A Trump tantrum....or a China one?

As profit-taking pauses go, yesterday was extremely modest in the grand scheme of things.  Whether this speaks to a market that is not yet fully positioned or one that is full of hubris remains to be seen, but either way it would appear to be ripe for a deeper shakeout if the environment of the last several years were to hold.  The qualifier in the previous sentence is an important one; as Macro Man has discussed over the last week, the single most important question for macro traders is not any specific of Trump's agenda, but whether the fundamental nature of the market has changed.

The question will receive its sternest test today with Yellen's testimony.  Assuming that she stays on message and doesn't attempt to predict or front-run fiscal policy (the likelihood of the latter being quite remote), it will be interesting to observe how the market reacts.   Macro Man has lost count of the number of times over the last few years when Yellen has been dovish and the greens have rallied a dozen or more ticks; if such an outcome were to eventuate today, it would raise the risk that the last week or so has been little more than a "Trump tantrum" in fixed income and the dollar within a trading climate that's still business as usual.

It certainly feels like this time is different, but then again it often does at the top.   What concerns Macro Man is this.  Having taken virtually all of his post-election risk off, he knows exactly what he wants to do in the event of a deeper correction or retracement.  Less obvious, however, is what to do if the market steamrolls over any dovish rhetoric that Yellen chooses to deliver and keeps on truckin'.  As Mike Tyson famously observed, everybody has a plan until they get punched in the mouth.

An obvious port of call in the event that the market keeps going would be to find those instruments that have lagged and look for a catch-up trade.   In the FX market, for example, if we look at current dollar levels against a range of currencies versus the extremes of the past year or two, we see a wide dispersion of current drawdowns.  While such an analysis really should be vol-adjusted, you don't need a z-score table to see that the USD is much further from its peak against the yen than against the euro.

     
The chart excludes cable, as sterling is obviously being driven by factors other than what's going on with the dollar.

One obvious pair at an extreme is USD/CNH, which highlights an important risk that could emerge later (or sooner) down the line.  Given the nature of the Chinese currency regime, rampant USD strength applies a lot of pressure to the mechanism.  Essentially, the authorities have three options:

1) Allow the RMB to strengthen versus the basket.    This would entail keeping the CNY essentially flat against the USD, thereby implying yuan strength against everything else as the dollar appreciates.  While bad for China's overall trade account, it would mitigate capital account pressures.

2) Keep the basket basically stable.   The implication here is that whatever the USD does against the rest of the world, it will also do against the RMB.     This is broadly neutral for China's overall trade account but runs the risk of engendering capital flight if the public's perception of  RMB weakness becomes too acute.

3) Say "damn the torpedoes" and weaken the RMB versus the basket.   While China has done this on occasion, particularly last August and early this year, it becomes problematic when USD strength becomes too acute.  The reason is that the mathematics of the basket mean that the RMB has to weaken more against the USD than other currencies for it to weaken against the basket overall; obviously, that can run into serious difficulties regarding capital flight and financial stability.

As Macro Man has observed several time in recent weeks, since July the authorities have opted for option 2 above.

The issue with this is that the authorities are essentially outsourcing the setting of the USD/CNY rate to the market.  While this has ostensibly what everyone's been asking for for years, it's not really; there's still a currency peg, it's just to a different target (i.e., the basket.)    What it does mean is that the higher the dollar goes, the stronger the upside pressure on USD/CNY and CNH...and, presumably, the greater the capital flight and strain on PBOC's reserves.  While they may not be in dire straits for the time being, the market can and will extrapolate; the FX reserve data for November will be of paramount importance.

The alternative, meanwhile, is to allow the currency to strengthen on a trade weighted basis by keeping the peg steady/jamming short rates higher/selling USD hard to screw RMB shorts.   This, too, has negative consequences for both markets and the real economy.

Either way, it's hard to shake the notion that if the "Trump revolution" is real and not simply a tantrum, Chinese markets will get pushed, perhaps to the breaking point...and that's before anyone's pointed a finger and accused them of being currency manipulators.
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abee crombie
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November 17, 2016 at 9:21 AM ×

Thanks for addressing my concerns mm, re china. The market could i guess also not really care fkr a bit as well, though i doubt it. How about just short sing dollar.

