All this adds weight to the feeling that September's seasonality sell offs are this year going to return to the Euro zone, just when all eyes are pinned on the US.
But for now we leave you with a postcard we were asked to pop in the post to Germany.
Team Macro Man is sure they are not alone in struggling for inspiration in these summer markets, so it seems like a perfect time for another batch of questions.
Because that's what they do. TMM is reminded of a time, many years ago when they were fresh-faced naive graduates doing a trading simulation where the guy running the training programme made the simulation do stupid things that make no sense and would never happen in real life just to throw us off. How mistaken we were... Perhaps the PBOC hired the guy?
A theme TMM are particularly swayed by at the moment is that competitive devaluations under the guise of "efforts to fight deflationary risks" are likely to result in trade frictions that have the potential to get nasty. As per yesterday's post, we think the Japanese have done their bit as far as being a good global citizen is concerned (the trade-weighted Yen has appreciated by 47% since it bottomed in 2007), and it is time for others to make a contribution. To be fair to the other big Current Account surplus country, Germany, their import growth has begun to outstrip their export growth, which means they are starting to do their bit, and the Eurozone as a whole essentially has a balanced Current Account. But the Chinese? They have done Nada.
It turns out "increased flexibility" just meant "we'll do a quick half-percent move so it looks like we're doing something and we'll just make it more volatile so we can screw the speculators". They must've learned that one from the French. In terms of cumulative appreciation since the announcement, we have pretty much flat-lined around 0.6% (chart below, purple line), looking not too different from the Hong Kong Dollar - a currency that is pegged (orange line). They say that they're targeting a Nominal Effective Exchange Rate-based policy, which is fair enough (Singapore do that too), but if they are, they clearly want their currency weaker because that's what it's done the past two months (green line).
Well, they certainly made it a bit more volatile, but it still looks a lot like the HKD:
But as far as TMM can see, they're just doing their usual currency piss-taking. TMM don't think it will be long before US politicians cotton on to this fact, especially if the Japanese do start to intervene, and the resulting noise could get very nasty.
But let's get to the point of this piece. There has been a lot of noise and jaw-boning about the Japan intervening in the Yen, with a very rare joint BoJ/Government statement about the risk it poses to Japan's economy, and the political debate around this appears to have reached a consensus that verbal intervention is no longer proving an effective deterrent against Yen strength. TMM is increasingly of the opinion that the bar to intervention in the Yen is now very low - not just because policymakers appear to have reached a consensus, but the key conditions that have been consistent with successful FX intervention in the past are now virtually all in place. The single remaining condition is a sharp upward move in the Yen of 2-3% which, given last week's low in USDJPY is very close, seems pretty likely to happen.
So what are the conditions? Looking back at past FX interventions, they have generally been successful if they have occurred when: (i) the FX market isn't pricing the relative economic outlooks of the two countries properly (whatever that means...), (ii) there has been a large "mis-valuation" of the real exchange rate, (iii) market positioning is large and viewing the trade as a one-way bet, and (iv) there has been increased momentum in the market moves.
As far as (i) is concerned, we can get a sense of the relative economic outlooks of the two countries by looking at a spread of real interest rates over the short to medium term (e.g. 5yr) because these will price in the relative policy paths of central banks, which themselves are a function of economic conditions. TMM wanted to use consensus economist forecasts historically, but getting that data has proved somewhat challenging - if they were wearing their tin foil beanies, they'd swear it was a cover up of their horrendous forecasting records! But on a serious note, the below chart shows the 5yr real rate spread between the US and Japan (brown line) vs. USDJPY (green line). [We used TIPS yields from 1997 for the US and Inflation Swaps from 2007 in Japan, prior to those periods, we used the 5yr bond yield minus CPI]. It's pretty clear that on this measure, USDJPY has diverged pretty significantly from the fixed income markets' views of the relative economic outlook, a condition that was not met particularly in early-2009, the last time the Japanese triggered a G7 statement on the Yen. That's a "tick" then.
Moving on to (ii), the Real Exchange Rate... the below chart shows the percentage deviation of the ratio of the Dollar to Yen Broad Real Exchange rates from its 5yr moving average. Looks to be about 15% undervalued. Another "tick"...
