Yesterday we talked about the Draghi remarks (head of the European Central Bank) that were intended to set expectations that the ECB might be moving toward the exit doors on QE and zero interest rate policy. That bottomed out global rates — which popped U.S. rates further today. The Bank of England piled on today, talking about rate normalization soon.
We’ve gone from 2.12% in the U.S. ten year yield to 2.25% in about 24 hours. These are big swings in the interest rate market – a big bounce and, as I’ve said, the bottom appears to be in for rates.
As importantly, this prepared speech by Draghi could very well cement the top in the dollar. It begins to tighten a very wide interest rate spread between the U.S. and global rates. We entered the year with the Fed going one way (tightening) while the rest of the world was going the other way (easing). That’s a recipe for capital to storm into U.S. assets — into the dollar. And now that may be over.
I’ve been researching long-term cycles in the dollar for a very long time and throughout the global financial crisis period, it these cycles in the world’s reserve currency have been my guidepost for drawing a lot of conclusions on markets and the outlook for capital flows over the past several years.
Despite the choppiness in the dollar for much of the crisis, if we look back at the cycles following the failure of the Bretton Woods system, we were able, very early on, to determine the dollar was in a bull cycle.
This view came in the face of all of the negative global sentiment toward the dollar in 2010. Foreign leaders were taking shots at the Fed, accusing the Fed of trying to destroy the dollar. People were calling for the end of the dollar as the world’s reserve currency. All the while, the dollar held firm and ultimately made an aggressive climb.
Take a look below at my chart on the long term dollar cycles…
I’ve watched this chart for quite some time, defining the five complete dollar cycles over the past nearly 40 years, and the most recent bull cycle.
If we mark the top of the most recent cycle in early January, this bull cycle has matched the longest cycle in duration (at 8.8 years) and comes in just shy of the long-term average performance of the five complete cycles. The most recent bull cycle added 47%. The average change over a long term cycle has been 56%. This all argues that the dollar bull cycle is over. And a weaker dollar is ahead. That should go over very well with the Trump administration.
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The Nasdaq trade unwound some today. From the peak this morning in the futures of 5898 the tumble started around 11am, falling to as low as 5660. That’s 238 Nasdaq futures points or 4% – quite a sharp move.
Remember, it seems like an overdone trade (driven by the big tech stocks). But as we discussed last week, the tech heavy Nasdaq has simply been a catch up trade — something that has lagged the strength in the broader market.
Here’s the chart we looked at last week.
This chart goes back to the lows driven by the oil price crash that bottomed out earlier last year.
Still, with the Nasdaq at +18% ytd and S&P 500 +9% ytd, as of this morning, as we’ve seen many times in this post-crisis era, the air pockets of illiquidity in stocks can give back gains very, very quickly. As they say, stocks go up on an escalator and down in an elevator.
The Trump trend, in the chart above, was nearly tested today — the same day a new all-time high was marked!
If we get another few days of sharp downside, it will be a tremendous buying opportunity – get your shopping list ready. And if that downside slide does indeed come, it could come at a very interesting time. It would add another (but very signficant) reason the Fed may balk on a rate hike next week. The other reasons? We discussed them yesterday (here).
Have a great weekend.
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Last week we looked at the some of the clear evidence that the economy is as primed as it can possibly get for a catalyst to come in and pop growth.That catalyst, despite all of the scrutiny, will be Trumponomics.
At the very least, a corporate tax cut will directly hit the bottom line of corporate America. And one of the huge drags on demand, structurally, is the lack of wage growth. And as we discussed, the big winner in a corporate tax cut will be workers/wage growth — a non-partisan tax think tank thinks it can pop wage growth, by as much as doublethe current growth rate. That would be huge, especially for one of the key pillars of the recovery — housing.Remember, the two biggest drivers of recovery have been: 1) stocks, and 2) housing. Those two assets have done the lion’s share of work when it comes to restoring confidence. And a lot of other key pieces fall into place when confidence comes back.
On the housing front, over the past year, both mortgage rates and house prices have gone UP – a new dynamic in the post crisis recovery (adding higher rates into the mix). So owning a house has become more expensive over the past year. But how much?
Let’s take a look at how that has affected the monthly outlay for new homeowners over the course of the past year.
From March 2016 to March 2017, the average 30 year fixed mortgage went from 3.70% to 4.20%.
The Case-Shiller housing price index of the top 20 markets in the U.S. is up 6% over that twelve month period (the most recent data). That’s increased the monthly outlay (principal and interest) for new homeowners by 11% over the past year.
