Notes From Underground

As the earth rock keeps spinning we continue to monitor global events that could make investors/traders dizzy. This week the FOMC is EXPECTED to announce that it will begin its quantitative tightening (QT) by revealing the date of its plan to shrink its balance sheet by a net $10 BILLION of assets a month ($6 billion of Treasuries, $4 billion of MBS) and increasing the amounts quarterly so the program results in little market disruption. Remember, Chair Yellen has said she believes that it will be “like watching paint dry.” The world’s equity markets — especially the U.S. — are reflecting little concern about the Fed withdrawing “small” amounts of liquidity.

Every day the S&Ps rally to new all-time highs, an indication investors have no fears about QT. Interesting though, in anticipation of the FOMC statement, GOLD and SILVER have retraced their recent rallies. The precious metals had RALLIED in-step with the equity markets so the recent divergence may be more about a move out of havens and into yield-paying assets. As usual, North Korea cannot lend any sustenance to GOLD. Buying GOLD in times of headline-based geo-political uncertainty IS ALWAYS a fool’s errand. (I have been adamant about this for the eight years on NOTES FROM UNDERGROUND.) GOLD has not just weakened against the DOLLAR but also against all the major currencies, even the weak YEN.

The real test for GOLD will come on Wednesday when the FOMC reveals its intentions about shrinking its balance sheet. The initial response to any action will be the algos selling GOLD and buying DOLLARS but the KEY will be whether certain currencies and the precious metals can hold support levels. Equity markets appear to be far more complacent in regard to possible FED actions, especially as it appears that the FOMC will be reticent to RAISE THE FED FUNDS rate. In a June speech, Fed Governor Lael Brainard said the Fed’s studies predict that merely shrinking the balance sheet will have less impact on the DOLLAR and other asset classes. The FED wishes to do something. It just desires to have as little market impact as possible.

***Wednesday night the BOJ will release its interest rate policy. The expectations are for the BOJ to stay the course by keeping overnight rates at -0.10% with its yield curve control in place. The YEN has been very weak of late versus the EURO, making almost two-year lows at 133.50 today. The YEN weakened Monday in response to the news that Prime Minister ABE was contemplating calling new elections. His opposition is very weak and he thinks that the polls will favor him in a time of high Japanese anxiety about North Korea. The Japanese yen weakness is deemed a positive by its exporters and seen as a support for meeting the inflation target of BOJ Governor Kuroda, a target Abe recently applauded.

No change is unanimously expected but if the FOMC does move to embark upon QT, and the BOJ acknowledges the Fed policy change, it may signal that central banks could potentially react to its counterparts’ actions. Global investors are HEAVILY short YEN and using it as a funding vehicle to purchase other global assets. It is doubtful the BOJ would willingly put an end to YEN weakness, but YEN shorts are a very popular trade and we are coming into the end of the first half of the fiscal year in Japan. It’s a time when Japanese corporations have been known to repatriate money. Be attentive, especially as the yen approaches the 200-day moving average of 112.25 in the cash market. The currency closed at 111.55.

***Lastly, there was a Financial Times article from September 15 titled, “Germany’s Foreign Assets Raise Questions.” The story noted that in the “past year, Germany’s net debt security holdings have turned positive–it now holds more foreign debt securities than foreign investors hold Bunds.” The result of the ECB bund purchases have pushed German investors into far more risky peripheral bonds. This has been analyzed by Dominic White, at Absolute Strategy Research, and he notes that when it begins to be reversed BUNDS will be bought while the peripheral debt sold. Mario Draghi has created a PORTFOLIO BALANCE CHANNEL in which conservatives have relinquished high-quality debt (German) in exchange for lower-grade Italian, Spanish Greek, Portuguese, etc. It works as long as the buyer remains in place.

It has been even more successful because of the dearth of German sovereign debt. German economic success coupled with fiscal austerity has limited the need for government debt issuance. The ECB QE policy has forced the Germans to become lenders to everyone in Europe. The numbers make my case as to why the circle is closing on the Germans and they will have to capitulate to the harmonization of the European fiscal situation and accept a EUROBOND. It is a shame that this week’s German elections on Sunday, September 24 have been devoid of a debate about this situation. Nothing like full stomachs and new computers to numb the electorate.

Also, the numbers put together by Dominic White call to question those who would be short BUNDS as a play on global bond markets. If all European debt is consolidated into a single instrument then the BUNDS will by design be the BEST SHORT. But if the Germans balk at being the EU creditor I would prefer to be SHORT FRENCH OATS (10-year paper) for the 27 basis point differential is a small cost if things were to not go as President Draghi plans. Much to ponder as the third quarter draws to a close.

Tags: Abe, BOJ, ECB, Equities, Euro, Eurobond, Fed, Fed Funds, FOMC, Germany, Gold, Janet Yellen, Japanese yen, Kuroda, Mario Draghi, portfolio balance channel, QT, silver, U.S. Dollar

This entry was posted on September 18, 2017 at 4:44 pm and is filed under BoJ, Currency, Debt Market, ECB, Fed. 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.