Well, it doesn’t happen all the time, but the EURUSD has performed exactly as expected since our last post. And not only this pair; if you were short the Euro, you are “in the money” against most currencies. As I said then, it doesn´t get any better than this. The trade makes fundamental sense, and we have the POMO desk of the ECB covering our back. Sex has been good lately.
No overconfidence though. Nothing is really 100% foolproof, particularly in these turbulent times. Only two days ago, Saxo bank research came out with a long the EURUSD recommendation, with a target at no less than 1,40. Wow! I have great respect for them, and the rationale for the trade certainly makes sense. They think US interest hike fears are overblown. Most likely they are; but in my view, not to forget is the other side of the trade. The European growth scare is consolidating daily, and we are on target for the end of the year stagnation I suggested in “reading this and long time short the EURUSD”. Last figures show zero GDP growth for Europe in the second quarter (and likely coming down further in the third and fourth). Doesn’t look like the recovery everybody was expecting. I very much doubt the euro can withstand the dismantling of the growth prognosis now embedded in financial pricing in most of continental Europe. Some weakness looks unavoidable, even if we end up with a new “whatever it takes”, or similar wording, by super Mario. I think I will stick to the same sex partner (euro shorts) for the time being. A weak euro should help with some nice and reasonably safe sex over the next weeks.
Apart from our trade, Dollar longs and Euro shorts are the main theme in currency crosses. I am less certain of the longs. After all, the Fed is still a glamorous acronym for a bunch of money printers that have promised to abandon their addiction beginning tomorrow … or the day after. We have to remain a touch skeptical. Add the fact they don´t like the dollar to appreciate, because they are aware of the tightening of financial conditions implied by currency appreciation. Tightening is still anathema at the Fed. They fire you if they find out you ever dreamt of it.
Last in the main currency arena, the yen is a gambling choice. The country is bankrupt and sports sustained commercial deficits as a new part of the economic landscape. But it is also a large creditor, and still considered a safe haven by a large mass of ill-informed investors. Beware of behavioural economics. Millions of idiots can alter the investment outlook for “longer than you can stay solvent” (oh yes, I have something in common with J.M. Keynes).
It does makes sense to short the yen (long USDJPY) only if combined with a S&P500 futures contract short. “Risk on”-“risk off” wise, it balances out the trade, making it theoretically neutral to both scenarios. It is indeed difficult to imagine JPY appreciation combined with S&P500 further increases to the 2000 to 2250 area. Be careful with sizing both sides of the trade adequately: in most trades the devil is in those details. Timing the entry levels is tricky as well.
That brings us square in to talking about the global equity scenario. Before getting into global bond investment analysis, let me insist on the idea that investing in equity is right now a risky proposal. Two weeks later, I still think it is riskier to buy and hold, than to look for a top to short. Either way, no guarantees on your principal invested. Cash, even with ZIRP or NIRP (negative interest rate policy) still looks as a better risk reward pair to me. Even if the chart point comes as (0, 0) in the chart.
Things get really interesting when we get to bonds. They have been an outstanding investment over the last 25 years. In fact, everything has turned out to be on the rosy side ever since the money printers took control (Alan Greenspan began the saga in 1987). Well, rosy if you stayed the course and never lost confidence in the central bank put. At times of extreme discouragement that took a lot of faith, but it has been well rewarded. CentraI Bankers are aware of the addictive power generated by the reiterated reward of a repeated conduct (Pavlovs experiment). They are keen to keep a solid player base (clientele) in the common knowledge game. They are certainly doing better than the Catholic Church at that. Reward is more addictive than remorse. Pope Francis please check on this issue, and give Bernanke a call, you are running out of clients!
In the bond investment area, it bears repeating, things have never been more interesting. I have read multiple knowledgeable traders and economists on both views: the reflationary outcome according to which interest rates will shoot up and yield curves steepen, and the deflationary troop (less crowded) in the opposite direction. I am an opinionated economist, but in this issue I cannot compromise with either side. We simply don´t know: it’s a politburo decision!
In a directory of more or less coordinated central banks, using only fiat money in the crosses, with unlimited printing power, and boundless interest rate fixing capabilities (NIRP ZIRP or “whatever it takes”), inflation is an uncertain variable in the medium run. If you add daily POMO desk manipulation of long term interest rates (a price that normally reflected market equilibrium levels), then you have a worse than random predictability of events. Yes, random is today a blessing (when anticipating market prices and volumes). Better than trying to foresee a lady’s reaction to future events (Sorry Janet, but you are, behind the economist, and the dove, an emotional human being).
So I can’t commit to duration in bonds, in any direction. My instinct tells me central banks will pull out of money printing, but only when it is the only option left to avoid inflation. In the meantime they will keep at it, printing money big time somewhere in the global economy (most likely Europe or China, and less so Japan). Global Money Base expansion will decide whether we get inflation a couple of years down the road, or the market breaks up before that. Why would it break up? A growth scare reigniting debt sustainability issues. So the setting is clear. It is either print money and grow, or print less, and break down on credit quality issues. Two different outcomes with opposite consequences in the bond market. It credit quality reappears as a concern, market rates in safe bonds are going down much further. If we keep up printing and continue with the muddle through economy, it will be an inflationary sell off in bonds in due time.
That is why I insist on remaining vigilant on the evolution of M2 and M3 aggregates in the main currency areas. The Fed is about to stop. But it looks as if money printing might be continued by other central banks if and when the fed effectively quits. If money printing continues in strength, the bond market evolution will be affected as explained, and the equity top will likely be postponed. A fast read of a Financial times editorial by Lorenzo Bini Smaghi requesting immediate QE by his ex-colleagues at the BCE, just because the Fed might be finishing it, highlights the issue. Somebody has to continue providing the punchbowl (and drugs and women/men) for the party. In his own words:
“The high yield segment of the Eurozone…could thus be the first to suffer from a tightening of US monetary conditions. Interest rate spreads may start widening again, endangering debt sustainability. The market dynamics could fuel a further reassessment of risks across the Eurozone countries and banks…”
This is perverse. He perfectly understands what’s going on. He is fully aware of the consequences of ceasing to print, and yet wants more of the same. At least for the time being. Nobody like Saint Augustine has been that prescient of human weakness: “Lord, grant me chastity and continence, but not yet.”
Lets remember the Chinese on the issue of monetary expansion. Their credit expansion is superb: top gun! Not to forget. What they do will be very important for the outcome of this agonizing global credit expansion. Lets see this in a couple of charts related to dollar credit, and yuan area credit (and social) financing.
So that’s about it. No bond trades for now. Bond pricing is just totally unpredictable. Only high quality low duration bonds today. That is equivalent to no sex. But If you are desperate for sex, not safe sex, any kind of sex, I can give you two ideas. If you want to play inflation expectations sell the US ten year bond future contract. When inflation rears its ugly head, rates could move up 100 bps easily. The US is the first area where inflation should appear, if it does before they cease printing.
If you want to play credit quality because you think the system breaks soon, play long the 10 year bund and optionally combine it with a short the 10 year JGB futures contract. It’s a great synthetic position if credit quality issues extend. Japan is bankrupt, and Germany is perceived by the market as a safe bet. And you still get a 1% yield on the ten year bund (the swiss ten year yields a symbolic 0.45%)
Whatever you do, don’t buy high yield, low credit quality bonds. Risk premiums are virtually nonexistent, and the downside is … (I was going to say unlimited, but you can only lose the total amount invested!)
To print or not to print. Who prints, how much does he print, and for how long. That is really the question. If you have the answer, you may become the greatest sex addict in the world. It will be an orgy of money making. Make sure you remember to give me a call.