Notes From Underground: A Desultory Philippic on the Markets, the Fed and World Finances

One of my favorite songs by Simon and Garfunkel is “A Simple Desultory Philippic” in which the duo takes the time to mock and criticize the world of culture and politics that surround them. Desultory means lacking a style or plan, while Philippic connotes a word for a tirade or rant. Will my readers entertain my desire to craft my own simple desultory philippic?

I have been equity and bonded till I am comatose. This summer, the global equity markets that have provided the catalyst for all asset classes. The SPOOS have teased all markets with its dance of the 200-day moving average. The SPOOS have traded through the highly valued indicator several times but we have NOT had a weekly close below the 200-day. Today, the SPOOS tickled the average again (2073.46 using a CQG continued moving average line in the September futures contract). When the SPOOS were testing its support, the German DAX was trading through its September level of 10941.7. As the SPOOS bounced off the 200-day, the DAX found strength and recovered to close above 10941.7. It is important to follow the global markets for the major indices tend to provide support for each other. In March 2009, the DAX, Spoos, Footsie, CAC, Nikkei, Aussie All Ords, et al all made synchronized lows the week of March 9.

Now it seems as if the markets are attempting to create a harmonized top as the Footsie, All Ords and Russell 2000 put in weekly closes BELOW their respective 200-days. The NIKKEI and CAC are far above their 200-days but it is of great interest that the German DAX and the SPOOS have flirted with recent violations of the important technical indicator. Just trying to keep readers aware of the technical formations we are visiting and possible market moving implications. The 200-day, in my opinion, gains great credibility when it is violated, up or down, on a weekly closing basis. Revisit the global markets in March 2009 and get a sense of the powerful price action that develops when the action is synchronized. In a world of “unfettered” capital flows financial feedback loops are powerful instruments.

The beloved yield curves  and their signalling power. For almost six years I have pointed out the role of flattening and steepening yield in identifying the market’s views on the effectiveness of central bank monetary policy. Prior to the financial crisis, the U.S. 2/10 curve inverted, predicting that the Fed’s  belated move to raise interest rates was warning of an impending slowdown. When a steepening takes place prior to central bank policy changes, the market signals that the central bank is behind the curve and needs to tighten monetary policy or the market will push the long-term rates higher until the bank reacts. The classic case of this was the 1979-1981 U.S. policy when inflation was rising and the FED was deemed to be well behind the curve, which resulted in the markets pushing BOND YIELDS higher until the FED had to react and play catch-up to halt the rising inflation. It resulted in a 20% FED FUNDS RATE, and, ultimately, a very INVERTED YIELD CURVE.

Today, because of the role of MASSIVE QE programs it is difficult to judge the forecasting value of market yields as central banks’ bloated balance sheets have rendered the signaling power of the long-end of the curve virtually useless. During the past two weeks the U.S. 2/10 and 5/30 curves have traded over and under their 200-days as investors try to ascertain the probability of a FOMC rate hike. When the probability of a Fed hike rises the curve flattens and when the data turns soft the probability lessens and the curve steepens. The U.S. 5/30 has vacillated around its 200-day, currently at 126.90, after it closed at 126.10. The 2/10 U.S. curve has recently settled in under the 200-day, closing at 146 basis points vs 200-day at 152.22. So past performance of the curves are suggesting a September rate hike but again the massive FED and ECB interventions have muted the signalling power of the yield curves.

Last week the newswires were alive with the story that the Chinese had made a record devaluation of the YUAN, a whole 1.9%. The U.S. dollar moves more than 25 regularly so the move in the YUAN was not significant on a percentage basis. In 1994–January 1 to be exact–the Chinese devalued the YUAN by 50% in response to the initiation of NAFTA. Now, that was significant. In an effort to show that Chinese officials were unhappy with the YUAN‘s appreciation versus many emerging market currencies (and also the euro and Japanese yen), China let the markets know that its policymakers had tools available to weaken the YUAN in response to global currency manipulation that was negatively impacting the Chinese economy. In a Bloomberg article by Toru Fujioka, “Japan’s Economy Contracts as Consumption, Investment Decline,” an adviser to PRIME MINISTER ABE, Koichi Hamada, stated, “Japan ‘need not worry’ about China’s currency devaluation of the yuan because it can always offset the effects by easing monetary policy.”

In my opinion, the Japanese will not be able to increase QE in response to the Chinese for the world will not sign off on initiating a new round of global currency devaluations. The world applauded Japan’s efforts at initiating growth via Abe’s three arrows but now that the Chinese have signaled that they are displeased by the enthusiasm of currency devaluations the Japanese will not risk angering global trading partners. In October 2012, I wrote a piece that the IMF was giving a quiet nod to the weakening of the overly strong YEN but three years have passed and consensual devaluation has passed.