Now, with that said, we look at the recent behavior of the 10 year note (the benchmark government bond yield that heavily influences mortgage rates). It’s been in world of its own — sliding back to seven month lows, while stocks are hitting record highs. Manipulation? Likely. As I’ve said before, don’t underestimate the value of QE that is still in full force around the world — namely in Japan and Europe. That’s freshly printed money that can continue to buy our Treasuries, keeping a cap on interest rates, which keeps a cap on mortgage rates, which keeps the housing recovery and the recovery in consumer credit demand intact.
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The past few days we’ve looked at the run up in bitcoin. Remember, I said: “If you own it, be careful. The last time the price of bitcoin ran wild, was 2013. It took about 11 days to triple, and about 18 days to give it all back. This time around, it’s taken two months to triple (as of today). ”
It looks to be fueled by speculation, and likely Chinese money finding its way out of China (beating capital controls). And yesterday we talked about the potential disruption to global markets that could come with a crash in bitcoin prices.
I suspect that’s why gold is finally beginning to move today, up almost 1%, and among the biggest movers of the day as we head into the long holiday weekend (an indication of some money moving to gold to hedge some shock risk).
Remember yesterday we looked at the chart on Chinese stocks back in 2015 and compared it to bitcoin. The speculative stock market frenzy back thin was pricked when the PBOC devalued the yuan later in the summer.
Probably no coincidence that bitcoin’s recent acceleration happened as Moody’s downgraded China’s credit rating this week for the first time since 1989 (an event to take note of). Yesterday, the PBOC was thought to be in buying Chinese stocks (another event to take note of). And this morning, the PBOC stepped in with another currency move! Historically, major turning points in markets tend to come with some form of intervention. Will a currency move be the catalyst to end the bitcoin run, as it did the runup in Chinese stocks two years ago?
Let’s take a look at what the currency move overnight means …
Keep in mind, the currency is China’s go-to tool for fixing problems. And they have problems. The economy is crawling around recession like territory. The debt was just downgraded. And they’ve had a tough time managing capital flight. As an easy indicator: Global stocks are soaring. Chinese stocks are dead (flat on the year).
Remember, their rapid economic ascent in the world came through exports (via a weak currency). The move overnight is a move back toward tying its currency more closely to the dollar. Which, if this next chart plays out, will also weaken the yuan compared to other big exporting competitors in the world.
That should help the Chinese economic outlook, which may help stem the capital flight (which has likely been a significant contributor to bitcoin’s rise).
We talked yesterday about run up in bitcoin. The price of bitcoin jumped another 14% today before falling back.
As I said yesterday, it looks like Chinese money is finding it’s way out of China (despite the capital controls) and finding a home in bitcoin (among other global assets). If you own it, be careful. The last time the price of bitcoin ran wild, was 2013. It took about 11 days to triple, and about 18 days to give it all back. This time around, it’s taken two months to triple (as of today).
If you’re looking for a warning signal on why it might not be sustainable (this bitcoin move), just look at the behavior across global markets. It’s not exactly an environment that would inspire confidence.
Gold is flat. Interest rates are soft. Stocks are constantly climbing. Commodities are quiet, except for oil — which fell back below $50 today on news that OPEC did indeed agree to extend its production cuts out to March of next year (bullish, though oil went south).
When the story is confusing, conviction levels go down, and cash levels go up (i.e. people de-risk). And maybe for good reason.
In looking at the bitcoin chart today, I thought back to the run up in Chinese stocks in early 2015. Here’s a look at the two charts side by side, possibly influenced by a lot of the same money.
The crash in Chinese stocks took global markets with it. It’s often hard to predict that catalyst that might prick a bubble and even harder to see the links that might lead to broader market instability. In this case, though, there are plenty of signs across markets that things are a little weird.
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As we discussed last week, we should expect more volatility in markets in the coming months, with the continued discovery surrounding Trump Policies (timing, size) and with UK/EU Brexit negotiations officially opening. That’s a dose of unknowns which should send stocks swinging around quite a bit more than we’ve seen for the past four months.
Remember, on Friday I noted the message the bond market was sending — with market interest rates (U.S. 10 year yields) closing the week, and quarter, at 2.39%. That’s almost a quarter point lower than the high that followed the March rate hike (the third in the Fed’s “normalization” process). And it’s about 10 basis point lower than where the 10 year stood going into the December 2015 rate hike. That’s a negative signal. And I suspect stocks will get that message.
With that said, the first day of the second quarter opened today with a slide in stocks, a slide further in yields and a rise in the price of gold.
