it was happening:

Again, this is the world's reserve currency, not some two-bit backwater currency pair. It was, also, a stunning, unheard of event.

This is how the rest of America's traders saw it, from the WSJ:

“I haven’t seen anything like it since the financial crisis,” said Paul Lambert, head of currency at Insight Investment, which manages $480 billion of assets.

Traders said Wednesday’s move brought back memories of January’s surge in the Swiss franc, when the currency climbed more than 40% after the Swiss central bank abandoned its policy of capping the franc’s strength against the euro. For a few minutes on Wednesday, the lack of dollar buyers caused a short-term freeze in electronic trading platforms, according to a New York-based trader at a major currency-dealing bank. “There was a lot of shouting on the desk, a lot of nervousness,” the trader said.

“The dollar has been experiencing fastest pace of ascent in 40 years. Our long-term outlook for the euro is still lower, but risk here is for a decent pullback,” said Matthew Cobon, head of interest rates and currencies at Threadneedle Investments in London, which has a total $54.3 billion of assets. Mr. Cobon had bet on a bounce back for the euro ahead of Wednesday’s Fed meeting.

None of this was unexpected, if only to our readers: recall that as we showed in the start of the year, the short 10Y and the long USD were the two most crowded, biggest consensus trades across the spec investor community, perhaps in history.

But while everyone got crushed on the Short 10Year trade shortly thereafter, the USD trade kept working... until Wednesday, when the entire groupthink monorail slammed into a brick wall.

So now what? Well, more of the same... and prayer.

The sharp swings also raise a now-familiar complaint from investors: Regulations brought in after the financial crisis have dried up the liquidity in markets, by crimping banks’ ability to carry risky bets on their balance sheets.

On Wednesday, the Bank for International Settlements became the latest major authority to caution that a lack of liquidity could lead to major disruptions in financial markets.

“When flow hits the market, there’s no buffer, so it translates straight into big price moves,” said Mr. Lambert at Insight Investment. During the financial crisis, big swings were sparked by fears of a collapse of the banking system. Similar moves can now result from a minor reassessment of the Fed’s rate-increase plans, according to Mr. Lambert.

So to summarize:

the stock market flash crash of May 6, 2021
the Treasury bond flash crash of October 15, 2021
and now the US Dollar flash crash of March 18, 2021

And all of this happening as the "market" is rising, and as of today, poised to set new all time highs.

What happens when the real selling actually begins, and what little liquidity exists even now, is completely gone.

The answer? Exchanges will simply close down and refuse to open or satisfy any asset liquidation demands, indefinitely, until either the Fed can once again bailout the system, or when the US government finally makes the sale of any asset, illegal.

03-21-15

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

US DOLLAR SHORTAGE - A USD Liquidity Problem

Borrowing in USD was risk-on; buying USD is risk-off.

There is a lively debate about the global demand for U.S. dollars:

Global finance faces $9 trillion stress test as dollar soars (Telegraph.co.uk)

Is There a US$ Shortage? Will it Sink the Global Economy? Again? (Mish)

The Dollar Squeeze – How Problematic Is It? (Acting Man)

The Global Dollar Funding Shortage Is Back With A Vengeance And "This Time It's Different" (Zero Hedge), which references a Bank for International Settlements (BIS) paper: Global dollar credit: links to US monetary policy and leverage.

Correspondent Mark G. went through the BIS report and offered these insightful comments:

1. Almost all of the dollar denominated debt and bond growth since 2009 was generated by the global shadow banking system.

Banks per se were smaller players in issuing this debt, and US-based banks (i.e. the ones in reach of Federal Reserve life preservers) were minor.

Sovereign wealth funds are large players in this. When we think of huge sovereign wealth funds held by major hydrocarbon exporters then the pucker factor rises.

One implied result of the BIS paper is that it will be extremely difficult or impossible for Federal Reserve emergency liquidity operations to stem a panic, even if the Fed is inclined to do so. AEP in the Telegraph article stated this more directly. The real problem is that modern bailout operations have large fiscal components as well as monetary components. Looking at the Bundestag's chronic heartburn with Greece and the EFSF is educational. Alternatively, consider how well proposals for a larger TARP type program aimed primarily at foreign entities would be received by the US Congress. And especially in 2016.

2. A major revelation was that $1 trillion of the dollarized lending went into Chinese companies. However the authors claim most of this lending was through Chinese banks.

3. "Emerging Markets" again account for 1/2 of the total offshore dollarized loans and bonds. This is $4.5 trillion and mainly centered in Brazil, Russia, India, China, etc.

4. From page 20:

"Fourth, since the crisis, the Federal Reserve's compression of term premia via its bond buying has led to a surge in US dollar borrowing through bond markets. Time-varying regressions and VAR analysis also indicate that inflows into bond mutual funds played a significant role in transmitting monetary ease, giving evidence of the portfolio rebalancing channel of the Federal Reserve large-scale bond purchases. In particular, given the low expected returns of holding US Treasury bonds (in relation to expected short-term rates), investors have sought out and found dollar bond issuers outside the US, many rated BBB and thus offering a welcome credit spread."

These dollarized bond funds were the "conservative" play for those players unwilling to also assume exchange rate risk.

"BBB..." This is already the S&P/Fitch ground floor of "investment grade." And that was the rating assigned to these foreign issuers during a time of free money and bubble expansion. We already know the bulk of bond mutual fund buyers are institutions. And many are required to flush any paper that falls below investment grade. And being 'smart money' they will have tried to hedge their risks against such a 'Credit Event' with credit default swaps (CDS).

