Notes From Underground: The Second Quarter Begins

First, let me apologize to my readers. I erred when I said Marine Le Pen made it to the second round of the 2012 French presidential election. Reader Al 13 corrected me. It was her father Jean-Marie Le Pen who made it to the second round in 2002 and got trounced, garnering 18% of the vote to Jacque Chirac’s 82%. But read Al 13’s comment on the previous post because he notes that if the second round were to be a choice between Le Pen and one of the two far-left candidates–Melenchon or Hamon–the impact would be highly volatile for European markets.

I agree with this and it should be something we watch closely over the next three weeks. Such an outcome would trash French bonds, equities and the euro currency. The ultimate play would be to be long Germany and short French, Italian and Spanish assets. This scenario makes the first round of the French elections very interesting.

As always, we like to revisit some investment outcomes that we discussed. In a January 29 post I called the Mexican peso and the Mexican equity markets the most undervalued asset in our world of tradeable instruments. On Friday, the Financial Times noted the PESO had its largest quarterly gain since 1977 (take that Bragan). The uncertainty around NAFTA seems to have calmed as the narrative switched from bashing Mexico and Canada to actually promoting the idea to improve upon NAFTA rather than seeking its destruction.

But to understand NAFTA and its relationship to the world at large I lean upon the Mexican peso relative value to the Chinese YUAN. As my readers know, the YUAN was devalued by 50% on January 1, 1994, the day NAFTA went into effect. The peso had devalued by 700% up until the end of January and President Trump’s insistence on criticizing and threatening the Mexicans was only making a difficult situation worse.

Also, listen to the March 31 FRA podcast. I noted that the GOLD/EURO, GOLD/SWISS, GOLD/YEN all were strong and everything but the GOLD/SWISS closed the quarter above the their 200-day moving averages. The Swiss/gold is close but has not quite cleared the longer term technical indicator. As I discussed with renown Swiss economist Uli Kortsch on the podcast, the Swiss franc still benefits from all the political uncertainty surrounding its borders. As Uli pointed out, Europeans like to keep their assets close to home, making Switzerland the recipient of scared money looking for a haven.

As many have written and BIGMAN commented on the last NOTES FROM UNDERGROUND, the Swiss National Bank made enormous profits on their equity holdings. (Fun fact: The SNB is a publicly listed stock which has appreciated 60% in value over the last year.) Yes, the SNB with its ability to buy assets with nothing but a printing press is held by private investors. As Yaakov Smirnoff would say, what a country!

***Something we will watch this quarter is the performance of the U.S. yield curves. The 2/10 and 5/30 curves both flattened in response to the two FOMC rate increases but we will watch to see if increased talk about the FED shrinking its balance sheet has a steepening impact. The market will try to front-run any the FED if they announce sales of Treasuries or MBS so the yield curves will provide a window on the market’s assessment of the central bank’s action. Also, there has been a great deal of discussion about this year’s FED rate increases mirroring that of 1994 and the havoc the FOMC caused in the global bond markets.

The FED started raising rates in early 1994 from a very low 3.00% to 6.00% 12 months later. Yes, the U.S. Treasuries were battered as many pension funds and insurance companies were long treasuries because the U.S. was coming out of a recession and the FED was trying to counteract a rising GDP. Yields on two-year Treasuries rose dramatically making a high of 7.73% on December 26, 1994, but more importantly, the 2/10 curve flattened to almost zero indicating that the FOMC was very aggressive and tightened too quickly.

If the FED is deemed to be too aggressive with its current rate hikes and a POTENTIAL shrinking of the balance sheet, the 2/10 will flatten and certainly test its previous low of around 75 basis points (it’s currently at 113 basis points). BUT THIS BECOMES A DIFFICULT TRADE BECAUSE WE ARE IN UNCHARTED FUNDAMENTAL TERRITORY. WE DON’T KNOW THE IMPACT OF THE FED’S MASSIVE BALANCE SHEET OF $4.5 TRILLION IN ASSETS. The Fed’s QE programs has distorted bond prices so it will take patience to understand how the Fed’s policy has affected the long end of the Treasury market. Regardless, the yield curves will be an important indicator for investors as we move forward into the second quarter.