As FX punters will know, working out how players are positioned in the FX market is difficult, as we only have data for CTAs (via the CFTC - see below chart of Yen longs) and for Mrs Watanabe. Clearly CTAs are very long of Yen, as is Mrs Watanabe, and TMM gets the sense that traders more broadly are also long the Yen. While we can't be certain here (proxy measures of the OTC market positioning such as Risk Reversals are clouded by their risk-on/off correlation and Black Swan derivative hedging), TMM thinks (iii) is a "tick" too.
Finally, market momentum (iv)... for such an esoteric concept, it's possible to come up with many measures. For example, it's pretty obvious when there is a large 3day move, but in terms of the underlying momentum in the FX market, TMM particularly likes using the 3month, 5day skip momentum measure (see chart below). In recent days we have surpassed the "normal range" for this, but are not quite at the levels exhibited in March 2008 (as the PRDC crowd were being taught about gamma) or Q4 2008. The point here is that the bar is not particularly high for this to move higher to the point where policymakers would act. TMM is of the opinion that a relatively quick 2-3% move is all that is needed to trigger this condition... we'll call it a "half tick".
One of TMM's mates this morning suggested that a further condition is support from other nations' policymakers. It's a fair point, in that coordinated intervention has only failed on one occasion (the Louvre Accord), while single country intervention has failed on several. TMM cannot help but point to Voldemort et al who have successfully intervened for many years now...
We digress... TMM thinks the BoJ are getting pretty close to adding the letters "LLC" to their name.
The biggest loser from recent US monetary policy has been the Nikkei, which has seen a 6.2% top to bottom move since the FOMC announcement through the US/JP rate spreads driving USD/JPY and hence, the Nikkei. This, of course, is being exacerbated by the Yen being the new default counter currency as we are so keen to sell everything else (see below chart: USDJPY - white, Nikkei - orange, 2yr US/Japan yield spread - yellow, 10yr US/Japan yield spread - green).
So we are back to a good old fashioned FX theme of trying to guess if the BoJ will try and do something about it and how. If they come in and buy cart loads of USDs there is no way they then want to park them back in Treasuries, as it is the US/JP yield spread compression that is the original cause of the problems. In fact, probably the best way for them to intervene is to sell their holdings of treasuries and bring it back down the curve and hold it as cash and hope it starts spreads widening again. Does that mean that Joe Public is paying back his maturing mortgages to Japan via the Fed taking the cash off their MBS maturities and using it to buy their Treasuries back from Japan? But what happens to the cash? The Japanese put it on deposit where it finds its way back onto to bank balance sheets and they use it to buy Treasuries again. Hmmmm.
Perhaps they should take the USDs in cash, actual paper notes, and burn them, effectively destroying the problem of too many USDs. So they can effectively print their own money and get the double whammy of QE'ing themselves, while deQE'ing the US. The extreme sport version of competitive devaluations, where you actually try and destroy someone else's currency faster than they can print it. If this took off seriously it would make Mugabe mighty bid as Finance Minister. So much for Austrian Economics, how about following the Zimbabwe school? Is there any value in burning money? TMM once worked out the price of oil needed to make it cheaper to burn Dollar bills instead in terms of cost per Kj output. From what we can remember, it came out at about $360,000 per barrel. Some way off yet, but if Voldemort is going to join in and burn his USD reserves that’s about 7,000,000 barrels of oils worth.
Though that may sound absolutely ridiculous it appears the money multiplier has gone into parabolic hyperspace where nothing is impossible.
We are afraid that this is all still heading towards more and more blatant FX manipulation which just increases the chances of trade sanctions and tariffs. The gloves may not yet be off but their laces are undone, so for now the market is back in prodding mode and will keep it up on JPY until they get something more substantive than today's BoJ mumble which came straight out of their ancient book of obfuscation.
The general panic mood of yesterday seems to have faded and as the dust clears we see a new landscape revealed with Euro center stage and previously neglected Euro-negatives being pulled out of the draw and dusted off. But this is not feeling like a general panic and is sectoral now rather than general. In fact, we are only back to levels we were at a month ago in most things and "most things" charts all look the same these days. So we look at this, so far , being a positional and reality rebalancing back to middle of summer range rather than the start of the "next big thing". And though a complete guess, it wouldn't surprise us if the next big thing involved a PIIS poor bank catalyst. The "G" has gone already, and so we hereby copyright the use of the term "PIIS" and all such headlines derived therefrom, such as "PIIS poor" etc.