When stocks go down, people get nervous and buy downside protection. That tends to spike implied volatility. There’s an index that measures that called the VIX.
Let’s talk about the VIX…
The VIX measures the implied volatility of options on the S&P 500. This is a key component in the price investors pay for downside protection on their portfolios.
So what is implied volatility? Implied volatility measures both actual volatilityand the options market maker community’s expectations (or perception of certainty) about future volatility. When market makers feel confident about the stability in markets, implied vol is lower, which makes the price of options cheaper. When they aren’t confident in stability, implied vol goes up, which makes the price of an option go up. To compensate those that are taking the other side of your trade, for the lack of predictability, you pay a premium.
You can see in the chart below, vol is very, very low — but has been ticking up.
Still, it takes a significant event – a high dose of uncertainty – to create a spike in implied volatility.
That spike tends to correlate well with a sharp slide in stocks. Otherwise, we’re looking at a garden-variety correction in stocks — and that’s what this low vol environment is spelling out.
We had a heavy event calendar last week for markets, with the Fed, BOJ and BOE meetings. And then we had the anticipation of the G-20 Finance Minister’s meeting as we headed into the weekend.
As I said to open the week last week, markets were pricing in a world without disruptions. But disruptions looked likely. Still, the week came and went and stocks were little changed on the week, but yields came in lower (despite the Fed’s third rate hike) and the dollar came in lower (again, despite the Fed’s third rate hike).
Is that a signal?
Maybe. But as we discussed on Friday, the divergence between market rates and the rate the Fed sets is part central bank-driven Treasury buying (from those still entrenched in QE — Japan, Europe), and part market speculation that higher rates are threatening to the economy, and therefore traders sell short term Treasuries (rates go higher) and buy longer term Treasuries (rates go lower). With that, the Fed has been ratcheting the Fed Funds rate higher, now three times, but the 10 year government bond yield is doing nothing.
As for the dollar, if your currency has been weak, no one wanted to head into a G-20 Finance Ministers meeting and sit across the table from the new Treasury Secretary under the Trump administration (Mnuchin) and be drawn into the fray of currency manipulation claims. With that, the dollar weakened across the board last week.
All told, we had little disruption last week, but things continue to look vulnerable this week. Today we have the FBI Director testifying before Congress and acknowledging an open investigation of Trump associates contacts with Russia during the election. Fed officials have already been out in full force today make a confusing Fed picture even more confusing. And it sounds like the UK will officially notify the EU on March 29 that they will exit.
With all of the above in mind, and given the growth policies from the Trump administration still have little visibility on “when” they might get things done, the picture for markets has become muddied.
This all makes stocks vulnerable to a correction, though dips should be met with a lot of buying interest. Perhaps the clearest trade in this picture that’s become more confusing to read, is gold.
Gold jumped on the Fed rate hike last week, and Yellen’s more hawkish tone on inflation. If she’s right, gold goes higher. If she’s wrong, and the Fed has made a big mistake by hiking three times in a world that still can’t sustain much growth or inflation, gold probably goes higher on the Fed’s self-inflicted wounds to the economy.
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With the Fed’s third rate hike this week in the post-financial crisis era, let’s take a look at how market rates have reponded.
Here’s a chart of the U.S. 10 year government bond yield.
On December 16, 2015, the Fed moved for the first time. The 10-year traded up to 2.33% that day and didn’t see that level again for 11-months. Despite the fact that the Fed forecasted four hikes over the next twelve months, the bond market wasn’t buying it. A month later, the fall in oil prices turned into a crash. And the 10 year yield printed a new record low at 1.32%, just under the crisis lows.
On December 14, 2016, the Fed made the second move. This was after they had spent the better part of the last nine months walking back on what they thought would be their 2016 hiking campaign. The difference? Trump was elected the new President and he was already fueling confidence from talk of big, bold fiscal stimulus. The Fed’s big hiking campaign was placed back on the table. The high in yields the day the Fed made hike #2 was 2.58%. The next day it put in a top at 2.64% that we have not seen since.
And, of course, this past week, we’ve had hike #3. The 10 year yield traded up to 2.60% that day (Wednesday) and we haven’t seen it since, despite the fact that the Fed has continued to tell us another couple of hikes this year, and that the economy is doing well, expect about three hikes a year through 2018. Yields go out at 2.50% today.
