Notes From Underground

Sometimes looking back provides perspective in moving forward. As December begins we know the year-end is the global market’s attempt to position themselves for the coming year. The rise of populist voices has certainly sent tremors through financial markets. The most interesting aspect is how short-lived the disruptions have been. Brexit, no problem; coup in Turkey, no problem; Chinese economy sputtering, no problem; Donald Trump becoming the U.S. President, no problem; and this week’s Italian referendum, no problem.

The world’s central banks believe that the massive accumulation of bonds in a global condition of continued QE will be no problem. That is something we will continue to examine in 2017. The FOMC is certainly constrained by its continued asset purchases. The question at the FOMC should be: Why don’t we raise rates by 100 basis points if the TRUMP administration is going to pursue a robust fiscal stimulus? The FOMC model maintains the U.S. is at full employment and a retreat from austerity in the time of full employment OUGHT to be met with a rapid rise in interest rates or at the least beginning the aggressive reduction of the balance sheet. The year ahead will be rife with volatility as politics and debt overhang prove the motors of turbulence.

“A Single Spark Can Start A Prairie Fire” (Mao, 1930)

You don’t have to be a weatherman to know which way the wind is blowing, or so says Bob Dylan. As long as all things are emanating out of China it may be the time to dust off the sayings of Mao for as the talking heads are reminding us daily: “The East Wind Is Prevailing Over the West” in all things financial. THE PROBLEM FOR ME IS I DON’T ACCEPT THAT VIEW AND AM IN THE CAMP OF FORMER DALLAS FED PRESIDENT RICHARD FISHER that all roads lead to the FED and certainly the European Union for providing the tinder for a financial prairie fire. There has been so much volatility during the first six trading days of the year it is difficult to get a handle on what is  algo-driven non-fundamental and what may be the commencement of a change in previous momentum trades. Today I will go through a list of POTENTIAL SPARKS TO IGNITE THE FLAMES OF A FINANCIAL FIRE so that we can be aware of what constitutes a genuine change in momentum:

1. If the U.S. 2/10 curve begins to flatten–currently holding around 117 area–the bigger test will be in the 80 BASIS POINT area to signify the initiation of the flames of deflation;

2. There’s a new break in the currency wars. On January 4, RIKSBANK of Sweden announced that it would intervene at any time to stem the appreciation of the Swedish kroner, especially against the EURO. Over the weekend Swiss National Bank (SNB) President Thomas Jordan warned about the Swiss franc still remaining overvalued against the EURO and other currencies. On Friday, a Dow Jones wire article warned that the SNB lost $23.5 billion trying to keep the Swiss weak as it purchased various currencies that dropped in value.

The SNB typically makes a profit that it turns over to the Swiss Treasury, but this lean year will not sit well with the cantonal governments. The SNB noted it will pay a dividend to the cantons out of its reserves (ah, the power of the printing press) but this will not ease the pressure by Swiss politicians who wish to curb SNB independence. There are sparks a plenty in the realm of global currencies and the Chinese yuan is a mere side-show. The dramatic fall in the some emerging market currencies have the ability to create a firestorm in global credit markets.

3. The dramatic fall in the price of OIL is significant but actually aids Europe, which has little production and benefits from a fall in the price of its energy imports. The larger problem, of course, is for the U.S. financial system, which has lent heavily to U.S. energy producers and is exposed via the bond markets. There is a complacency among some investors that the loan exposure of banks is minimal compared to the sub-prime crisis but as we know a single spark can ignite a large fire. The more important question: What are the Saudis up to? The last time the House of Saud drove the price of OIL dramatically lower it was 1986 and Vice President George H.W. Bush went to Saudi Arabia and convinced the Saudis to cut production because it was a disaster for U.S. producers in Texas. This time the Saudis seem to be sending a message but it’s not clear what and to whom. Given its anger at the Obama White House over its dealings with IRAN, the Saudi message my cut deeper then all previous political machinations.

There was an extraordinary meeting of the Arab states in Cairo this past weekend. The Saudis called the meeting and it seemed to signify that the Arabs would unite and the Sunni Turks were left out. By leaving out the Turks, the end result is that Russia becomes an ally of the Arabs and the price of OIL is close to its lows. Russia has proven to be a more trusted friend, as proven by Putin’s intervention to save President Assad. The U.S. 70-year support of the autocratic House of Saud is certainly being called into question by the Obama policies of the last four years. Oil and politics make for strange bedfellows and it seems that the mattress is made of straw.

4. The most dangerous spark of all is something I have warned about in this blog and on television with Rick Santelli and that is the rise of anti-euro fringe parties in Europe. More importantly, these parties are also opposed to the insular nature of the governing elites. Chancellor Merkel is under great pressure, even as she has been touted as the greatest Chancellor since Konrad Adenauer. It is amazing how quickly the winds change. Frau Merkel cancelled her trip to Davos because to leave Germany to cavort with the epitome of crony capitalists would not play well with the Burhgers of Bavaria.

The recent scandal of the rapes in Cologne over New Year’s Eve has lit the fires of the AFD and its anti-refugee platform. But the real spark to German political pressure on Merkel is the RAPE of German savers by the ECB-imposed negative interest rates that are condoned by the German Chancellor (yet vehemently opposed by Bundesbank President Jens Weidmann). It is this potential conflagration that can cause the greatest problem for the EU and global financial markets. The ECB’s swollen balance sheet has caused the sovereign debt of Spain, Portugal, Italy, France, Greece and others to be absurdly priced risk. The world is a tinder box.

***If the central banks lose control, meaning that investors grow fearful of their ability to control outcomes, GOLD will become a haven (also factor in concerns about currency wars). The GOLD has been in a medium-term bear market but in the long-term it’s still corrective. The GOLD held the important $1048 price level (of the IMF 200-ton sale to the Bank of India in November 2009). Currently, the GOLD/YUAN spread has rallied above its 200-day moving average but the other gold currency crosses have not reflected any such strength. The GOLD/EURO cross remains rangebound. The ultimate haven spread, GOLD/SWISS has held at  the 200-day m.a. and failed to continue last week’s rally of the fearful. (The Gold/Swiss 200-day is 1097.33 on the CQG daily continuation.) This is an important signal because the world’s speculators are short gold. Remember, last year GOLD outperformed BERKSHIRE. In the realm of GLOBAL MACRO all values are relative. Gold reflects the lack of global leadership and no GREAT HELMSMAN steering the ship.

Tags: FOMC, Italian referendum, QE, tightening

This entry was posted on November 30, 2016 at 6:08 pm and is filed under Fed, United States. 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.