The world is still steadily competing for raw materials, so any slow down in the West can only express deflation through lower wages as competition for jobs tightens and hence labour cost inputs fall. So whilst service sector (higher labour component) may see a higher relative price deflation, the basic cost of survival, food and energy to the individual stays the same, or rises as we are now seeing.
That isn't an individual enjoying deflation, that’s an individual suffering poverty.
Look at what happened in 2008 in the UK to inflation (chart below - white line) on the gas (UK Gas Prices - brown line) and electricity price spike and we know what happened to wealth functions (UK Real Disposable Income, lagged 9months, inverse scale - green line).
And we must not forget that food production nowadays is almost all a matter of converting fossil fuels to food, as solar energy isn't enough alone to make the fertiliser and drive the machines and transport. So food is not only being competed for directly but via energy costs too - see below chart of Wheat (white line) and Oil (brown line).
This could all be looked at as a symptom of the big big macro picture that we mustn't lose track of. The one of the flattening of the global wealth gradient based on the rule that if someone is willing and able to do your job for less than you , you are stuffed. As the pressures on labour costs in the West are falling we see the Chinese wage costs rising. The labour costs balance one way facilitating the wealth balance going the other. I would suggest that there is still a long way to go but it was interesting that local UK TV was running a piece on some small UK companies coming home from India and China and 7/10 UK cos now saying UK is competitive. The Global Gods of the Big multinationals and the super-rich have become so mobile these days that their national boundaries vanished years ago and they are left to happily exploit the disparities that the rest of us mere mortals are bound by. One reason why major stock indices reflect local economies less and less. But these smoothing functions can only occur whilst there are no barriers to free trade. And the worse the effects for the mortals the more they will vote for something to stop it. Sanctions?
Or perhaps macroeconomic policymaking will change with respect to the unholy trinity of money supply, interest rates and FX. Targeting FX, rather than other two which are now effectively globally driven. Of course the first people to do this, or be PROVED to be doing this (looking at you Voldemort) trigger a trade war. Go back to "Sanctions". So we let money supply & interest rates be controlled by the market with banks controlling money and central banks reverting back to purely to being lender of last resort, leaving governments to follow FX policies that pursue zero current account balances (God forbid we mention SDRs or gold linkages). It all sounds too familiar.
The alternative is to let the rebalancing continue which, without true social, cultural and business mobility for the masses, will remain a painful process.
Of course whilst this argument of external pressures preventing a dramatic deflationary function in the West suggests less likelihood of bonds going higher (see Yesterday's post) one can equally argue that if you are suffering poverty and the inflation function is external and not controllable by domestic rates then you are NOT going to be wanting to raise them. HOWEVER, this could be countered by the risk premium function. If you are suffering poverty then folks are not going to be happy to lend to you. If you are able to repay then its only by printing money or by growth and both functions counter the original deflation argument.
So whilst TMM look forward to cheap haircuts, none of them is enjoying an increase in wealth. As with the markets, it may be summertime, but the living is squeezy.
If Mr. Market is asking questions on whether we get Deflation or Inflation, you'd think that he had been on a telephone sales course selling Deflation and received a Distinction in "closed question" asking. "So Sir, would you be taking the 'Really Bad Deflation' or the 'Not Quite So Bad Deflation' or maybe our 'Japanese Deflation' option?".
We understand that equity market players are usually a pretty optimistic bunch (well, they kind of have to be, given they are dependent on an income-stream supposedly linked to growth), but bond guys are clinically depressed, worrying about inflationary risks one minute and then deflationary risks the next. This schizophrenia was most clearly demonstrated in 2008 with a 250bps pendulum swing in 5yr note yields. TMM bring this up because they believe that the pendulum may be approaching its zenith.
One of the biggest fears macro punters have at the moment is the Core PCE Price Index (see below chart) going negative. Now, as far as TMM can see, it is near the bottom of the range of the last 17yrs or so, but given the Fed is generally assumed to have a 1.75% target for this number, it does not seem particularly unusual for it to be this low at this stage in the cycle. The *real* oddity was that it was so high between 2004-2008...
...perhaps because of the BRICs and the pass-through of commodity price increases, along with Fed policy having been too loose. So the recent increases in Commodities, particularly Wheat are worth keeping an eye on (see below chart of normalised percentage appreciation of Wheat - white, Oil - orange & Copper - yellow - since the beginning of the year)...