Fwiw, try getting crushed (though maybe finally stopping today. Anyone up to speed on the story there. Politics still.

And long bitcoin. What a lovely chart.

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checkmate
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November 17, 2016 at 9:38 AM ×

'Bitcoin'. Coincidentally I was in the US last week and sharing a table with a couple whose son joined us. Turned out he worked finance in the US specifically working on bitcoin systems with various National and corporate bodies. Naturally I was interested. He summarised it that their inside collective assessment was that Bitcoin was akin to the Internet in the late 80's in terms of it's development process.

Re bonds for me it's become the story where shorts need to think they are going to be countertrend trading. Doesn't mean that won't make money ,but it does mean hit and run. I think it would be a mistake to think bonds are going back where they have been. I appreciate the 3 sigma event etc ,but exactly what was this ludicrous move of recent years in terms of deviating from norms ? Such a snapback might see extreme ,but not when viewed in terms of the context of the prior move which was even more extreme. I'm with Gundlach and Dallio on the future outlook.
Thanks for the China assessment. With eyes turned to US and Europe it wouldn't be the first time if something came out of left field to provide the next issue.

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washedup
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November 17, 2016 at 12:17 PM ×

@MM yes interesting how China doesn't seem to command any equity punters attention these days with the focus on the election - a bit like staff in the break room of the hospital happily chatting about the game as a long parade of ambulances gets loaded up and heads towards it, no?

CAT, which apparently needs a weak dollar and strong China for sales growth, is up 80% from its Feb lows - hmmm. Whats that, ah, bridge repairs in Georgia from Trump's infrastructure spend - all good then.

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abee crombie
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November 17, 2016 at 1:39 PM ×

@ washed were you watching Chanos on bloomberg yesterday? ;-) re CAT

http://imgur.com/a/mvvgu - some high yield charts....

BBB's have been the ones that have sold off the most relatively, though thats total return change, not necessarily spread, as most IG spreads are in a very tight range for the past 6 months. HY spreads have ticked up a bit but cant see that going on much longer if Russell pushes new highs

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washedup
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November 17, 2016 at 1:53 PM ×

@abee I did not - I kinda know what he would say but if you have a link would appreciate it.
I think its a $4 EPS long run with possibly a $2.50-3.00 trough so see it as a 24 P/E, you know, close to Google's - I know other people have higher targets and hope dies eternal on this one - I think I will nibble at a short around 100.

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wcw
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November 17, 2016 at 1:55 PM ×

@checkmate, having been a high school computer miscreant in the 1980s, I can attest that Bitcoin is not like the internet in the late '80s. Boiled down to core elements, what we think of today as the internet then was both more potentially useful and mostly ignored.

All, in re bonds, core CPI missed low, but initial claims and housing starts/permits came in a touch low/high respectively and bonds are getting sold. Like our friend LB I have been eyeing Cal munis in the form of widening CEF discounts, but I am not wading in yet.

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checkmate
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November 17, 2016 at 2:53 PM ×

Depends what you mean by the term 'like'. The guy giving the opinion was making a chronological analogy to where abouts they thought Bitcoin was in terms of development and take up and obviously suggesting it was akin to where the development of the Internet was at a particular point in time. Both Bitcoin and the indeed the NoiseAnet are both beyond my area of expertise. For context I don't even have a mobile phone.

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SRX
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November 17, 2016 at 3:11 PM ×

I think one thing that is not considered is that PBoC is expecting trump to talk up CNY. The classic setup used to be to keep CNY weak and then let it go up before US officials visit. I think PBoC is happy to keep CNY moving in-line with CFETS which allows them to maintain moral superiority while letting outflows and US jawboning counteract.

Trump's rise gives China the opportunity to build soft-power by appearing rules-based, rational and impartial. Recent climate change banter coming out of the Foreign Ministry is a good example. There has never been a better time to score political points by appearing dependable.

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abee crombie
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November 17, 2016 at 4:19 PM ×

on bitcoin, probably for the financial industry its like the internet in the 80's. Massive implications there. For the rest of the economy not as much

Lots of VC money pouring into bitcoin, and of course most of the recent move is due to chinese, so if they ever plug that hole, its a long way down. But for now, the trend is firmly established, growing adoption and lots of inexperienced traders trading the thing like its a penny stock. Current market cap is around $12B USD, which is a smaller mid cap stock. I wouldn't be surprised to see it do a 10 bagger before it get really over valued. Pure retail speculation, including Chinese (love those parabolic markets) and tech money (which I think kinda are like Dr's in terms of their understanding of stock/global markets)

And lastly the core technology/methodology of implementation is ingenious. The mysterious creator has been nominated for a Nobel prize and many super bright academics and computer ppl love the idea. How it progresses in the future is another story.

