These last few weeks of trading have been tough. It looked like a promising week on Monday the 27th of June -just after the Brexit vote. Positioning in the less crowded Brexit related trade allowed me to make big money (10% return in two market days). And I had enough sense to cash in some of it. Better not to remember what happened to whatever positioning I left working in the global financial markets -on that very same Monday the 27th. The week did not end well. Ditto for the weeks that followed. Nevertheless, I will take solace in the fact that I managed to keep nearly a fourth of those hard earned profits. I am up barely above 5% for the year -but that is after being crushed by a deluge of coordinated CB indiscriminate buying. It is a difficult year indeed.
More of the same happened once again. The previous Citibank chart (via Zerohedge) speaks for itself. Central Banks went all in, and we explored new depths in the meaning of the expression “whatever it takes”. CBs managed to turn the tide, in spite of 19 consecutive weeks of withdrawals by equity investors. They own the printing press, and they sure know how to use it by now.
Topping the list of their ruthless actions, they even resorted to rumors to suggest the ECB would buy sovereign bonds in its QE program according to the free float of every issue, and not adjusting to the GDP weights of the different Eurozone countries. They squeezed the price of the Italian 10-year sovereign up 4% in less than two trading days. Can you imagine?
In the US we saw an impeccable turnaround, in true POMO style, with a three-day awesome S&P rally handily beating the shock and awe generated by the Bullard rally in late 2014 -to name one of the preceding CB induced short squeezes. It gets better still. Some gruesome manipulation of BLS stats (any bets that those figures will be corrected next month?) helped recent liquidity increases, and stop busting by POMO desks, in their quest to penetrate the previous highs. So much for the old top. Nothing is forever, more so in this crazy, desperation driven, CB controlled, market environment. Please remember I always said that some relevant extra printing could impulse markets above the previous, one-year-old top. Liquidity and turbocharged CB buying are game changers. Everybody (meaning professional market players) is hastily playing catch up as I write.
With all this fresh liquidity, probably directly invested in equities, we could be in for a final blow off top. And it might take some time after this extraordinary run-up. CBs generate the need to cover by investors, and then they can sell them back part of what they bought for a profit. It would be a criminal activity if it was done by a corporation or, god forbid, a private investor. But CBs have a special waiver. They can manipulate all they want because they act in a metaphoric public interest (or so they say). I had to cover most of my shorts. Risk management always trumps conviction.
Janet is being helped worldwide by her colleagues. Japan joined in with a fresh 100 billion USD round of Abenomics monetized spending – unsurprisingly, following Heli-Ben’s visit. The PBOC and Mario Draghi also complied in their own way. State of the art, Mossad-level, coordination techniques. And, second to nothing, let’s remember we have seen a magnificent “One for all and all for one” musketeer interaction between them all. I am not emotionally touched though. We ought to jail them all under the charge of manipulating market prices.
The global currency market saw another battleground, as CB’s drew a line in the sand at the 1.10 level in EURUSD. At least that was a standard, clear to all, intervention level. EURUSD is an important pair to manipulate, and, naively enough, I kept my fingers crossed. Still, they won again, and to make the victory jaw-dropping, they went through it virtually unscathed, except for a couple of hours trading at the 1,0980 levels. These guys are well trained and have unlimited gunpowder. Somehow, their next intervention is always more magnificent than the last.
The obvious first conclusion is that Brexit has been, as I suggested it might turn out to be, only a warm up catalyst -preparing us for the Lehman moment to come later. That’s pretty clear as I write -but that wasn’t the case on the 27th of June. Once again, I got the real move (Brexit) right, and CB behavior wrong. They always manage to surprise me with a new twist to the full meaning of “whatever it takes”.
Bonds do not need manipulation (if you don’t want to include ZIRP as a manipulation technique). The exception is credit spreads in the eurozone, for the different sovereigns. They have kept stable in spite of Brexit, and the huge publicity of the Italian NPL problem. I know, hard to believe ain’t it? Nearly 13 trillion USD in bonds are now trading at negative rates, and Italy and Spain sport ten-year yields well below the US 10 year bond. The Swiss ten-year bond trades for a yield of -0.60! The price to sales of the S&P 500 sets a new record! A truly bizarro world for us to see. Madness and stupidity are well above historical bounds. Is there a limit to any of the two?
I was licking my wounds and trying to get my nerve back when I came across an excellent post by Ben Hunt called Cat’s Cradle. I think he sums it all up quite clearly. He uses the word stuck, but we could also use “cornered”, or “surrounded”. CBs have precious little wriggle room left. The rest of us, even less.
