Yesterday we looked at the charts on oil and the U.S. 10 year yield. Both were looking poised to breakout of a technical downtrend. And both did so today.
Here’s an updated look at oil today.
And here’s a look at yields.
We talked yesterday about the improving prospects that we will get some policy execution on the Trumponomics front (i.e. fiscal stimulus), which would lift the economy and start driving some wage pressure and ultimately inflation (something unlimited global QE has been unable to do).
No surprise, the two most disconnected markets in recent months (oil and interest rates) have been the early movers in recent days, making up ground on the divergence that has developed with other asset classes.
Now, oil will be the big one to watch. Yields have a lot to do, right now, with where oil goes.
Though the central banks like to say they look at inflation excluding food and energy, they’re behavior doesn’t support it. Oil does indeed play a big role in the inflation outlook – because it plays a huge role in financial stability, the credit markets and the health of the banking system. Remember, in the oil price bust last year the Fed had to reverse course on its tightening plan and other major central banks coordinated to come to the rescue with easing measures to fend off the threat of cheap oil (which was quickly creating risk of another financial crisis as an entire shale industry was lining up for defaults, as were oil producing countries with heavy oil dependencies).
So, if oil can sustain above the $50 level, watch for the inflation chatter to begin picking up. And the rate hike chatter to begin picking up (not just with the Fed, but with the BOE and ECB). Higher oil prices will only increase this divergence in the chart below, making the interest rate market a strong candidate for a big move.
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Yesterday we looked at some key markets, some that have recovered nicely following the Brexit news, and others that are still down on either safe-haven demand or speculation of economic drags due to the Brexit. One particular spot that hasn’t fared well in the past week is Japan.
Japan is three years into a bold plan to beat two decades of deflation and restore its economy to prominence. The data shows that their efforts haven’t translated so well just yet. Inflation is still dead, and economic growth — about the same.
Two key tools in the Bank of Japan’s QE program, which is designed to drive inflation and economic activity, is a weaker yen and a higher stock market. Since they telegraphed their intentions of big, bold QE in late 2012, Japanese stocks have risen by as much as 140%. And the yen has declined by as much as 38% against the dollar. But over the past 12 months, about half of those “policy gains” have been given back. And post-Brexit the attrition has only worsened.
Still, after three years and big moves in the yen and stocks, the inflation objective remains a distant target. What does it mean? The Bank of Japan has to do more. A lot more.
We think they can, and will, ultimately destroy the value of the yen — mass devaluation.
Unlike the U.S., which is constrained by “flight to safety” global capital flows and a world reserve currency, Japan has the ingredients to make QE work, to promote demand, and to promote growth. Japan has the largest government debt problem in the world. They have an undervalued currency. They have a stagnating economy with big demographic challenges. They have are in a deflationary vortex.
They have the perfect attributes for a mass scale currency printing campaign. Not only can it work for their domestic economies, but it serves as the liquidity engine and stability preserver for the global economy.
In normal times, the rest of the world wouldn’t stand for a country outright devaluing their way to prosperity. But in a world where every country is in economic malaise, everyone can benefit – everyone needs it to work. It can be the solution for returning the global economy to sustainable growth. We wouldn’t be surprised to see USDJPY return to the levels of the mid-80s (versus the dollar)in the not too distant future. That would be 250+. Currently, 103 yen buys a dollar.
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The world was stirring today over the UK decision to leave the European Union. Here are a few things to keep in mind. As we discussed earlier in the week, the repercussions of the Brexit are very different than those that were feared over the potential “Grexit.” Greece was threatening to leave the euro. It would have had major and immediate financial complications, which could have quickly paralyzed the financial system.
The Brexit is more political than economic (not financial). And any retrenchment in the banking system because of uncertainty can be immediately quelled by central bank intervention. Not only were the central banks out in front of the potential exit outcome, promising to provide liquidity to the banking system, but they were also in last night stabilizing currencies, and likely bond yields as well.
As we said, there are also huge differences between now and 2008. When Lehman failed and global credit froze, we had no idea how policy makers might respond and how far they might go. Now we know, they will “do whatever it takes.”
The market volatility surrounding the Brexit may actually be a positive for the global economy. Seven years into the global economic recovery, global central banks have thrown the kitchen sink at the crisis, and they’ve proven to be able to stabilize the financial system and the global economy, and restore confidence. And that has all indirectly created an economic recovery, albeit a slow and sluggish one. But they haven’t been able to directly stimulate meaningful economic growth (the kind you typically see coming out of recession) because of the nature of the crisis.
