Notes From Underground: A Long Time Ago In A Galaxy Far, Far Away…

Financial repression was not the ultimate weapon in central bankers’ armories. The light saber was symbolic of market-driven levels of interest rates allowing for a genuine return on capital. The Darth Vader PUT was relegated to the outer rings of the galaxy while the VOLCKER RULE provided the rule of law and prevention of over leverage. Planet Mario was under assault as its storm troopers were defeated by the battalions of the financially repressed. All banking DOVES from the Dark Side were driven off by the foresight and power of the Millennium FALCON. A mechanical droid was given the power over all financial decisions and order was restored to the financial galaxy … in a realm far, far away. The world is calm as the DROID runs off an ALGO relying on the intelligence of an unseen oracle, devoid of emotion (or Yoda). Okay, enjoy the fantasy.

***The world is powered by the designs of the central banks. QE programs are the continued tool of choice and all the world’s major economies have utilized the power of asset purchases to try and stimulate their economies. Purchasing assets on a large-scale puts downward pressure on interest rates in an effort to stimulate borrowing to help drive the engine of economic growth. Any bank that readily drives borrowing costs to zero or below is trying to remove the burden of excess debt overhanging its economy. The experiments of the last 20 years have failed to realize any conclusive results as the Japanese, U.S., British and European economies are still saddled with anemic economic results. When the Japanese were the sole practitioners of QE it was hard to measure the program’s success because the world economy was stronger. Developing economies and European and U.S. growth was enabling the Japanese to muddle through its vicious downturn.

Now, there is not enough growth in the world to support all the financial systems struggling to sustain themselves with ZERO INTEREST RATES. The initial impact of ZIRP is always the depreciation of the currency but if everybody is pursuing lowered currencies to stimulate exports the end result is global stasis. In its annual communique the G-20 maintains that they are making great strides but the ultimate outcome is that the U.S. has to carry the financial burden since it has been the only appreciating currency for the past three years (except for the Swiss Franc, which cannot carry the world with its minute economy). The FED has aided the globe by raising rates last week but the outcome for the DOLLAR has been mixed as the EURO and YEN have both appreciated as long-held profitable positions are squared before year-end.

The question for investors is whether the FED‘s rate hike was a one-and-done and that those pricing in higher U.S. rates are going to be disappointed. If the FED is very concerned about the economic drag from a strong DOLLAR then DOLLAR BULLS will be disappointed. Remember, 2016 is a presidential election and the FED may be reluctant to have an overly strong DOLLAR as a campaign issue. If the U.S. is beginning to slow in response to foreign central initiatives to weaken their currencies, the FED will suffer the criticisms of all types of elected policymakers. We have already heard from Ralph Nader in a plea for the FED to stop its policy of financial repression of savers and pensioners. The National Association of Manufacturers will be very vocal is American exports begin to falter in response to a STRONG DOLLAR.

In Europe, the political climate is very fragile as non-status quo parties are raising the heat on the Brussels Eurocrats, and, more importantly, the ECB. Up until now a strong German chancellor has been able to shield ECB President Draghi from the criticisms of the German hard-money crowd. But as Chancellor Merkel’s political status diminishes, the voices from Germany’s saving class will be loud against the financial repression its is being forced to suffer. It seems that 2016 may be the year in which the interest rate policies of the world’s central banks come under severe scrutiny from elected officials. If my opinion bares out, the global sovereign debt markets are going to be the markets to create all sorts of investment volatility.

When France can borrow at 85 basis points for 10-year debt and Italy at 1.5 percent for their 10-year note, the markets are in for an increase in volatility. There was an article in the December 23 Financial Times by Dan McCrum and Elaine Moore titled, “Bunds’ Ride Highlights dangers of Herding.” The writers point to the ridiculous low yields on German debt that investors have accepted as the ECB‘s purchases have put a premium to the “scarce” high quality German financial paper.  My point has been– and will be going forward–that it is not the mispricing of German debt that is the problem but rather the insanity of low yields on French, Italian, Spanish and others who all rely on the high credit rating of Germany. Low European yields are only viable as long as German citizens support the ECB.

As European politics become more uncertain, watch the yield differentials between Germany and its partners to determine fissures in the EU system. As Bill Gross declared the BUNDS the sale of the century back in April 2015, I still believe it is better to own the top creditor rather than the debt of those searching for a co-signer. But I am be living in a galaxy far, far away.

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6 Responses to “Notes From Underground: A Long Time Ago In A Galaxy Far, Far Away…”

  1. the american limey Says:

    first STOP writing these missives whilst watching Star Wars films you are subliminally channeling geekdom 🙂

    second the great Authers wittered on about the pace of the Fed hiking causing more volatility ( which is EXCELLENT to us options bods ) so based on what you describe ( zee germans et al causing chaos) and we’re one chinese factory gate announcement away from devaluation ( fed take the snake ( and ladders) all the way back to zero) ERGO we are in for a bumpy ride WHEEEE!

    A happy new year to you and yours
    see you in Ceres soon
    the american limey

  2. Alex Says:

    USD-JPY is very over-extended on the monthly chart. If it rallies I can’t see it going much above the low 130s, if that. But I wouldn’t be long here expecting that sort of move. It’s a real long shot.

    A move back down to 100-110 looks more likely. Look at the daily action in August 2015, massive 2 day dump, suggests to me that there aren’t as many bulls willing to buy as the longer terms charts would suggest. Plus, look at the recovery since the late summer, there’s a word for that sort of price action – lacklustre.

    Then we have a big crowded trade of USD bulls out there. So how about a crazy prediction for 2016, the rate goes back below 100 and maybe even back towards the all time lows of around 80.

    Or perhaps we move lower quickly. That’s often the key as the boys will be the downside jammers looking to generate panic (thrust is the boys weapon of choice, it’s very effective), get many of the now panicking longs out before boom, liftoff, back into the 130s. That would be the perverse move, price is normally always perverse.

    Whatever the case, lot’s of cash waiting to be made on FX this year. It’s going to be great (but only if you concentrate). Good luck everyone.

  3. yra Says:

    Alex–good comments and the need for concentrating is point on–this is going to be an extremely volatile year and I am not talking about just equities–the election year in U.S. and the middle-east spell a year of great uncertainty and the fact that equity markets are priced for perfection because of zero interest rates puts everything on the table–everything

  4. Mike Malone Says:

    You said ” all hell will break loose” if curve sets new flattening low. Could you elaborate ?

  5. yra Says:

    mike–yes .It is CLOSES under that critical low tested twice in the last three years and more importantly on July,24th 2012 the day Draghi made his whatever it takes comment–this will be indicative that the FED will have waited too long to begin hiking and that those arguing that the global economy was far weaker then the equity markets have priced for—this is the Gundlach argument for being long bonds—- a renewed flattening of the curve has historically been a negative for equities and although I have watched this for many years I cannot put a time to it—-there is a lag but just don’t know the duration of the lag effect.The only response that will be a positive will be a fiscal stimulus package out of Congress and in an election year for president that has not been the norm–but a fiscal stimulus package will turn the flattening but it is a warning sign of problems on the horizon–remember if it happens this week it won’t be as powerful because of the thin markets and lack of liquidity so what happens the first week of the New Year will be far more important

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