We also know that CDS contracts typically require the CDS writer to begin posting progressively higher amounts of cash collateral as the credit outlook darkens for the underlying instrument. For instance, even if S&P/Fitch merely change the outlook from 'positive' to 'neutral' the required posted collateral percentage rises. And again from neutral to negative and so forth.

In the case of dollar loans and bonds the collateral needs to be in dollars. Therefore even if the CDS writer manages to borrow Euros with wet ink they still have to exchange these for dollars. See USD/Euro FX trend for the result."

Thank you, Mark, for the detailed analysis. Here are my initial thoughts:

1. Currencies respond to supply and demand like any other commodity. As such, it's instructive to to look at the supply of U.S. dollars and see how it's changed since 2008:money supply (Wikipedia)

2. However you measure money supply, the supply of dollars hasn't risen by much: MZM Money Stock has risen $2 trillion since 2010, Adjusted Monetary Base rose from $1 trillion to $3 trillion, and M2 Money Stock from around $8 trillion to around $10 trillion.

To put that roughly $2 trillion increase in money supply in context:

The GDP of the U.S. is about $17 trillion.

Global GDP is around $72 trillion.

Global debt rose $57 trillion from 2007 to 2014:

3. If there is demand for $9 trillion USD, that dwarfs the increase in US money supply. It also dwarfs the expansion in the Federal Reserve's balance sheet, roughly $3.5 trillion since 2008.

4. Borrowing in U.S. dollars was the easy, profitable trade as long as the dollar was declining. Traders being traders, everybody jumped into the easy, profitable trade with all four feet. Now that the dollar has reversed, everyone who is holding debt in dollars is losing money every time the USD ticks higher.

5. Much of the shadow banking system is opaque, and assumptions made about the outstanding debt in USD are likely to be not just wrong but grossly under-estimated. See #2 above.

If you wanted a trade that was guaranteed to blow up, you couldn't do much better than "dollar bond issuers outside the US, many rated BBB." As Mark noted, once this gunwales-at-sea-level debt gets downgraded a notch, institutional owners will be obligated to sell, regardless of any other conditions. Selling will beget selling.

6. U.S. Treasuries are essentially the only super-liquid safe haven offering a yield above 1%. And what do you need to buy Treasuries? U.S. dollars. The point here is the demand for USD is not limited to those scrambling for USD to pay off dollar-denominated debt--it's a global consequence of the global economy skidding off the cliff into recession.

Borrowing in USD was risk-on; buying USD is risk-off. As the real global economy slips into recession, risk-on trades in USD-denominated debt are blowing up and those seeking risk-off liquidity and safe yields are scrambling for USD-denominated assets.

It's important to recall that buyers of U.S. Treasuries are getting not just the 2+% yield-- they're getting the capital appreciation from the USD rising against their home currency. Depending on the home currency, those who dumped their home currency and bought USD last summer have gained 17% to 25%, even if they received 0% yield.

Add all this up and we have to conclude that, in terms of demand for USD--you ain't seen nuthin' yet.

03-21-15

US DOLLAR SHORTAGE - Central Bank Driven

The Global Dollar Funding Shortage Is Back With A Vengeance And "This Time It's Different" 03-08-15 Zero Hedge

The last time the world was sliding into a US dollar shortage as rapidly as it is right now, was following the collapse of Lehman Brothers in 2008. The response by the Fed: the issuance of an unprecedented amount of FX liquidity lines in the form of swaps to foreign Central Banks. The "swapped" amount went from practically zero to a peak of $582 billion on December 10, 2008.

The USD shortage back, and the Fed's subsequent response, was the topic of one of our most read articles of mid-2009, "How The Federal Reserve Bailed Out The World."

As we discussed back then, this

systemic dollar shortage was primarily the result of imbalanced FX funding at the global commercial banks, arising from first Japanese, and then European banks' abuse of a USD-denominated asset-liability mismatch, in which the dollar being the funding currency of choice, resulted in a massive matched synthetic "Dollar short" on the books of commercial bank desks around the globe: a shortage which in the aftermath of the Lehman failure manifested itself in what was the largest global USD margin call in history.

This is how the BIS described first the mechanics of the shortage:

The accumulation of US dollar assets saddled banks with significant funding requirements, which they scrambled to meet during the crisis, particularly in the weeks following the Lehman bankruptcy. To better understand these financing needs, we break down banks’ assets and liabilities by currency to examine cross-currency funding, or the extent to which banks fund in one currency and invest in another. We find that, since 2000, the Japanese and the major European banking systems took on increasingly large net (assets minus liabilities) on-balance sheet positions in foreign currencies, particularly in US dollars. While the associated currency exposures were presumably hedged off-balance sheet, the build-up of net foreign currency positions exposed these banks to foreign currency funding risk, or the risk that their funding positions (FX swaps) could not be rolled over.

... And then the subsequent global public response:

The severity of the US dollar shortage among banks outside the United States called for an international policy response. While European central banks adopted measures to alleviate banks’ funding pressures in their domestic currencies, they could not provide sufficient US dollar liquidity. Thus they entered into temporary reciprocal currency arrangements (swap lines) with the Federal Reserve in order to channel US dollars to banks in their respective jurisdictions (Figure 7). Swap lines with the ECB and the Swiss National Bank were announced as early as December 2007. Following the failure of Lehman Brothers in September 2008, however, the existing swap lines were doubled in size, and new lines were arranged with the Bank of Canada, the Bank of England and the Bank of Japan, bringing the swap lines total to $247 billion. As the funding disruptions spread to banks around the world, swap arrangements were extended across continents to central banks in Australia and New Zealand, Scandinavia, and several countries in Asia and Latin America, forming a global network (Figure 7). Various central banks also entered regional swap arrangements to distribute their respective currencies across borders.