Fiscal stimulus has been the missing piece of the puzzle.
Governments have been reluctant to spend, given the scars of the debt crisis. This may give policy makers an excuse to green light fiscal stimulus. After all, growth (or the lack thereof) is the primary driver of the public discontent – not just in the UK, but globally. Growth has a way of solving a lot of problems.
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Tomorrow is the UK vote, where UK citizens will vote on whether to ‘stay’ or to ‘leave’ the European Union. In this post-Lehman (failure) era, we’ve had no shortage of fear and doubt. Remember the Fiscal Cliff, Sequestration, Cyprus, several chapters of the drama in Greece, Italy and Spain were threatening default, China’s slowdown – the list could go on.
Along the way, the message in the media has always had little substance, but one very common word to promote and validate fear: the word, “uncertainty.”
But throughout this entire post-Lehman era, the world has been a very uncertain place. Whether times have been relatively good or not so good, given the state of the world seven years ago, and given the unprecedented policies it has taken to get us here, uncertainty is the new normal. But what is certain, following the near apocalypse of the global economy, is how policy makers will respond. We know, without a question, they will do ‘whatever it takes’ — their own words. And they’ve proven that their actions can avert disasters and promote confidence and recovery.
With all of this in mind, let’s dig in a little bit and talk about the UK vote.
First, to be clear, there are a lot of comparisons made to the Greek vote last year (the “Grexit”). The UK vote (the “Brexit”) is very different.
The notion of Grexit threatened the existence of the second most widely held currency in the world, the euro. That was a much, much bigger deal. The UK, of course, is part of the European Union, but not part of the currency union. They did not adopt the euro. They have their own currency and their own monetary policy. The UK vote is about trade, immigration, ability to work and live in other EU countries — perhaps mostly about control and politics.
The polls have been broadly building the story for an exit, though they are also broadly deemed unreliable. Meanwhile the bookmakers have had the chances of an exit, along much of the way, as slim (at about 70/30 favoring the ‘stay’ camp). Still, at the peak of the frenzy last week, that number had narrowed to 56/44 favoring ‘stay.’ But when the pendulum of sentiment swung, so did the bookmakers odds of a ‘leave’ vote winning. They are putting the chances of an exit at just 25% as we head into tomorrow’s vote.
As we said, we’ve seen a number of events over the course of the past several years that have introduced fear and doubt into the minds of investors (and especially the media). Something to keep in mind: Any and all of the dips in markets associated with those flare-ups have proven to be extremely valuable buying opportunities. As we noted yesterday, some of the best spots to buy the dip this time around will likely be German and Japanese stocks.
Have a great night.
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On Friday we looked at four key market charts that suggested the worst of the Brexit storm may be behind us.
As of Friday afternoon, the bookmakers had the odds of the UK staying in the Eurozone at 64%, versus 36% leaving. And as we looked across the prices of gold, oil and stocks, all were suggesting, at least technically, that the peak of fear, regarding a Brexit, had passed.
Gold was rising sharply early last week. Oil began to slide. These are two very important barometers of global risk appetite, and those moves were clearly demonstrating fear and uncertainty in markets.
But on Thursday, gold put in a key reversal signal. So did oil, on Friday. Those reversals continued today. Additionally, a very key bond market in Germany (the German 10 year bund yield), which traded into negative yield territory at one point last week, has been clawing back into positive territory since Friday (trading above 5 basis points today – positive 5 basis points).
Why? Because of this chart…
Above is an update of the bookmaker odds on a Brexit. The chances of a leave have now dropped from 44% to 25%, since Thursday.
That’s why global markets are aggressively taking back the hedging and selling from last week.
The UK vote is this Thursday. We’ve said months ago, that despite the speculation of a UK exit, it was not going to happen, given where the oddsmakers were pricing the risk (at about 70/30 in favor of staying for much of the way), and given the scale of the “fear of the unknown” in the voter’s eyes. Adding to that, we expected that the warnings from big public figures would come in hot and heavy as the date approached. Type in the words “Brexit” and “warning” into Google and you get almost 7 million results.
Already, everyone has weighed in with draconian warnings in an attempt to influence the decision: from the UK Prime Minister, the head of the Bank of England, the head of the IMF, to the ECB, to the Fed and the U.S. President. Now UK employers have been latest, directly writing their employees to warn of the business damage from a ‘leave’ vote.
If the Brexit risk continues to abate, and the referendum comes and goes on Thursday, with a ‘stay’ vote, that should clear the way for broad global stock market rallies and a sharp bounce back in yields, as the focus will quickly turn to a July Fed rate hike.