***Finally, the Trump Administration’s efforts to curb the U.S. trade deficit may see the executive branch try to depreciate the U.S. dollar if Secretary Mnuchin and Secretary Ross fail to persuade certain global actors to embark upon policies to adjust their current account and trade surpluses. The Fed’s recent tightening has not rallied the dollar–it actually closed lower on  the quarter–so if the political status quo is sustained in Europe and no new political crisis emerges, the DOLLAR will become a barometer of Trump’s policies on trade.

This Friday, President Trump hosts Chinese president XI at the Donald’s Palm Beach home. This will present an opportunity of how tough Trump will be on issues of rebalancing U.S. trading patterns. If the U.S. fails to have any impact on its trading partners the DOLLAR will become the weapon of choice. Enjoy the podcast.

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15 Responses to “Notes From Underground: The Second Quarter Begins”

  1. Richard H Papp Says:

    Is the secondary reaction from the March 1, 2017 highs of the Industrials (21,115.15) and Transports (9,674.99) of any importance?
    If the market breaks again, after a failure to pass these old highs and the decline carries the closing price of the Industrials below its low of 3/27/17 (20,550.98) and the Transports low of 3/24/17 (8,928.78), the bearish indications will be strong and might well represent something more than a secondary reaction, however severe.
    I refer Students of the Market to the writings of William P. Hamilton in the WSJ of Oct,1 1929. The above is an adaptation of his editorial.

    • yra Says:

      Richard—good question and I am sure some one who is a more astute technical analyst will provide an answer.But in relevance to your question I have been pondering a very rudimentary chart I love to watch—SP/usam[sp bond] and the all time high was made in December ,1999 and while we recently approached it the market failed to make new highs while the same chart in Dax/Bund is breaking out to all time highs—I will discuss this very soon

  2. Al 13 Says:

    Thanks for the hat tip. I have been following your blog since reading Inside the House of Money and now that I work in commodities and can only keep up with so many macro-themed commentaries, you are my go to. Good luck out there.

  3. Richard H Papp Says:

    A typo: Hamilton’s editorial was dated Oct 21, 1929

  4. ShockedToFindGambling Says:

    Yra- Good post

    IMO, if the FED tightens too much, the curve will steepen, at least out to 10 years. Sharply higher rates will cause a credit crisis, as the cost to roll over debt will become too high, relative to the huge pile of debt outstanding AND investors will fear that a higher rate environment will trigger a recession and cause a lot of debt to default.

    • yra Says:

      Shocked—if what you think happens it would be very unusual as the scenario you draw out would create a rush for the long end of the curve and result in a classic flattening as the business cycle would warrant to safety for investors but with the the huge fed balance sheet I certainly don’t rule out your thesis—but I am not in your camp as of yet

      • ShockedToFindGambling Says:

        Yra- I could be wrong, BUT the Treasury balance sheet is in much worse shape than in 2008, AND the Central Banks countered a bubble in 2008 by creating an even bigger debt bubble. I don’t believe the markets will trust the Central Banks the next crisis. and longer term debt will be dumped.

      • yra Says:

        Shocked–this has been a continual theme of this blog for over 5 years as you know–this is the great danger and why gold sustains the bid against all currencies

  5. Chicken Says:

    Jeffrey Lacker resigns in Medley Global Advisors scandal? Moral Compass.

  6. Financial Repression Authority Says:

    […] LINK HERE to the artice […]

  7. Yra Harris: The Federal Reserve’s QE Programs Have Distorted Bond Prices - Investing Matters Says:

    […] LINK HERE to the article […]

  8. Notes From Underground: Trump Delivers on Using the Dollar as a Policy Tool | Notes From Underground Says:

    […] In an interview with the Wall Street Journal, the tweeter-in-chief was reported to have said, “The DOLLAR IS GETTING TOO STRONG.” As some pundits discussed, instead of Trump calling China a currency manipulator it seems he wants to use the dollar as a cudgel to pressure others into not embarking on policies to weaken their currencies. As I wrote on April 2: […]

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