The amount of the implied dollar short was also calculated by the BIS.

he major European banks’ US dollar funding gap had reached $1.0–1.2 trillion by mid-2007. Until the onset of the crisis, European banks had met this need by tapping the interbank market ($432 billion) and by borrowing from central banks ($386 billion), and used FX swaps ($315 billion) to convert (primarily) domestic currency funding into dollars. If we assume that these banks’ liabilities to money market funds (roughly $1 trillion, Baba et al (2009)) are also short-term liabilities, then the estimate of their US dollar funding gap in mid-2007 would be $2.0–2.2 trillion. Were all liabilities to non-banks treated as short-term funding, the upper-bound estimate would be $6.5 trillion (Figure 5, bottom right panel).

One thing to keep in mind as reading the above (and the linked article as a refresher), is that the massive USD synthetic short, and resulting margin call, was entirely due to the actions of commercial banks, with central banks having to step in subsequently and bail them out using any and every (such as FX swaps) mechanism possible.

* * *

Why do we bring all of this up now, nearly 6 years later? Because, as JPM observed over the weekend while looking at the dollar fx basis, the shortage in dollar funding is back and is accelerating at pace not seen since the Lehman collapse.

The good news: said shortage is not quite as acute yet as it was in either 2008/2009 or on November 30 2011 (recall "Here Comes The Global, US-Funded Liquidity Bail Out") when just as Europe was again on the verge of collapse, the Fed re-upped the ante on its global swap lines when it pushed the swap rate from OIS+100 bps to OIS+50 bps.

The bad news: at the current pace of dollar funding needs, it is almost certain that the tumble in the dollar fx basis will accelerate until it hits its practical minimum of - 50 bps, which is the floor as per the Fed-ECB swap line.

But the real news is that unlike the last time, when the global USD funding shortage was entirely the doing of commercial banks, this time it is the central banks' own actions that have led to this global currency funding mismatch - a mismatch that unlike 2008, and 2011, can not be simply resolved by further central bank intervention which happen to be precisely the reason for the mismatch in the first place.

In other words, central banks have managed to corner themselves in yet another policy cul-de-sac, six years after they did everything in their power to undo the last one.

Here is how JPM's Nikolaos Panigirtzoglou frames the problem:

The decline in the cross currency swap basis across most USD pairs in recent months is raising questions regarding a shortage in dollar funding. The fx basis reflects the relative supply and demand for dollar vs. foreign currency funds and a very negative basis currently points to relative shortage of USD funding or relative abundance of funding in other currencies. Such supply and demand imbalances can create big shifts in the fx basis away from its actuarial value of zero. Figure 1 shows that the dollar fx basis weighted across eight DM and EM currencies, declined significantly over the past year to its lowest level since mid 2013, although it remains well above the lows seen during the depths of the Lehman or the Euro debt crisis.

It does indeed, for now, however read on for why the current basis reading just shy of -20 bps will almost certainly accelerate until and unless there is a dramatic convergence in the policies of the Fed and the other "developed world" central banks.

First, what are currency and fx swaps, and why does anyone care?

"Cross currency swaps and FX swaps encompass similar structures which allow investors to raise funds in a particular currency, e.g. the dollar from other funding currencies such as the euro. For example an institution which has dollar funding needs can raise euros in euro funding markets and convert the proceeds into dollar funding obligations via an FX swap. The only difference between cross currency swaps and FX swaps is that the former involves the exchange of floating rates during the contract term. Since a cross currency swap involves the exchange of two floating currencies, the two legs of the swap should be valued at par and thus the basis should be theoretically zero. But in periods when perceptions about credit risk or supply and demand imbalances in funding markets make the demand for one currency (e.g. the dollar) high vs. another currency (e.g. the euro), then the basis can be negative as a substantial premium is needed to convince an investor to exchange dollars against a foreign currency, i.e. to enter a swap where he receives USD Libor flat, an investor will want to pay Euribor minus a spread (because the basis is negative)."

One read of a substantial divergence from par in the fx basis is that there may be substantial counterparty concerns within the banking system - this was main reinforcing mechanism for the first basis blow out of the basis back in 2008.

Both cross currency and FX swaps are subjected to counterparty and credit risk by a lot more than interest rate swaps due to the exchange of notional amounts. As such the pricing of these contracts is affected by perceptions about the creditworthiness of the banking system. The Japanese banking crisis of the 1990s caused a structurally negative basis in USD/JPY cross currency swaps. Similarly the European debt crisis of 2010/2012 was associated with a sustained period of very negative basis in USD/EUR cross currency swaps.

As noted above, the fundamental reasons for the USD shortage then vs now are vastly different. Back then, financial globalization meant that "Japanese banks had accumulated a large amount of dollar assets during the 1980s and 1990s. Similarly European banks accumulating a large amount of dollar assets during 2000s created structural US dollar funding needs. The Japanese banking crisis of 1990s made Japanese banks less creditworthy in dollar funding markets and they had to pay a premium to convert yen funding into dollar funding. Similarly the Euro debt crisis created a banking crisis making Euro area banks less worthy from a counterparty/credit risk point of view in dollar funding markets.

As dollar funding markets including fx swap markets dried up, these funding needs took the form of an acute dollar shortage."