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After a shaky few days for markets, we head into the weekend with some relative calm today. Next week the UK vote on leaving or staying in the European Union will dominate the market focus.
The pressure in markets had been building in recent days on the pick-up in momentum for the Brexit vote in the UK. A log on the fire for that pressure was the inaction from the four central banks that met this week (Fed, BOJ, SNB and BOE). Yields in German 10-years slid below zero. U.S. yields (10 years) hit four year lows. Stocks were sliding, globally. The upward momentum for gold started to kick in. And then we had the tragic murder of a member of British Parliament (widely considered to be politically driven, as she was a ‘stay’ advocate).
So leveraged positions across markets that were leaning in the direction of the momentum unwound, to an extent, on the news.
Today we want to step back and take a look at some key charts as we head into next week.
First, the odds of a Brexit from the bookmakers…
As we’ve said, along the way, despite the coin flip projections coming out of the many polls in the UK, this estimation has been clearly favoring the ‘stay’ camp by about 70/30. Though in recent days the probability of an exit had risen to 44%. Following the tragic news yesterday, that number is now back to 36%.
Next is a chart of gold. This is the safe haven trade, though it hasn’t much allure in quite some time. Still, gold found some legs in the past 10 days.
But as you can see in the chart above, after a $35 higher yesterday, it reversed sharply to close on the lows. In the process it put in a very nice technical reversal pattern (an outside day – where the day’s range engulfs the prior day’s range, caused by low conviction ‘longs’ reversing course near the highs and hitting the exit doors, exacerbating the slide into the close). That price action would argue for lower gold, and in general, the end of this recent flurry of doubt surrounding the UK vote (and uptick in broad market volatility).
As we know, the sustainability of the crude oil recovery is a huge factor in global financial market stability. After trading above $50, it had six consecutive days of lower lows, but it bounced back aggressively today, also posting a key reversal signal (bullish outside day – again, good for the global stability outlook).
Finally, a look at the chart of the S&P 500 …
Despite all of the negative messaging across the media and uncertainty from the investment community, as we head into the weekend stocks sit just 3% off of the all-time highs.
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The Fed held rates steady today. As we’ve talked about, this was a decision they laid the ground work for over the past two weeks. We want to talk about a few takeaways from the Fed event, and then continue our discussion from yesterday on the Bank of Japan decision tonight (where the big news may come).
First, the Fed did indeed consider the global stability risk that comes with the decision in the UK on whether or not to leave the European Union. The polls in recent weeks have continued to show that it could go either way. Meanwhile, the bookmakers have had this vote clearly in favor of “staying” in the European Union all along — as much as 70/30 ‘stay’ much of the way. But those odds have been narrowing in the past week.
Still, as we discussed yesterday, holding pat on rates today was a “no risk” decision, especially because they had an event (the weak jobs data) and the platform (through a prepared speech by Yellen just days after the weak jobs data) to manage away expectations for a hike.
With that, stocks remained steady on the decision. And markets in general remained tame.
So now the Fed is in position to see the outcome in the UK. There was some two way talk about the jobs and inflation data, but it looks like the Fed is most concerned with what’s going on in the global economy. That’s clear in their reaction to the oil price bust, when they responded back in March by taking two rate hike projections off the table. And it’s clear in their reaction now to the Brexit risk.
But their new projections on the future path of interest rates have been ratcheted down in the coming years, and in the long run. For perspective, a year ago the Fed thought the benchmark rate would be 2.75%. Now they think it will be 1.5. Why? What’s been acknowledged more and more in recent meetings is the impact of the weakness and threats in global economies on the U.S. economic outlook. The U.S. economy has been relied upon to drive global economic recovery, but it’s being dragged down now by the weight of global economic weakness.
This all puts pressure on Europe and Japan to follow through on their promise to do “whatever it takes” to restore their economies.
As we’ve said, the most important spots in the world, right now, are Japan and Europe. The Fed only began its campaign of removing its emergency level policies because Europe and Japan took the QE baton handoff from the Fed – picking up where the Fed left off. And unlike the U.S., which is constrained by “flight to safety” global capital flows and a world reserve currency, they have the ingredients (primarily Japan) to make QE work, to promote demand, to promote growth. Japan has the largest government debt problem in the world. They have an undervalued currency. They have a stagnating economy with big demographic challenges. They have are in a deflationary vortex.
They have the perfect attributes for a mass scale currency printing campaign. Not only can it work for their domestic economies, but it serves as the liquidity engine and stability preserver for the global economy.