You know, I’ve written a lot of Epsilon Theory notes over the past three years. … But in all that time and across all those notes I’ve never felt so … resigned … to the fact we are ALL well and truly stuck. The Fed is stuck. The ECB and the BOJ are stuck. The banks are stuck. Corporations are stuck. Asset managers are stuck … We are all stuck in a very powerful political equilibrium where the costs of changing our current bleak course of ineffective monetary policy and counter-productive regulatory policy are so astronomical that The Powers That Be have no alternative but to continue with what they know full well isn’t working….
… the U.S. is well and truly stuck in the current macroeconomic regime of low growth + massive debt + insanely low interest rates, and there’s nothing the Fed can do in terms of jawboning or “communication policy” or forward guidance to get us out. So, Bullard says, let’s stop this charade of dot plots and just admit the truth: rates are not going up, maybe not EVER, until something beyond the Fed’s control shocks the world into some other macroeconomic regime.
…. in a nutshell — volatility is not allowed to reach historically normal levels. Not allowed by whom? By central banks, of course. S&P 500 down 8%? Gasp! We must provide more accommodation!
… don’t tell me that the Fed “has no choice” but to accept the current macroeconomic regime, because they DO have a choice. The Fed giveth. The Fed can taketh away. It’s just a very, very, very painful choice that the Fed would have to make in order to taketh away, full of loss assignment and bankruptcy and status quo shattering. It’s a very brave choice they would have to make, a Volcker-esque choice they would have to make. And that’s why I don’t think they will ever do it.”
I agree with every word, and even every comma, in the transcript. I should stress the point that this not only applies to the FED, but also to the rest of the important CB’s. Rajan Raghuram, the only CB Governor with the guts to fight against this global fiasco was fired (Oops sorry, he “resigned”) -certifying the validity of those brilliant paragraphs by Hunt.
This is where we find ourselves, and we have to adapt. CBs run the show and they are increasingly more desperate and resolute. I made big money twice this year (January-February, and post Brexit), and saw most of my gains wiped out, in both events -by CB manipulation. No complaints, finding out what’s next from them is part of my Job! I will take it all in with a positive bias! But I will not deny being tired and upset once again. This is an unfair trading field.
What are the choices we investors have? Invest with the crowd, and get wiped out any day a big enough catalyst manifests itself, or try position ourselves for the inevitable melt down to come? Both strategies are now inconvenient, but the crowd’s option is not as stressful -and it does help to fail conventionally. If you fail unconventionally, you are truly out. I play with that risk daily and, it is exhausting. I’m fed up with the permabear label, and I am desperate to be able to invest normally once again.
The main question is what catalyst will take us out of this seemingly eternal situation. We can’t move forward, but we cannot back-paddle on the monetary and fiscal orgy, or the markets will collapse. I continue to think that a controlled market contraction is a lot better than waiting for a shock that finally overrides POMO presence. They think different. Or do they think at all? Right now I think they are kicking the can forward and not looking back. They follow no other strategy than printing for their daily survival. CBs are actually running (printing) for their financial lives.
But the catalysts, or black swans if you like, do exist. Nothing projects for ever into the future. I have made those catalysts clear in different posts. One of two drivers, or maybe both simultaneously, will push us over the edge at some point. Now we need something more powerful than Brexit. Maybe “Chinabust” or “Frexit”.
The first driver is “Social anger”. Angry crowds, lost and upset in a situation they do not understand, can only perceive the grotesque inequality, and the permanent stagnation in the economy. The do not understand the game being played by CB’s. They will break the social contract that keeps things together. It is already happening all around. The chart below illustrates the point.
Brexit might be the conspicuous event that nobody can miss. But really, symptoms are everywhere. The next major event is the Italian Referendum, but the spark that lights the fire could come from … anywhere. Social mood darkens daily, and tensions flourish all over the globe. Urban violence will spread. Geostrategic tensions between countries will increase. Brexit only marks the beginning of a series of populist draw backs for the establishment. If they do not change the model, and inequality continues to grow, they will lose control at some point. And, not to forget, using credit growth to alleviate increasing inequality, and low wages, is hardly a viable, stable, long term fix.
Sociology is not really my focus, so I think it pays to zoom in exclusively on the most likely financially relevant social events to come next. Trading wise, the schedule of events is as important as the events themselves. Right now we have a couple of active fronts,
- The Italians look particularly fed up with the Eurozone, their GDP having been stagnant for a decade now. If they don’t go for the exit alone, some other country will take their place later on.
- Le Pen might win the French election. That would be a knock-out “Frexit” event, and the likely end of the EEC.