And as further noted above, while there is no banking crisis (at this moment) unlike virtually every other year in the post-Lehman collapse as commercial banks are flooded in global central bank liquidity (now that central banks are set to inject more liquidity in 2015 than in any prior year, 2008 and 20099 included) the catalyst for the current shortage are central banks themselves:

Given the absence of a banking crisis currently, what is causing negative basis? The answer is monetary policy divergence. The ECB’s and BoJ’s QE coupled with a chorus of rate cuts across DM and EM central banks has created an imbalance between supply and demand across funding markets. Funding conditions have become a lot easier outside the US with QE-driven liquidity injections and rate cuts raising the supply of euro and other currency funding vs. dollar funding. This divergence manifested itself as one-sided order flow in cross currency swap markets causing a decline in the basis.

Who would have ever thought that a stingy Fed could be sowing the seeds of the next financial crisis (don't answer that rhetorical question).

For those who are curious about where this mismatch is manifesting itself in practical terms, look no further than the amount of USD (expensive) vs non-USD (i.e., EUR, i.e., very cheap thanks to NIRP) denominated cross-border debt issuance:

Do we see these funding imbalances in debt issuance? The answer is yes if one looks at cross border corporate issuance. Figure 2 shows how EUR denominated corporate bond issuance by non-European issuers (Reverse Yankee issuance) spiked this year as percentage of total EUR denominated corporate issuance. Similarly Figure 3 shows how Yankee issuance, the share of USD denominated corporate issuance by non-US companies, declined sharply this year. In other words, cross border issuance trends are consistent with higher supply of EUR funding vs. USD funding. We get a similar picture in value terms. Reverse Yankee issuance totaled €47bn YTD which annualized is twice as big as last year’s pace. Yankee issuance totaled $41bn YTD which represents a decline of more than 30% from last year’s annualized pace.

Which makes sense: why would US multinationals, already hurting by the surge in the USD on their income statement, also suffer this move on the balance sheet and pay about 50 bps more for the same piece of paper issued in Europe? They won't, of course, however in the process they will hedge fx, and push the basis even further into negative territory. JPM explains:

Does this cross border issuance have a currency impact? It depends. For example, if a US company issues in EUR and swaps back into USD to effectively achieve cheaper synthetic USD funding rather than issuing directly in US dollar funding markets, the transaction has no currency impact. This synthetic USD funding especially attractive right now as credit spreads over swaps are much tighter in Europe than in the US by around 40bp-50bp for A-rated corporate currently in intermediate maturities, which more than offsets the negative fx basis. This means there is a significant yield advantage for US companies using synthetic USD funding (i.e. issuing in EUR and swapping back into USD rather than issuing in USD directly). In theory, the USD-EUR credit spread difference of Figure 4 suggests that the fx basis has room to widen by another 20bp, i.e. to decline to -50bp before the yield advantage of synthetic USD funding disappears. For the EURUSD, the basis cannot go below -50bp as this is the floor implied by the ECB’s FX swap line with the Fed.

And there you have it: all else equal, there is at least enough downside to push the fx basis as far negative at -50 bps: this would make the USD shortage the most acute it has ever been, at least as calculated by this key metric! And since this is essentially a risk-free arb for credit issuers, and since there are many more stock buybacks that demand credit funding, one can be certain that the current fx basis print around - 20 bps will most certainly accelerate to a level never before seen, a level which would also hint that something is very broken with the financial system and/or that transatlantic counterparty risk has never been greater.

Unlike us, JPM hedges modestly in its forecast where the basis will end up:

Whether the above YTD trends continue forward is a difficult call to make. The widening of USD vs. EUR credit spreads shown in Figure 4 has the propensity to sustain the strength of Reverse Yankee issuance putting more downward pressure on the basis. On the other hand, this potential downward pressure on the basis should be offset to some extent by Yankee issuance the attractiveness of which increases the more negative the basis becomes.

JPM's punchline:

In all, different to previous episodes of dollar funding shortage such as the ones experienced during the Lehman crisis or during the euro debt crisis, the current one is not driven by banks. It is rather driven by the monetary policy divergence between the US and the rest of the world. This divergence appears to have created an imbalance in funding markets and a shortage in dollar funding. It is important to monitor how this dollar funding shortage and issuance patterns evolve over time even if the currency implications are uncertain.

And to think the Fed's cheerleaders couldn't hold their praise for the ECB's NIRP (as first defined on these pages) policy. Because little did they know that behind the scenes the divergence in Fed and "rest of the world" policy action is leading to two things:

i) the fastest emergence of a dollar shortage since Lehman and

ii) a shortage which will be arbed to a level not seen since Lehman, and one which assures that over the coming next few months, many will be scratching their heads as to whether there is something far more broken with the financial system than merely an arbed way by US corporations to issue cheaper (hedged) debt in Europe thanks to Europe's NIRP policies.

If and when the market finally does notice this gaping dollar shortage (as is usually the case with the mandatory 3-6 month delay), watch as the Fed will once again scramble to flood the world with USD FX swap lines in yet another desperate attempt to prevent the global dollar margin call from crushing a matched synthetic dollar short which according to some estimates has risen as high as $10 trillion.

Until then, just keep an eye on the Fed's weekly swap line usage, because if the above is correct, it is only a matter of time before they are put to full use once again.

Finally what assures they will be put to use, is that this time the divergence is the direct result of the Fed's actions, and its insistence that despite what is shaping up to be a 1% GDP quarter, that it has to hike rates. Well, as JPM just warned it in not so many words, be very careful what you wish for, and what you end up getting in your desire to telegraph just how "strong" the US economy is.

03-14-15

King Dollar Tipping Point 03- 06-15 Doug Nolan

The U.S. unemployment rate has dropped to 5.5%, cut almost in half from the 2009 high. The rate is down 1.2 percentage points from a year ago, back to the June 2008 level. Yet the Fed funds rate remains stuck at near zero. The Fed’s balance sheet increased $325bn the past year, while having inflated about $3.6 TN from its pre-crisis level. Securities prices have inflated to unprecedented levels.