...given that survey-based inflation expectations (chart below - green line) are more a function of *current* CPI (orange line) than the core PCE (brown line), and are "upside" sticky. If food & energy prices continue to ramp, the appears little danger of inflation expectations morphing into deflation expectations. This is significant as far as the expectations-augmented Phillips Curve model is concerned.
Over the past few days there are signs that the fixed income frenzy is becoming increasingly, dare we say, "bubble-like", with the 10 day autocorrelation of the 5yr Note's returns hitting new highs of 0.85 at a time when its price exhibits a clear trend. This is important as evidence of "return chasing", a key phenomena evident in bubbles. TMM would add to that the recent media hype about both deflation, the possibility of the Fed extending QE, economist calls for more QE, along with the WSJ today publishing a "Defending Yourself Against Deflation" article.
Now, all of the above may well be true, but it looks to TMM as though punters have the trade on, and we all know what happens to consensus trades. Speculative positioning in 5yr notes as a percentage of total open interest (see chart below) has also begun to plumb the highs of 2008, a period when fixed income actually had room to rally. TMM is struggling to see any risk-reward in being long fixed income...
...while Commercial Bank holdings of USTs as a fraction of GDP are at their highest since the early-90s. Basel III may well result in banks buying a lot more of these, but the relaxation of these rules to be scaled in over the next 10yrs means that the duration risk on balance sheet is pretty large.
Combining this with speculative positioning, Team Macro Man cannot help but remember just how consensus the Carry Trade was back in late-1993...
...just before thishappened:
Team Macro Man have learned over the years that when smart corporates begin to issue debt that it is usually indicative of a top (or at least, a short term top) for bonds, and yesterday's news that IBM's 3yr note cleared at 1% was the red lights and klaxon "DIVE! DIVE! DIVE!" in their submarine.
Although the chat out of Washington regarding a GSE-sponsored refinancing wave is just chat for the time being, the level of rates mean that the 2009 mortgage vintage is likely to begin to refinance (they are not LTV-constrained as anyone who got a mortgage in 2009 clearly must've had a good credit score).
Now to TMM, we either get the deflation that has largely become priced by certain parts of the fixed income market, or else there is a serious risk of a 1994-style unwind in the rates market. We won't know about the former for some time, probably, but short-term, at least, it seems to us as though things are ripe for a turn...
With TMM beginning to find the UK ONS data dubious and Merv bending the stats to suit his base rate-linked mortgage, we thought it time to dispatch ourselves out there to get our own TMM feel of what is really going on.
In the UK there has always been a corner of Cornwall that is forever Chelsea. It's called Rock. And its neighbour, Polzeath, is Fulham-on-Sea. Together they are the "Hamptons" of England with property prices to match. Except that the property prices in Rock have been bullet proof against the recent recession and the rental market has seen 100% summer occupancy for years as generations of red-trousered lawyers and bankers have taken their little Jemima's and Rory's on traditional English beach holidays that remind them of their own sunny youths. But this year is different. Apparently 10-20% of rental property is un-let and the Mariner's Arms, normally heaving with drunken public school boys, is hosting tumbleweed races. The beach at Fulham-on-Sea was not much better, with last Friday seeing a normally rammed full car park practically empty. We would have suggested that Merv the Swerve must have holidayed there recently to justify his recent UK outlooks, but that can't be the case as inflation down there is still rampant. He'd have raised base rates 20% if he'd have dined at the Blue Tomato Café where its now about £15 for a truly appalling "Full" English Breakfast and a coffee. The Rock is no longer Rocking.
Aldeburgh on the East Coast of England however has been much more of a home to the "Arts" set, a veritable an Islington on Sea. And here things were very different- the place was packed full last weekend. We are scratching our heads at this finding of the Rock/Aldeburgh (or lawyer/ luvvey) cross. We would have thought that the Arts would be more under the cosh than the bankers and lawyers, but may be its just because the East Coast is closer to London and costs less to get to. This year we know a lot of families dramatically cutting back on discretionary holiday spending but we wondered if the Cornish result was a backlash against last years' "save and stay at home" holiday choice which ended up with most folks realising that the UK is still very expensive... And it rains.
To see if the Brits had indeed headed overseas, we went to Italy. And there we found them in the sun and enjoying what our man reports to be a booming economy, though he was a little surprised that the opening of Turandot wasn’t as busy as previous years. But as he knows nothing about opera he may have confused it with a Turin internet site. We have therefore called him home.
For some reason we don't seem to be getting any reports from our man in the UAE. Perhaps he forgot his Blackberry charger.