So why aren’t market rates screaming? The 10 year yield should be 3.5%+ by now. And consumer rates should be surging. Is it the Bank of Japan, the European Central Bank and China buying our Treasuries, keeping a cap on yields? Is it that the market doesn’t believe it and thus the yield curve is flattening (which would project recession)? Probably a bit of both. The important point is that the Fed absolutely cannot do what they are doing if they think they will push the 10 year yield up to 3.5%+, and fast.
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Following the Fed yesterday, we heard from the Bank of Japan overnight, and the Bank of England this morning. As for Europe, we heard from the ECB last week.
Coming into this week we’ve had this ongoing dynamic, for quite some time, of the Fed going one way on rates (up) and everyone else going the other way (cutting rates, QE, etc.).
That’s been good for the dollar, as global capital tends to flow toward areas with rising interest rates and better growth prospects. That combination tends to mean a rising currency and rising investment values. What really determines those flows though, is the perception of how that policy spread, between countries, may change. Most recently, that perceived change in the spread has been in favor of it growing, i.e. Fed policy tighter or at least stable, while other spots of the world considering even easier on monetary policy.
That divergence in policy has been bad for currencies like the euro, the pound and the yen. But that hit to the currency is part of the recipe. It promotes higher asset prices, better exports and growth. And as Bernanke says, QE tends to make stocks go up, which helps.
Still, those stocks have lagged the strength in U.S. stocks. With that, over the past six months or so, I’ve talked about the opportunities in European and Japanese stocks for a catch up trade.
While U.S. stocks have continued to set new record highs, stocks in Europe and Japan have yet to regain the highs of 2015 — when the global economy was knocked off course, first by slowing China and a surprise currency devaluation, and later by a crash in oil prices.
With that, if you think Trumponomics marked the end of the decade long deleveraging period (post-financial crisis), and that the Fed is signaling that by ending emergency level monetary policy, then the rest of the world should follow. That means the next move in Europe, Japan, the UK will be toward normalization, not toward more emergency policies.
That means the expectations on the policy gap narrows. With that, we may have seen the bottom in the euro. If negative interest rates and an election cycle that has parties that are outright promising to destroy the euro can’t push it to parity, what can? If it can’t go lower, it will go higher.
And if the euro has bottomed and the next move for the central bank in Europe is tapering, the first step toward ending emergency policies, then this stock market in Europe looks the most intriguing for a big catch up trade – still about 20% off of the 2015 highs and well below the pre-crisis all time highs.
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As we head into the Fed tomorrow, stocks have fallen back a bit today.
Yesterday we looked at the nice 45 degree climb in stocks since Election Day. And the big trendline that looked vulnerable to any disruption in the optimism that has led to that climb. That line gave way today, as you can see.
The run up, of course, was on the optimism about a pro-growth government, coming in after a decade of underwhelming growth. The dead top in stocks took place the day after President Trump’s first speech before the joint sessions of Congress. There is a phenomenon in markets where things can run up as people “buy the rumor/news” and then sell-off as people “sell the fact.”
It’s a reflection of investors pricing new information in anticipation of an event, and then selling into the event on the notion that the market has already valued the new information. It looks like that phenomenon may be transpiring in stocks here, especially given that the timeline of tax reform and infrastructure spending looks, now, to be a longer timeline than was anticipated early on.
And as we discussed yesterday, it happens to come at a time where some disruptive events are lining up this week: from a Fed rate hike, to Dutch elections, to Brexit, to G20 protectionist rhetoric.
Stocks are up 6% year-to-date, still in the first quarter. That’s an aggressive run for the broad stock market, and we’re now probably seeing the early days of the first dip, on the first spell of profit taking.
What about oil? Oil and stocks traded tick for tick for the better part of last year, first when oil crashed to the mid-$20s, and then when oil proceeded to double from the mid-$20s. Over the past few days, oil has fallen out of it’s roughly $50-$55 range of the Trump era. Is it a drag on stocks and another potential disrupter? I don’t think so. Oil became a risk to stocks and the global economy last year because it was beginning to trigger bankruptcies in the American shale industry, and was on pace to spread to banks, oil producing countries and the global financial system. We now have an OPEC production cut under the belt and a highly influential oil man, Tillerson, running the State Department. With that, oil has been very stable in recent months, relative to the past three years. It should stay that way – until demand effects of fiscal policy start to show up, which should be very bullish for oil.
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Yesterday we talked about the Draghi remarks (head of the European Central Bank) that were intended to set expectations that the ECB might be moving toward the exit doors on QE and zero interest rate policy. That bottomed out global rates — which popped U.S. rates further today. The Bank of England piled on today, talking about rate normalization soon.