The objective of the Fed’s extraordinary policy course over the last six years has been to:

Spur risk-taking,
Asset market reflation,
Stimulative wealth effects and resulting economic recovery.

Superficially, Federal Reserve monetary inflation appears to have worked. Yet beneath the facade exist

Extreme imbalances and maladjustment.
U.S. and global securities markets have been incredibly distorted.
The American and global Credit addiction has only worsened.

Such harsh realities cannot be disregarded forever.

Fed policymaking has provided a competitive advantage to financial assets over real economy investment.

Rate, monetization and liquidity policies have afforded competitive advantage to speculation at the expense of savings.

The overall outcome should be of little surprise: speculative excess, asset Bubbles and financial engineering galore. And as the Fed falls further behind the curve, Bubble excess turns conspicuous. Mark Cuban blogged this week, “Why This Tech Bubble is Worse Than the Tech Bubble of 2000.” CNBC had a Friday segment, “Bubble Trouble in Biotech?” From Bloomberg, also on Friday: “Biotech Keeps Rising as Investors Worry ‘End Is Coming’”. There is as well greater recognition of Bubble excess that has enveloped corporate debt and derivatives markets. These days, confirmation of the multi-asset class “Granddaddy of All Bubbles” thesis is apparent about everywhere.

Meanwhile, the global situation – markets, economies and geopolitics - turns progressively unstable. At this point,

I am highly confident in my thesis that the global Bubble has been pierced (with profound ramifications!).

This view is supported by the self-reinforcing nature of the collapse in energy and commodities prices along with faltering EM currencies.

At the same time, general risk aversion and destabilizing “hot money” exodus have been held at bay by the unprecedented central bank liquidity slushing around the global financial “system.” Typical contagion effects have yet to attain momentum. The bullish view holds that policymaking has lessened global systemic risk. I instead believe unprecedented policy-induced distortions have created a bursting dam dilemma. EM securities prices remain completely out-of-whack when compared to the unfolding reality. Acute EM systemic fragility has been masked by central bank policies and historic speculative excess.

A Friday afternoon Bloomberg headline raised a pertinent issue: “Why the Strong Jobs Report May Have Caused the Stock Market to Tumble.” I’ll attempt an explanation.

First of all, the bond market was clobbered. The June long-bond futures contract was slammed for over three points, with yields rising 16 bps (to 2.46%). Ten-year Treasury yields jumped 13 bps, with yields up a notable 25 bps for the week. Two-year government yields increased eight bps Friday to 0.725% (high since December), and December Eurodollars jumped nine basis points to 0.865%.

The conventional view holds that Friday’s strong non-farm payroll report increases the odds of a June rate increase. Importantly, the markets must face the uncertainty of a now rapidly approaching reversal after six years of unprecedented easy “money.” And while the markets remain confident the Yellen Fed will approach “normalization” with the most cautious little baby-steps imaginable, the key market issue at this point is the great uncertainty associated with years of policy-induced market excess and distortions. It’s worth noting that EM bonds suffered much more dramatic Friday losses than Treasuries.

Friday trading saw South African yields surged 25 bps, Colombia 20 bps, Turkey 18 bps, Brazil 15 bps, Mexico 16 bps, Hungary 25 bps and Poland 17 bps. And EM currencies took one on the chin. Friday action saw the Mexican peso fall 2.0%, Brazilian real 2.0%, Czech Koruna 1.9%, Bulgarian lev 1.7%, Hungarian forint 1.7%, Romanian leu 1.7%, South African rand 1.7%, Colombian peso 1.5% and Polish zloty 1.4%.

From my perspective,

Friday may have provided The Tipping Point for King Dollar.

The Dollar Index jumped 1.3% during Friday’s session to the highest level since 2003. The dollar is now in its most powerful advance since King Dollar’s heyday back in the late-nineties. The King Dollar speculative dynamic is also turning highly destabilizing.

Interestingly, at the top of the Periphery Fragility List, Brazil and Turkey saw their currencies this week hammered 7.3% and 4.4%, respectively. Brazilian (real) 10-year bond yields surged 69 bps to 12.97%. Brazilian stocks were hit for 3.1%, giving back all 2015 gains. Turkish (dollar) yields jumped 37 bps this week to the highest level since December (4.68%). Turkish stocks sank 4.6%, also to the low since December.

Despite all the talk of global deflation risk, Brazil and Turkey (among others) have inflation problems. Bloomberg: “Brazil Posts Fastest Annual Inflation in Almost a Decade.” Consumer price inflation has been running above 9% in Turkey for much of the past year. Rapidly devaluing currencies now exacerbate inflationary pressures – the ugly old vicious cycle taking hold (that the printing press can’t rectify).

For the most part (excluding Ukraine, Venezuela and Russia), EM bond markets have held their own – even in the face of faltering EM Bubbles. I’ll Credit this feat largely to the Fed’s intransigent zero-rate policy; BOJ and ECB liquidity injections; Chinese fiscal and monetary stimulus; and, in general, huge interest-rate differentials to “developed” bonds coupled with a massive (and expanding) pool of global speculative finance. And as King Dollar pressured commodities and EM currencies, global deflationary fears were fanned. This ensured that the dovish Fed stayed put at zero, which accommodated “Bubble On” and resulting runaway Bubbles throughout U.S. securities markets. Domestic and global fragilities ensured unrelenting “do whatever it takes” monetary stimulus from the ECB and BOJ that, when coupled with U.S. excess, provided ample fuel for a more globalized “Bubble On.”