- If the European banking situation gets worse, it might even be Germany and satellites that opt out of the euro. Yes, that was not a tippo! If Germany sees debt mutualization as the last resource, they will probably walk out of the EEC. I would do it myself if I were in their position. They would see a deteriorated competitive situation (much like the Swiss), and they would have to foot the bill for both their bank clean up, and the target 2 imbalances. But they would do it. I think they will not mutualize Club Med debt.
- Trump would be a disaster, and Hillary probably means war with China, or the soviets.
The second driver is of financial nature, as the sustainability of debt is increasingly being questioned. Bank runs in Europe are again, not that far (remember 2012?). Three different scenarios would provide the catalyst for the demise of the “debt is all payable” paradigm/lie.
A global recession is one sure way to end the illusion of debt sustainability. They know full well that it is incredibly near. They are fighting it with all they’ve got. They are massaging economic stats again. Having recovered from the Brexit lows, they are also once again engaged in generating a wealth effect, together with a simultaneous stimulation of “animal spirits” in order to compensate for the recessionary impact of Brexit.
If a recession consolidates, they have run out of options. Helicopter money will be next, and a brutal bond selloff will follow, with an unknown time lag. With yields up, a wave of defaults would end it all. The know it, and will put up a more than decent fight. But you can’t stop the tide. At some point the recession is inevitable, and it can’t be that far away.
Global indebtedness is so loathsome that a straightforward default wave, without a recession, is not entirely out of the question. That would also be the last nail in the coffin for the establishment. They are also trying to preclude that outcome. They need high prices for collateralized loans to be kept working. So they will keep on patching and repairing the debtors’ balance sheets as different debtors in delicate situations flare up. Eventually the amount of holes in the structure will put it beyond repair, but in the meantime they will keep bailing out the key potential defaulters.
In this respect, if China tanks and its NPL problem runs out of control it is game over for all.The Chinese financial situation evolves from bad to worse. Many of their SOEs are burning money, and they have to print and increase credit just to keep their vast amount of NPLs booked as solvent. A credit event is not unthinkable. In this regard, I continue to be short the yuan as a strategic trade. USDCNY at 6.80 is a done deal. It could go above 7.50 in less than a year. If they devalue big time, it is global event that would successfully compete with Brexit as a black swan.Lastly, a market repricing of risk (ie an equity melt down) would ensure a recession with a default spiral to follow swift. It is for that reason that POMO desks abort every single bearish impulse. And they do it with a vengeance. See the 28th, 29th and 30th of June events as a part of a series. More to come. They cannot lift rates meaningfully either. They are locked in to their actual position: Last stand Hill -very near Little Bighorn river.
Like George Custer, they cannot win -even though, like him, they don’t know it. Power normally isolates you from the truth. They feel invincible -just like the seventh cavalry did. But it’s only a matter of time. At some point they will fall, victims to one of these events. The trillion dollar questions are:
- When will this happen?
- What precise event will be the final catalyst?
- When they get to their final stand, what will they do?
This last question is the most important of them all. They have no clean way out of this mess, so they will face their grandiose finale sooner or later. At that point in time, if they opt for helicopter money, they will generate a market stampede in equities -with a consequential impact on yields. Short term the reflationary trade would move equity markets up big. Long term, this kind of money printing will erode the credibility of our fiat currencies ever further. And, not to forget, it will generate substantially higher yields. Higher yields will bust the system. In the end we will also have to mark down the value of outstanding debt. And a default cycle will ensue. I hope they can keep the ATM network operational. But the actual paper bills coming out of it might be, by then, mostly worthless.
If they opt for a debt default, and a market repricing scenario, the bust will be immediate. Worse in the short term, but a faster way to get productivity and GDP moving again (in the right direction). The endgame is always a brutal default, but we can see a massive money debasement scenario in between, or go for the defaults straight. The helicopter money detour looks increasingly likely.
Needless to say, the schedule of events is crucial for investment. We know the endgame, but we are dependent on their last move before their Little Bighorn bloody end. Do not be fooled by the last episode of CB induced, market exhuberance. They are surrounded, and cannot move forward … or back. They are stuck and using their last rounds of ammo. Social anger and or debt unsustainability will ensure a Custer role for Commander Janet Louise Yellen.
Custer paid for his mistakes, and for those of his liutenants. She will pay for those of Saxo-Alan, Heli-Ben and herself. After their Little Bighorn defeat, Central Banking will change profoundly. The impact of these wasted years of monetary opulence and credit extravaganza, will be felt decades later. I will take so long, that I won’t be here by the time we are finished with the hangover.