Notes From Underground

After rallying 2.5 percent on the algo readers, the NIKKEI reversed and dropped 2.5 percent for a combined move of 5 percent. The DOLLAR/YEN performed in a similar fashion as the initial interpretation sent the dollar/yen to 123.50 only to watch it drop to 121.25 once it was determined that there was no new additional purchases planned. The YEN closed on its highs while the Nikkei closed on its lows following the large selloff in the SPOOS. However, the BOJ did announce an additional ETF purchase program. (The BOJ buys equities as well as bonds which is why its program is Qualitative, Quantitative Easing [QQE].)

The BOJ will be buying the stocks of companies that increase wages in another effort to increase the level of inflation. The program is a targeted 3 trillion yen, not a great deal of money but an incentive for smaller corporations to raise employee pay and also get support for its stock price when the BOJ places the equity on its balance sheet. The BOJ holds a great deal of the “higher quality” bond assets and therefore is being forced to purchase lower quality instruments so as not to totally disrupt the balance sheets of banks, insurance companies and other entities in need of assets to meet future obligations. The lack of bonds means that during the next year the BOJ will be forced to purchase equities in order to meet its QQE purchases. This OUGHT to support the Nikkei’s outperformance relative to other global equity markets. Of course the strength of the NIKKEI will be tied to the performance of the yen, at least initially.

As the Chinese allow the YUAN to depreciate it will be important to monitor how the Japanese respond for theABE administration does not seem overly concerned with the recent weakness in the YUAN (as of now). Over the previous three years the BOJ’s policies have led to a 35% depreciation of the YEN VERSUS YUAN. Some correction in the YEN/YUAN cross is to be expected, especially in response to the slowdown in China.

***In the December 16 blog, I preached patience in regards to the Fed’s 25 basis point rate increase. The initial rally in the U.S. equity markets was expected as a sign of relief that the FED had actually moved and Yellen signaled that it was in response to the strength in the U.S. economy. But by Friday’s close the relief rally had ended as the market had been up 3.5 percent for the week on Thursday morning, actually wound up lower by Friday’s close.

The U.S. stock markets are struggling under lower profits and the sense of some type of credit event. Lower profits with increased debt on the balance sheets of non-financial companies can be toxic for equity prices. The last two years have seen an increase in corporate debt as U.S. companies have borrowed money for stock buybacks and to sustain dividends. This is financial engineering 101 and works as long as free cash flow is strong enough and interest rates remain low. A slowing global economy and a strong DOLLAR may test the ability of corporations to meet obligations without severely impacting the bottom line. Very few companies have decreased dividends during the last three years but that will be an important indicator for the financial health of the equity markets.

***Tonight we get the results of the Spanish elections. It seems that the outcome raises more questions than answers. Current Prime Minister Mariano Rajoy’s Popular Party lead the votes but he failed to get any outright majority. It seems that the PODEMOS Party, which ran as an anti-austerity party,is polling a strong third behind the Socialists while the upstart Ciudadanos ran a disappointing fourth. The outcome of the strong showing by Podemos and Ciudadanos, two new parties, reflects the discontent of voters throughout Europe with the previous establishment parties.

It will be difficult for Rajoy to build a coalition with Podemos because he has promised Brussels that Spain would adhere to its budget promises. The mainstream media have crowned Spain as a poster-child of growth through austerity and proclaimed that Spain is out of its severe recession. But with a still Europe high of 22 percent unemployment, Spanish voters were not as enamored with the Spanish economy as are the blowhards of Davos. The Spanish election results are proof that fringe parties are on the rise across Europe as voters reflect on how the Brussels elite and the establishment parties are out of touch with a disillusioned populace. The ECB will be under pressure to keep the monetary floodgates open in an effort to stimulate growth through low borrowing costs.

Tomorrow it will be important to watch the European debt markets as the ECB said it would finish its QE purchases by December 22–its 60 billion euro per month total–so as not to create excess volatility in a holiday thinned market. There is very little transparency to the ECB’s actions so I would expect we will see a great deal of volatility in the euro and the European debt markets. The BUNDS, OATS and BTPs have had sizable rallies following the FED‘s raising of rates as the ECB seemed to hold off until the Yellen Fed made its decision. How much more buying the ECB has to do will be important for if the ECB is done the euro may stage a late-month rally in a market that is very short euros, especially if the U.S. equity markets remain under pressure. For all you traders, year-end volatility will not be like ghosts of Christmas past.

***For all the followers of the 2/10 yield curve, the critical level (in my opinion) is 117 on a closing basis. Back in July 2012 when the EURO was under pressure and the existence of the entire EU project was being questioned, all the yield curves were flattening in a dramatic fashion while Europe was having problems funding the peripheral nations. Two-year notes in Spain, Italy and Portugal were yielding more than 7%, which prompted Draghi to make his, “whatever it takes,” statement to assure the markets that the EURO currency was going to exist.

The U.S. 2/10 curve was flattening also because the idea of the demise of the euro was causing havoc in all financial markets. The low on July 24, 2012 was 117.25 and it was tested on January 29, 2015  but held. If the 2/10 level of 117 gives way it will signal a new bout of curve flattening and may be an indicator of the dramatic global slowdown that some BOND BULLS are predicting. This is important to pay attention to and it begins just after a FED rate increase. This is something to watch for because flattening yield curves will put new fears into the global central banks. What will they do when they are already at ZERO, which makes the present situation far different from 2007. Be alert to the signals being sent by the debt markets.

Tags: Abe, BOJ, BTPs, Bunds, Dollar/Yen, ECB, Euro, Fed, Janet Yellen, Kuroda, Mario Draghi, Nikkei, oats, Podemos, QQE, Spain, SPS, U.S. Dollar, YEN/YUAN

This entry was posted on December 20, 2015 at 7:31 pm and is filed under BoJ, Central Banks, Currency, Spain. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.