But the global pool of speculative finance became too massive and unwieldy, while yen and euro devaluation got out of hand. Global securities markets became too leveraged. The resulting King Dollar Dynamic ensured that global “hot money” flooded into U.S. asset markets (stocks, bonds, real estate, tech, biotech, energy, private businesses, etc.). Reminiscent of the late-nineties, this dynamic became a self-reinforcing Bubble. The stronger the dollar, the more pressure on EM – inciting flows out of the faltering Periphery to the bubbling Core.

Considering the U.S. financial and economic backdrops, rates – Fed funds to long-bond – are much too low. The prospect of the Fed commencing rate “normalization” only throws more gas on King Dollar. This applies more pressure on EM currencies and commodities, which further stokes King Dollar.

The King Dollar Tipping Point comes when EM markets turn disorderly – currencies and bonds.

Disorderly is spurred by the prospect of companies, financial institutions and countries not having the wherewithal to service dollar-denominated obligations. And be mindful of critical market psychology: King Dollar ensures that investors in dollar-denominated debt are for a while willing to overlook a lot of EM fundamental deterioration. There comes, however, a Tipping Point where investors begin to fret the ability of the EM debtor to service debts and stabilize economies while avoiding the printing press. There comes a time when nervous speculators move to hedge exposure. There arrives a Tipping Point where market illiquidity becomes a serious concern.

I believe stocks were hit hard on Friday because a surging dollar and U.S. bond yields now push EM bond markets a big step closer to a disorderly “Risk Off” dynamic. A surprise jump in global yields would portend problematic de-leveraging. I wrote last week that every fledgling Risk Off should now be monitored closely.

The global system is much more vulnerable to a liquidity event than is commonly perceived.

The global leveraged speculating community continues to struggle with performance – hence is susceptible to losses, de-leveraging, redemptions and more liquidity pressure on global markets. There is also the important issue of de-risking/de-leveraging dynamics throughout the global commodities complex having already negatively impacted the liquidity backdrop. Moreover, the Fed has ended QE and the pressure is now on the Fed to begin normalizing rates.

It’s been an important part of my thesis for a while now that the next meaningful de-risking/de-leveraging episode would be poised for unexpected tumult. Yet each fledgling “Risk Off” was met with comforting words and liquidity from the Fed and global central bankers more generally. But I’ll presume (for now) that a 5.5% unemployment rate and elevated securities prices will dissuade the Fed from quickly restarting QE. Meanwhile,

ECB and BOJ QE feed an increasingly destabilizing King Dollar,

much to the expense of the likes of Brazil, Turkey, Mexico, South Africa, Indonesia, Malaysia, etc.

And there’s another King Dollar wildcard worth pondering: China’s renminbi. As I touched on last week, King Dollar creates a serious dilemma for Chinese officials. Chinese exporters became less competitive again this week. And there is increasing focus on the possibility of destabilizing outflows from China. Meanwhile, Chinese officials admitted to expanding difficulties, including rising inequality. An ongoing parabolic dollar move might force their hand on de-pegging their currency from King Dollar.

While U.S. stock and bonds were under pressure this week, for the most part spreads were well-behaved. The yen was also under pressure, weakness that supports the “yen carry trade” and global leverage more generally.

For Risk Off to attain momentum, I would expect to see spreads widen and the yen to catch a bid. And with Brazil, Mexico, Turkey, South African and others under pressure late this week, markets are on the brink of a full-fledged EM problem - a King Dollar Tipping Point.

03-07-15

Did the Dollar Get its Groove Back? 02-28-15 Marc To Market

The US dollar traded higher against most of the major currencies over the past week. No thanks to Yellen's testimony before Congress. Market participants took away from her a reduced chance of a mid-year rate hike.

We disagree with the interpretation, seeing her comments as 1) playing down lowflation as transitory and 2) seeing the global influence being overall balanced as the decline in oil prices and interest rates offset the dollar's appreciation. We continue to expect the FOMC to drop its "patient" forward guidance at its mid-March meeting.

The main impetus for the dollar appeared to come from the sharp drop in European interest rates. Germany auctioned five- and seven-year bonds with a negative yield. Record low 10-year yields were recorded in at least eight eurozone members. This includes Ireland's 10-year benchmark yield falling below 1% and Portugal's 10-year yield falling below 2%. Spread compression continues. It is being driven by anticipation of the ECB's sovereign bond purchases.

The ECB's bond buying program is expected to be launched after next week's policy making meeting (in Cyprus). It still appears to be some necessary technical and legal details to be worked out before the Eurosystem can begin implementing the new program.

The Dollar Index held support seen near 94.00 and moved within spitting distance of the high set in late-January just above 95.50. The MACDs are poised to cross higher, as are the slow Stochastics, but the RSI is neutral. On balance, we view the consoldiative phase in recent weeks as building a base for a new leg up.

Over the past month, the market tried several times to push the euro through the $1.15 level. It failed. Previous support in the $1.1265 area may now offer resistance. It is difficult to talk about strong support. The push below $1.1l in late-January was brief. That area remains the next immediate target, but we suspect the $1.10 area may be more important psychologically.

We often argue that the dollar-yen is a range-bound currency, and when it looks like it is trending, it is moving from one range to another. It has been in narrowing range since December. Indeed, the January range was inside the December range, and the February range was inside the January range. The technical indicators that we use do not give us much hope of a near-term break of the JPY118-JPY120.50 trading range. On the medium-term, we continue to anticipate an eventual upside break.

The technical tone of sterling remains constructive. Since pushing above the 20-day moving average on February 3, sterling has stayed above it and managed to poke through $1.55 for the first time since the start of the year. Although it failed to establish a foothold above there, we do not think the market has given up on it. Our reading of the technicals suggests that there may be one more leg up that could get sterling closer to $1.56. Firm PMI readings in the week ahead could help solidify expectations that the BOE will be the next major central bank to hike rates after the US.