In normal times, the rest of the world wouldn’t stand for a country outright devaluing their way to prosperity. But in a world where every country is in economic malaise, everyone can benefit – everyone needs it to work. It can be the solution for returning the global economy to sustainable growth.
With that, and given the position of the yen and Japanese stocks (see our chart yesterday), along with the underperforming economy in Japan, even after three years of QE, now is the time to throw the kitchen sink at it (i.e. they should act tonight, and in a ‘shock and awe’ fashion).
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Last week we talked a lot about the German bund yield, the most important market in the world right now. Today we want to talk about how to trade it.
The best investors in the world love asymmetric bets (limited downside and virtually, if not literally, unlimited upside). That’s the true recipe to building huge wealth. And there is no better asymmetric bet in the world right now than the German 10-year bund.
With that in mind, in recent weeks, we’ve revisited Bill Gross’ statement last year, when the 10-year government bond yields in Germany were flirting with zero the first time. He called it the “short of a lifetime” to be short the price of German bunds – looking for yields to bounce back. It happened. And it happened aggressively. Within two months the German 10 year yield rocketed from 6 basis points to over 100 basis points (over 1%). But even Gross himself wasn’t on board to the extent he wanted to be. The bounce was so fast, it left a lot of the visionaries of this trade behind.
But over the past year, it’s all come back.
Is it a second chance? German yields are hovering just a touch above zero — threatening to break into negative yield territory for one of the world’s most important government bond markets.
As we said on Friday, the zero line on the German 10-year government bond yield is huge psychological marker for perceived value and credibility of the ECB’s QE efforts. And that has huge consequences, not just for Europe, but for the global economy.
Given the importance of this level (regarding ECB credibility), it’s no surprise that the zero line isn’t giving way easily. This is precisely why Bill Gross called it the “short of a lifetime.” With that, let’s take a look at the incredible risk/reward this represents, and a simple way that one might trade it.
There is a euro bund future (symbol GBL) that tracks the price of the German 10-year bund. Right now, you can trade 1 contract of the German bund future at a value of 164,770 euros by putting up margin of 3,800 euros (the overnight margin at a leading retail broker). If you went short the bund future, here are some potential scenarios:
If you break the zero line in yield, the euro bund future would trade up to about 165.50 (it currently trade 164.77). If you stopped out on a break of zero in yield, you lose 730 euros (about $820 per contract). If the zero line doesn’t breach, and yields do indeed bounce from here, you make about 1,500 euros for every 10 basis point move higher in the German 10-year bund yield.
For example, on a bounce back to 32 basis points, where we stood on March 15th, the profit on your short position would be about 4,600 euros (or about $5,200). If German bund yields don’t breach zero and bounce back to 1%, where it traded just a year ago, you would make about 15,000 euros ($16,900) per contract on your initial risk of $820 – a 20 to 1 winner. Of course, there are margin costs to consider, given the holding period of the trade, but in a zero rate world, it’s relatively small.
If you’re wrong, and the German 10-year yield breaches zero, you’ll know it soon.
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We’ve talked about the bullish technical break occurring in stocks. That’s continuing again today.
Remember, a week from this past Friday we talked about the G7 (G8) effect on stocks. We stepped back through every annual meeting of world leaders since 2009. And the results were clear. If the communiqué from the meetings focused on concerns about the global economy, stocks went higher. It’s that simple.
Why? In the post Great Recession world, stocks are the key barometer of global confidence. Higher stocks can help promote economic recovery (better confidence, higher wealth effect). Lower stocks can derail it, and threaten a bigger downturn, if not fatal blow to the global economy.
Policymakers can and do influence stocks. And thus, when we’ve seen clear messaging from these meetings about global economic concerns, stocks have done well (in most cases, very well).
With all of this said, on May 27th, from the meeting in Japan, the G7 issued their communiqué and it started with global growth concerns. They said, “Global growth is our urgent priority.” The S&P 500 closed at 2099. Today it’s trading 2116 and is closing in on the all-time highs set in May of last year (less than 1% away).
Now, we talked in past months about the importance of Europe. The Fed’s best friend (and the global economy’s best friend) is an improving economy in Europe. We’ve seen some positive surprises in the data out of Europe, but the actions taken this morning by the ECB could be the real catalyst to get the ball rolling — to mark the bottom, to get Europe out of the slow-to-no growth, deflation funk.