This is similar to June 1998 when China complained that YEN devaluation had been overdone. With President Bill Clinton on his way to Beijing, the U.S. Treasury, under Secretary Bob Rubin, intervened in foreign currency markets and BOUGHT YEN, driving YEN values substantially higher with the currency appreciating to 112 YEN to the DOLLAR from 145 YEN/$ by October 1998. Interestingly, the IMF said last Thursday, “China’s new pricing regime was ‘a welcome step as it should allow market forces to have a greater role in determining the exchange rate.'” It cautioned, however, that the “exact impact will depend on how the new mechanism is implemented in practice.” The outcome from the YUAN‘s downward move is far more difficult to comprehend than the simpletons in the financial media would lead us to believe.

This Desultory Philippic is over as I have broken my keyboard, Albert. (Thanks to Paul Simon for the inspiration.)

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10 Responses to “Notes From Underground: A Desultory Philippic on the Markets, the Fed and World Finances”

  1. the american limey Says:

    I have heard it said that the market is now approximately 70% machine trading AND given the quants who program the algos are pretty similar in behavior. Would it be too far out there to consider the possibility that the old merits are not as useful as they used to me except in broad strokes ie the 200sma. I suppose my real question is

    “is this Thaler or Von Neuman? behavioural finance or internally stored programs?”

    • Alex Says:

      Machines are no different from human traders – not all human traders can make money so not all machine trading can make money. Therefore there is always opportunity.

  2. Chicken Says:

    I sensed Japan was incensed about Rubin driving the Yen higher. Then again, Wal-Mart is/was headquartered in Arkansas so I can comprehend why Japan was unhappy.

    Nice work if you can get it.

  3. Dustin L. Says:

    Yra- When it comes to the PBOC’s actions I am more in the camp that it seems like a reasonable thing to allow the currency to have a more free floating rate at a time when the world is not tremendously bullish the Yuan, allowing the Chinese policy makers to transition to a more market driven rate in their proffered fashion, gradually. It looks good for entering the SDR and seems like a good thing for growth, even if the goal is rebalancing, to not fight a slight drop against other currencies after a 33% increase in the Yuan on a trade weighted basket of currencies. Not to mention, the problem wasn’t a market driven weak Yuan that created the great imbalances, it was intentional undervaluation by the PBOC who have been taking these losses on their own balance sheet. Let’s also not forget financial repression and intentionally limited workers rights to reduce wage rates have also been at the heart of China’s mal-invetsment. So, as you have said, time will give us a clearer picture as to what China’s policy makers are thinking. But, with all the behind the scenes motives of the Chinese policy makers and the non-linear effects of any action, good thing we don’t have to have all the answers. Risk-to-reward, ’nuff said. I often find it calming to admit that I never have it all figured out and neither does anyone else, haha. Mind you, the way the media has reacted you would have thought markets were straight forward and excess returns were easy to come by. 😉

    Best Regards,
    Dustin

  4. asherz Says:

    Demosthenes of Athens gave the first phillipic against King Phillip ll of Macedon who he considered to be a greater danger to his city than Persia.The Central Bankers have been the market’s King Phillip as their QEs have made rates set by the markets non-existant, and ZIRP distorting asset prices. Last Monday after the Yuan devaluation the Dow was down over 200 points. The next day the Dow was down another 200 plus points but the cavalry arrived and it closed up for the day preventing a waterfall drop.
    The markets used to be called a weighing machine (Ben Graham). However a heavy thumb on the scales since 2009 have caused distortions for technicians and analysts alike that have not allowed our markets to perform their proper functions.
    This will end at some point as the markets will have the last word over the bankers and a proper directed and not desultory phillipic will be delivered agaimst those who distorted the free markets.

  5. yra Says:

    Asherz—as well put as it could be —market fundamentals may be UNDER WEIGHTED on a daily basis–hence a bubble is created when scant attention is provided to the fundamentals for as Bernard Connolly ,I believe,stated that a “bubble is a lack of fundamental valuation” and the machines cannot prevent the power of the siege of the overwhelming reality of market forces –that is the fundamental other then the last TIC—–and the Demosthenes reference was spot on but your background and age reveals an education when there was a genuine core curriculum and VALUE was placed on the FUNDAMENTALS of the great books paradigm

  6. paul heffernan Says:

    what are the chance and implications of the IMF making the yaun a reserve currency at there 5 year review meeting in oct

    I have read some reports that think it is highly probable that this is the time for it to happen.

    any thoughts or comments ?

  7. Jesse Says:

    The central banks certainly provide the resources and the bad example, especially as regulator, but it goes far beyond their policy errors, alas.

    Perhaps after the third crash since 2000 we will see some serious effort at rolling back the abuses in deregulation that have turned the playing field into a algo-driven, unprincipled game of snakes and ladders.

  8. yra Says:

    Jesse–read the nonsense op ed by Greenspan in today’s FT.

  9. yra Says:

    Paul Heff–great question and I also believe it is highly probable.The IMF economists and Europeans believe China is the future and is the most powerful emerging market representative–so in order to begin dismantling the colonial nature of the original Bretton Woods agreement they will make China the new highly esteemed member of the SDR community—then maybe the Chinese will move to cash in their U.S. Dollars for IMF gold—and the score will be evened from the British efforts at devaluing silver to harm the Chinese government in the 1800’s.The Chinese have a much different time line then the quarter to quarter asses on Wall Street

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