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wcw
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November 17, 2016 at 4:51 PM ×

@checkmate, leaving aside the putative potential the chronology needs to move forward five years. You can buy a car for Bitcoin; in 1988 even email was unusual outside academia. Gopher was 1991 and Mosaic was 1993, if you must make the analogy go early '90s.

@abee, on blockchain I am confused by the excitement, but make hay while the sun shines.

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Anonymous
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November 17, 2016 at 5:43 PM ×

Dear MacroMan,

What is a good/liquid futures product to get exposure to inflation?

Thanks.

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johno
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November 17, 2016 at 7:21 PM ×

Well, LB was right about USDJPY tagging 110 first (4 pips away as I write). BoJ bid for 2s and 5s in INFINITE size. Frankly, I hadn't properly thought through USDJPY implications of the US rate rise driving Japanese money expansion as JGBs hit their yield ceilings. Mercifully the markets gave me a chance to close out yesterday's short at <109. Anyone have a view on whether the USDJPY-rates relationship changes as we get to the BoJ's rate ceiling?

Today's fool's errand I've tasked myself with is buying US bond futures (down on that). There's a nice pickup for Japanese and European buyers using short-term FX hedges now (only slight pickup for Europeans and none for Japanese on maturity matched basis). And I don't see high rates being sustainable given the economy's debt load, unless credit creation picks up massively (ability to service is largely a function of interest rates and newly printed money/credit that allows interest and principal to be paid). Also, we have a rate shock, a dollar shock, and a massive negative sentiment shock to Clinton voters. I do think it's possible that we could have a year or two of higher nominal growth maybe one or two years out, and the markets may over-interpret that and we'd get the kind of yield numbers Gundlach talked about, but that would end up killing the expansion and we'd wind up back in a secular stagnation state of the world, just with higher inflation than before.


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Leftback
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November 17, 2016 at 7:36 PM ×

Trading CPI inflation, "real" inflation and FOMC inflation expectations, e.g. 5y5y forwards, are three very different things, anon. If you want a traditional and often leading inflation indicator, check out GDX, which actually turned downwards in August and CLZ6, which peaked in June. There is an interesting message there for those who care to hear it.

Sorry to point this out, but Peak Reflationary Hallucinations often coincide with punters seeking suitable punting vehicles, sort of like looking for a horse in the barn after it has already bolted out the wide open door.

Short to medium-term, we can now see signs of tops in: USDJPY, UUP, XLB and XLF, with signs of bottoms forming in TLT, AGG, etc.. and EURUSD. The munis and preferred ETFs (IQI and PFF) have already bounced to some extent. The "Great Rotation / Trumper Tantrum / Reflation Trade" may be ending here. Interestingly, junk bond ETFs have been almost a total snooze since the election.

Punters involved in the Ponzi scheme known as Dry Ships (DRYS) have had an interesting week....

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Anonymous
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November 17, 2016 at 7:44 PM ×

Interesting point Johno. I still have some shorts on USDJPY, no doubt underwater for now. My biased view is that the news of BOJ's infinite bidding does not seemed to excite the JPY shorts. I wonder if anyone beyond BOJ still owns JGB 2s and 5s. Thus, I did not rush to close my (small) positions. Also, where would the squeezed out Japan real money go after they exist JGB positions?

I would still bet on some short-term profit taking next week due to holidays. But I think we should prepare for a rotating bull till the end of the year, again mostly for tax reasons: major players would not want to liquidate their winning positions this year and be subject to a higher marginal tax rates, since the tax cut in 2017 is almost a certainty at this stage.

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AB
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November 17, 2016 at 8:36 PM ×

The Trump trade is and probably will be an oppressive theme for the next few months. Expectations of US reflation and foreign stagnation. Dollar continues up, yields rise, US stocks probably go up as money comes from overseas and out of bonds (but the fundamentals are going to be hurt by rising wages and rates).