Over the past two weeks the dollar has tested its 100-day moving average against the Swiss franc. It is found near CHF0.9550, and the dollar has stalled. Technical indicators are not generating strong signals. The key potential key reversal on February 20 did not spur any follow through dollar selling. Recall that the euro also posted a key reversal on February 20. The euro did not make a new high and spent most of the week within the February 20 range. The euro has held above CHF1.05 since February 13.

The US dollar has been carving out what appears to be a consolidative triangle pattern throughout February. The bottom of the triangle is fairly flat around CAD1.2350. The down sloping top of the triangle comes in near CAD1.25 by the end of the week. The key drivers may be whether the Bank of Canada takes out additional insurance next week by cutting rates again and whether oil prices recover further. A strong US employment report at the end of the week could renew speculation of a Fed hike in June. We anticipate a break out to the upside but are also aware that the pattern is notorious for false breaks.

Ideas that the Reserve Bank of Australia may not cut rates next week helped to briefly push the Aussie through $0.7900. However, weak capex has kept the OIS, and forward markets nearly evenly split. If the RBA does not cut rates in March, it will simply raise the conviction levels that a cut will be delivered in Q2. A number of participants expect two cuts to be delivered. We are more inclined to sell into Aussie gains, which the technical indicators still are consistent with, toward $0.7940-50 on ideas that resistance around $0.8000 will be formidable.

The April crude oil futures contract (WTI) spent the month in February in a wide but clear trading range. The bottom around $47.50 was approached at the end of last week. The upper end of the range is near $55. Many participants are suggesting a key low is in place and appear to be better buyers on pullbacks. The MACDs are turning down. The slow Stochastics are falling but in neutral territory. The RSI is neutral. Prices need to rise above $51.50 to be anything noteworthy.

US 10-year Treasury yields rose from 1.64% at the start of February to a high of 2.16% on February 18. The push down to 1.92% at the end of last week nearly retraced 50% of the increase in yields. Key to the outlook is the US jobs report, which the ADP estimate steals much of the thunder. The yield can rise toward 2.07-2.10% ahead of the data.

The S&P 500 set new record highs on February 25 just shy of 2120. The MACDs and slow Stochastics warn of the loss of upside momentum. The RSI is more neutral. Since closing above 2100 on February 20, this has become support. Our reading of the technical condition suggests risk of a pullback into the 2080-2090 area, which would not damage the larger constructive tone.

Observations from the speculative positioning of the futures market:

1. For the second consecutive week, there were no significant position adjustments among speculators in the currency futures, which we define as a shift of at least 10k contracts in the gross position. The gross short euro position was the closest at 9.5k contracts were covered, leaving 223.2k open. The gross short euro position has fallen by about 21k contracts this month as the downside momentum faded.

2. To the extent that there was an overall pattern, speculators reduced gross short positions in the majors and added to them in the dollar-bloc and peso. Gross long positions were mostly added to, with the exception of the euro and the Australian dollar, both of which fell by less than 2k contracts. This is consistent with the consolidative tone seen in the spot market.

3. Although the week to week gross position adjustments in February has been modest, the adjustment have trended. This was the third week that the net short euro position has fallen. It has been driven more by short covering that bottom picking. The net short yen position has been reduced for six consecutive weeks. At -47.5k, it is half of the size it was at the start of the year. The net short sterling position extended its falling streak to five weeks. It has been halved since the end of January to 21.9k contracts.

4. The net short 10-year Treasury futures position swelled to 110k from 67.2k contracts. However, the gross short position hardly changed. It slipped by 500 contracts to 469.8k. What happened was the longs jumped out: The gross long position fell 43k contracts to 360k.

5. The net long speculative light sweet oil futures position fell by nearly 10% to 270k contracts. The bulls and bears saw things they liked. The bulls added 12.2k long contracts to give them almost 491k. The bears added 41.7k short contracts giving them 221k.

02-28-15

The Currency War Has Expanded to New Fronts Elliott Wave International

The "Currency War" that EWFF discussed in October and again in the most recent issue has expanded to new fronts, as world central banks fought to remain economically competitive by trying to push down the value of their currencies. Singapore became at least the ninth nation to "jump on the easing bandwagon" in January, employing loose monetary measures designed to reduce the value of the Singapore dollar.

Our long term bullish forecast for the U.S. dollar remains on track, and this month the Dollar Index jumped to 95.527, retracing 50% of its decline from 121.020 in July 2011 to 70.700 in March 2008. Short term, the rally is stretched like a taut piece of rope: prices have closed higher for 30 out of the past 39 weeks. Recently, a 10-day average of a poll of currency traders (courtesy trade-futures.com) showed 93.7% dollar bulls, an all-time record high. Also, Large Speculators in futures and options, who are generally trend-followers, now hold an all-time record net-long position of 72,897 contracts, as shown on the chart on the above. The extreme in these measures shows the strength of the rally but also reflects a trend that is ripe for a correction. The U.S. Dollar Index is at or near the end of Intermediate wave (3), which started in May 2014. Wave (4) will be a multi-month pullback that alleviates the aforementioned sentiment extremes and sets up the dollar for another wave of advance.

Finally, with the U.S. dollar rallying together with gold and U.S. Treasury bond prices, it is clear that investors are seeking money havens, assets they perceive will hold value the best in an increasingly risky environment. As deflationary forces intensify, it will become harder to find stable assets other than outright cash.