They ECB started implementing a new piece to its QE program today. Of course, they promised bigger and bolder QE back in March (mostly as a response to the cheap oil threat). Today they started buying corporate bonds as part of that ramped-up QE plan.
With that, this is a very important observation to keep in mind. Over the history of the Fed’s three rounds of QE, when the Fed telegraphed QE, rates went lower. When they began the actual execution of QE (actually buying bonds), rates went HIGHER, not lower (contrary to popular expectations). Why? Because the market began pricing in a better economic outlook, given the Fed’s actions. We think we could see this play out in Europe as well.
Take a look at this chart of German yields. This is probably the most important chart in the world to watch over the next several days.
The German 10-year yield traded as low as 3 basis points (that’s earning 30 euros a year for every 100,000 euros you loan the German government, for 10 years). Of course, the most important visual in this chart is how close the German 10-year yield is to zero (the white line), and then negative rates.
Remember, we’ve said before that Draghi and the ECB have made it clear that they won’t cut their benchmark rate below zero. And “that should keep the 10–year yield ABOVE zero.” Were we right? We’ll find out very soon. If so, and if German yields put in a low today on the “actual execution” of the ECB’s new corporate bond buying program, then U.S. yields would be at bottom a here too.
You can see in the above chart, it’s a make or break level for the U.S. 10 year yield as well (as it is tracking German yields at this stage). While lower yields from here in these two key markets might sound great to some, it comes with a lot of problems, not the least of which is a negative message about the outlook for the global economy and thus damage to global confidence. Keep an eye on German yields, the most important market to watch in the coming days.
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Today the rebound in oil led a significant turnaround for stocks. With that, the broader sentiment of uncertainty across markets tends to abate. Broader commodities swung from negative to positive. And yields on the U.S. 10-year Treasury, which were in deep decline this morning, swung to positive territory by the afternoon.
If you own stocks, a house, have a job or need to eat, you should cheer for higher oil prices.
As we’ve talked about quite a bit in recent weeks, cheap oil, at this point in the global economic recovery, is a catalyst to destabilize the global economy. While consumers gain a few bucks from cheaper gas, the oil industry leans closer to the edge of bankruptcies and weak oil exporting countries toward default. That would be very bad news (global financial crisis, round 2). So the longer we’re down here, and the more persistent these low levels appear, the riskier the world looks. And when the world looks risky, people sell stocks, and other relatively risky assets and they hold cash or buy U.S. Treasuries (which pushes yields lower).
For proof, here’s a look at the 10-year yield on the U.S. Treasury note.
Keep in mind, the Fed raised rates in December! They did so when the 10 year was trading at a yield of 2.20%. The yield is now 45 basis points lower. And even though a voting Fed member said yesterday that in her view, a second hike was still on the table for next month, the market has still virtually priced out the possibility of any further hikes for the rest of the year.
Why? Because other parts of the world are moving (or are moving deeper) into negative rate territory, because economic conditions continue to soften, mostly driven by sentiment and weakening inflation prospects. A big driver of that mix is the oil price crash.
In the next chart, you can see how yields, despite the December rate hike, have tracked oil lower.
Again, when people think the world looks risky, they pile into the safest parking place for capital on the planet, U.S. Treasuries –and that drives yields on Treasuries lower. While that flow of capital has certainly occurred, the pressure on yields from speculators is also a big component.
If you recall, we discussed a couple of weeks ago how markets can have it wrong – sometimes very wrong. If indeed, the market is wrong on this one, there is a tremendous opportunity to ride yields back to the 2.25% area. And it may be a violent move.
But oil will be the driver.
As we said, oil turned the tide for stocks today. Here’s a look at the relationship of oil and stocks over the past three months.
In this longer term chart above, you can get perspective on where oil prices stand relative to history. You can see in this chart the sharp rise, the sharp fall and the rebound from the depths of the global financial crisis.
That rebound was all China. China stepped in and used their three trillion dollars in foreign currency reserves AND their massive fiscal stimulus package to gobble up cheap commodities.
And you can see this most recent price crash was triggered by move by the Saudis to block an OPEC production cut in November 2014. It was the night of the Thanksgiving holiday in the U.S. and oil was trading about $73. We haven’t seen that price since.
The low at the depths of the financial crisis was 32.40. That’s about where oil closed today. We’ve made the case in recent weeks that, if OPEC refuses to cut production (likely), the central banks could/should step in and buy oil (the ECB, BOJ and/or China).
Bryan Rich is a macro trader and co-founder of Billionaire’s Portfolio,a subscription-based service that empowers average investors to invest alongside the world’s best billionaire investors.
