The markets are in turmoil and it gets the mind to thinking: What could possibly have caused today’s reversal in the stock market and the long end of the BOND MARKET? The market seemed like it was on the edge of a complete risk capitulation. The dollar was dropping, bonds all over the world were in rally mode and the precious metals were finally finding some technical strength as the GOLD (in pure dollar terms) had finally rallied through its 200-day moving average. Even the SILVER was able to synchronize with the GOLD and break out of three months of resistance. (The silver 200-day is at 15.13, still a bit above its closing price.) The global stock markets were cascading lower as the Nikkei and German DAX took out their lows made the night of the BOJ’s surprise move to a three-tiered negative interest rate policy.
The U.S. economic releases today were mixed as the SERVICES PMI was on the weak side, but the ADP data was stronger than expected. There was an early attempt at a stock market rally as NY FED PRESIDENT Dudley tried to “do right” and talk U.S. economy down and interest rates lower for longer. The DUDLEY rally soon lost steam and joined the foreign markets lower, taking away last Friday’s substantial gains. Then the reversal began at 1 p.m.
Yes, I know the OIL was HIGHER, SHORT-TERM INTEREST RATES WERE LOWER and THE DOLLAR HAD DROPPED MORE THAN 2 PERCENT. In FACT, THE CHINESE GOVERNMENT CALLED TO PROTEST U.S. EFFORTS TO DEPRECIATE THE STRONG DOLLAR (SARCASM INTENDED). So the stage was set for a total rout of the global financial markets. BUT WHY THE REVERSAL IN EQUITIES?
Here are my pure thoughts without the pollution of the DAVOS crowd: THE FED HAS HAD A SERIOUS PROBLEM SINCE THE END OF QE. THERE APPEARS TO BE A SHORTAGE OF DOLLARS AVAILABLE TO FUND THE OVER-LEVERAGED BALANCE SHEETS OF EUROPEAN, ASIAN AND MOST EMERGING MARKET FINANCIAL INSTITUTIONS. THE FEDERAL RESERVE HAS A POLICY TOOL TO OPENLY LEND TO FOREIGN CENTRAL BANKS: SWAP LINES. UNDER THE RULES IMPOSED AFTER THE GLOBAL FINANCIAL CRISIS, THE FED HAS THE ABILITY TO LEND MONEY TO FOREIGN BANKS AT A CURRENT RATE OF 86 BASIS POINTS, a high cost in a negative rate global environment.
BUT THE PROBLEM IS (AS HARD AS IT TO BELIEVE) THERE IS A GLOBAL SHORTAGE OF DOLLARS RELATIVE TO THE WORLD’S BLOATED BALANCE SHEETS. IT IS THE BLOATED BALANCE SHEETS ENABLED BY THE FED’S EFFORTS AT QE THAT WILL CAUSE THE FED TO REMAIN EXTREMELY ACCOMMODATIVE FOR LONGER. THE FED WILL OFFER UP DOLLAR RESERVES TO THE WORLD AT ZERO INTEREST RATES TO PREVENT A COLLAPSE OF THE GLOBAL FINANCIAL SYSTEM.
THIS IS A CLASSIC CASE OF RICHARD KOO’S BALANCE SHEET RECESSION ON A GLOBAL SCALE. THE FED OFFICIALS ARE CAUGHT IN A BAD SITUATION AS THE WORLD’S BANKER WITH THE RESERVE CURRENCY IN ITS ARSENAL. THIS IS WHAT MICHAEL PETTIS HAS FOREWARNED: THE EXORBITANT PRIVILEGE HAS MORPHED INTO AN EXORBITANT BURDEN.
If we are in a paradigm shift then the algos and all their correlations are going to be caught off guard. One day does not a trend make but be aware of shifting sand beneath your feet. News of large usage in SWAP LINES may not be made this week or next but watch for the recently established patterns to undergo a metamorphosis. Remember, good trading, like science, advances one funeral at a time in the realm of ideas.
***At 6 a.m. CST tomorrow the Bank of England will announce its interest rate decision. There will be no change as BOE Governor Carney will be slow to change policy, especially in the midst of the political discussion on the EU referendum. Some analysts believe that British inflation data is rising and will force the Monetary Policy Committee to move earlier than the market has anticipated. Carney speaks at 6:45 a.m. about the INFLATION REPORT, but the BOE has allowed inflation to run hotter than planned without raising rates. This happened several times under the Governorship of Mervyn King. Again, be cautious in buying the POUND in anticipation of a more aggressive BOE.
“Ooh, you’d like to be my fatheryou’d like to be my dadand give me kisses when I’m goodAnd spank me when I’m badBut since I’ve left my parentsI’ve forgotten how to bowSo when I’ve got something to say,sirI’m gonna say it now.”— Phil Ochs