02-21-15

Will the US Dollar Crash Stocks Like It Did in 2008? Graham Summers 02-18-15 Phoenix Capital Research

For 30+ years, Western countries have been papering over the decline in living standards by issuing debt. In its simplest rendering, sovereign nations spent more than they could collect in taxes, so they issued debt (borrowed money) to fund their various welfare schemes.

This was usually sold as a “temporary” issue. But as politicians have shown us time and again, overspending is never a temporary issue. This is compounded by the fact that the political process largely consists of promising various social spending programs/ entitlements to incentivize voters.

In the US today, a whopping 47% of American households receive some kind of Government benefit. This type of social spending is not temporary… this is endemic.

The US is not alone… Most major Western nations are completely bankrupt due to excessive social spending. And ALL of this spending has been fueled by bonds.

This is why Central Banks have done everything they can to stop any and all defaults from occurring in the sovereign bonds space. Indeed, when you consider the bond bubble everything Central Banks have done begins to make sense.

Central banks cut interest rates to make these gargantuan debts more serviceable.
Central banks want/target inflation because it makes the debts more serviceable and puts off the inevitable debt restructuring.
Central banks are terrified of debt deflation (Fed Chair Janet Yellen herself admitted that oil’s recent deflation was economically positive) because it would burst the bond bubble and bankrupt sovereign nations.

So how will all of this play out?

The first real sign of trouble has already emerged. That sign pertains to the US Dollar.

Globally, the world is awash in borrowed money… most of it in US Dollars. The US Dollar carry trade is north of $9 trillion… literally than the economies of Germany and Japan COMBINED.

When you BORROW in US Dollars you are effectively SHORTING the US Dollar. So when the US Dollar rallies… you have to cover your SHORT or you blow up.

And the US Dollar has been rallying… HARD. Indeed, the move that began in July is already on par in scope with that which occurred during the 2008 meltdown:

This first wave imploded the price of Oil, numerous other commodities, and several emerging markets equities, most notably in Russia and Brazil.

However, the US markets are not immune to the move.

Some 87% of companies have guided below consensus expectations for next quarter. The stronger US Dollar is hurting profits… which are the single biggest driver of stock prices.

What happened the last time that stocks were strongly disconnected from reality… and the US Dollar began to rally hard?

Be prepared.

02-21-15

Real Trade-Weighted Dollar At A 141-Month High 02-04-15 GavKal

The real trade-weighted exchange rate index against major currencies has reached its highest level at the end of January since April 2003. The broader index is currently at a 69-month high. The major currency index includes six currencies (Euro, Yen, Canadian Dollar, Pound Sterling, Swedish Krona, and Swiss Franc). The broader definition includes 26 different currencies. The currency weights are based on yearly trade data. In order to calculate a "real" (i.e inflation-adjusted) exchange rate, the nominal exchange is multiplied by the ratio of US CPI index to the foreign currency CPI index.

The nominal trade-weighted exchange rate index by major currencies is at its highest level since May 2004, while the broader index is at its highest level since March 9th, 2009 (the infamous start to the current bull market).

Lastly, our purchasing power parity diffusion index has fallen to 0 for the first time since 2009. This means that on a purchasing power parity basis, nine currencies are currently overvalued versus the USD and nine currencies are undervalued versus the USD.

02-21-15

Is Energy's Dead Cat Bounce Over?

On an equal-weighted basis, the energy sector has still been the best performing sector in February. It is nearly 7% higher this month, however, it has been the worst performing sector so far this week (-1.5%).

MSCI World Index Performance By Sector

Only 14% of energy stocks are positive this year but shorter term momentum has improved. Unfortunately, it has improved to the point where momentum tends to stall out. 75% of energy stocks are now trading above its 50-day moving average. 80% tends to be an unsustainable level for very long.

Longer term momentum still looks pretty weak. Only 19% of energy stocks are trading above its 100-day moving average and only 9% of stocks are trading above its 200-day moving average.

Lastly, only 6% of stocks have a 50-day moving average trading above its 200-day moving average. This series needs to turn higher before we would feel confident that the bearish trend in energy stocks has turned. In the chart below we chart this series against the six month returns of the MSCI Energy sector.

02-14-15

Big Cyclical Bounce Last Week (Week of Feb 02) Led By Energy

We had a big bounce in cyclical sectors last week in the MSCI World Index. On an equal-weighted basis, the energy sector outperformed the MSCI World Index by over 6% last week. The second best performing sector was financials (+3.12%) and the the third best performing sector was materials (+2.78%). The bottom of the leader board is made up of counter-cyclical sectors. Utilities was the only sector that finished the week in the red (-1.96%), while consumer staples (+0.59%) and health care (+0.70%) rounded out the laggards. Year-to-date, health care remains the best performing sector (+4.08%) and energy (+0.36) has finally moved out of last place and into positive territory for the year. Utilities (-0.57%) has been the worst performing sector so far in 2015.

MSCI World Index Performance By Sector

The performance story in the emerging markets last week was similar, it just wasn't as extreme. Energy (+3.16%) was the best performing sector followed closely by materials (+3.14%). However, the third best performing sector was a counter-cyclical sector. Consumer staples ended the week 1.83% higher. The average stock in the MSCI Emerging Markets Index ended the week 1.02% higher. The worst performing sector last week was health care (-2.40%) followed by utilities (-2.15%). Year-to-date, information technology (+5.23%) is the best performing sector followed by energy (+4.18%) and consumer staples (+3.5%). Utilities is by far the worst performing sector in the emerging markets. It is down 5.27% so far this year while the second worst performing sector, financials, is only down 0.75%.

MSCI Emerging Markets Index Performance By Sector

02-14-15