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Nico G
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November 17, 2016 at 8:57 PM ×

Would fit a blow off top à la 2000 very well - this is also when dollar peaked, for no other reason than the whole world rushing to buy equities. Above 2180 you are in rarefied air after a 6.5 year rally and it is taking a Trump illusion to invite all the gullible in

Rates are going up.

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Leftback
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November 17, 2016 at 9:04 PM ×

Yes, China moves markets, but China doesn't usually continue to move in a reckless manner after creating instability. With Bucky making 13 year highs this might be time for the PBoC to activate the stabilizers and allow the global capital markets a breather. Ready for a spot of mean reversion, punters?

Here at Hammock Capital we are in a state of mild excitement, having today deployed some of our cash pile into bonds for the first time since, well, maybe a year ago or so. So we are now long some TLT, IQI and some AGG; it's easy to be skeptical that we are at a bottom in bonds here, but the RSI made a low below 20 on Monday, and trading volumes have declined since then. We have been trading this event very technically, hoping that patience and discipline will be rewarded.

At the same time, we have started a short of the XLF to go along with our view on a reversion to a flatter yield curve. We are also beginning a tiny EURUSD long as well as a short of USDJPY, because with the RSI for UUP now closing in on 80, it's getting a little euphoric up here, and Bucky may need to come down for oxygen. DX has a little gap above 99, might be a good place to pull back to.

"Markets peak on good news" is an aphorism that Polemic used to use on the blog, back in the days of Team Macro Man, and with Dame Janet more or less affirming a hike, and the positive US employment and housing data today, we think Polemic's old saw about market tops may be apposite for rates, banks and the dollar just at the moment. Although we are not "all in" here, we are ready to add to our long US fixed income position in the days ahead, as we expect the true nature (and timing) of the GOP's much-ballyhooed "reflationary" fiscal policy to become clearer, and perhaps less thrilling for equities.

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Phileas Fogg
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November 17, 2016 at 9:47 PM ×

@ LB

TLT best of the bunch with 200 SMA, 120 and TL just below, I also like XMPT but Ill wait to see its reaction with 25

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washedup
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November 17, 2016 at 10:01 PM ×

@Nico check out the price action in small caps i.e. IWM - definitely checks the 'blow off' box - don't know about the 'top' I guess time will tell!

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Nico G
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November 17, 2016 at 10:33 PM ×

i hear you loud and clear Shantaram!

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Anonymous
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November 17, 2016 at 10:50 PM ×

Last time euro was this low, Dax was near 12000. Fancy an opex pullback into Thanks Giving .

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abee crombie
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November 18, 2016 at 12:03 AM ×

I am as bearish as the next on US equities but looking at the charts and earnings expectations and US growth data i dont really see a bearish picture. We can peak on good news. For sure. But i dont like to short tops like the xlf. Big gap up on huge volume after consolidation. Just not a good setup imo. Much safer bet to short once it comes back to old range.

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rs55
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November 18, 2016 at 12:07 AM ×

The action since Nov 9 has felt like very large short positions getting squeezed out. Cant have the good-time-charlies enjoy the real moves - right?
So now - we have a spiking Dollar, sharply higher bond yields and everything else pretty much the same except for some vague campaign promises - is a $100 Bn/yr fiscal spending package to revitalize inner cities really going to mean much? Especially when the orders of magnitude larger capital spender , China, in cut back mode?
Stagflation, declining earnings and sharply slower global trade - this is going to bail out a market trading at 24X? Sure.

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Anonymous
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November 18, 2016 at 12:33 AM ×

So where does the money coming out of the US bond market go?

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checkmate
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November 18, 2016 at 6:24 AM ×

Given the events of recent months and the events still to come in the next months I am particularly looking forward to the Year End 2017 forecasts ,or non-forecasts !
I'll kick off early with
1. Renzi resigns after losing his referendum and becomes despondent. This awakens the maternal instincts of Mama Merkel who decides not to stand for reelection and the two run off to live happily ever after in the tax haven of Mauritius. Schaubal loyal to the last ,but heavily conflicted agrees to stand up as best man at their nuptials if the Mauritians agree to overhaul their disclosure practices.
Using my Trump/Brexit polling system I assign that event a 99% probability that it will happen.

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