Notes From Underground

As Stephen Sondheim wrote in the dark musical Sweeney Todd, “What’s the sound in the world out there. It’s man devouring man. The history of the world, my sweet, is who gets eaten and who gets to eat.”

I open with this thought in regards to a wonderful op-ed piece in the Barron’s over the weekend by John Curran titled, “The Coming Renaissance of Macro Investing.” Curran has the pedigree of writing this piece as he served his time at one of the greatest global macro funds, Caxton Partners. There are no greater thinker/traders than Stan Druckenmiller or Bruce Kovner. When it came to understanding the role of foreign currencies in creating investment opportunities Kovner is the wisest I have ever had the pressure to read. The last 10 years have been difficult for the global macro discretionary crowd but as John Curran suggests the winds of change are blowing. This is also a theme I have been discussing of late. The big difference in my opinion is that short-term trades will morph into momentum investments.

Yes, I know EQUITIES have certainly been a long-term momentum play as the central banks have prevailed in pushing equities and real estate prices ever higher, while the fungible nature of fiat currency has kept global bond yields historically low. Meanwhile, forward guidance maintained the powerful regime of negative interest rates in Japan, Switzerland, Germany, France, Spain, Italy, Sweden, etc. The use of negative interest rates and zero interest rate policy has been the ultimate determinant of “Who Gets Eaten and Who Get’s To Eat.”

As Carmen Reinhart has argued for the last nine years, the ultimate outcome of the Fed’s efforts at financial repression is that savers get crushed while borrowers and hard asset owners get rewarded. If the Fed is truly on a path of “normalizing” interest rates owners of interest-yielding products will get some relief. Are the short volatility crowd and risk parity positions ready for the end to a beautiful deleveraging?

Back to the op-ed. Curran makes a very important point: “The U.S. will need to finance enormous and growing entitlement programs, and our historical international sources for that financing will no longer be willing to support us in that endeavor.” Curran spends a great deal of space on the issue that NOTES FROM UNDERGROUND raised in the Oct. 3 post about China seeking to use the YUAN as payment for OIL, especially as the currency would be convertible in a GOLD HEDGE.

The significance of all this discussion is that the world is changing in ways that fail to grab our attention. The television and social media are adept at showing the effects of major natural disasters but it fails miserably in reporting on the slow change of erosion, which does far more continual damage to the natural order. Few remember the theories of Georges Cuvier while we are all familiar with the work of Charles Darwin. Slow change is everywhere and it is that slow change that provides the impetus for a MINSKY moment.

In the past I have offered up a piece called potential sparks to a global prairie fire (an idea from the theories of Mao). These pieces have pointed to areas I believe might be upsetting to the established order and more importantly to the narrative put forth by the Wall Street/Washington combine. In setting the tone to a change in the financial landscape let me posit a few areas of concern:

1. Ten days ago, Saudi King Salman made his FIRST EVER official visit to Russia. This is an important issue as it represents the enhanced role of Putin’s Russia to supplant the U.S. as the key determiner of Middle East events. The Saudis and Russia are the key actors in the global energy markets on any short-term basis (fracking aside), so this rapprochement carries significant weight. As European and Turkish relations deteriorate, the Saudis are seeking to find friends of substance and the Russian success in Syria has shifted the balance towards Moscow. The Saudis are searching for military might to counter the rising influence of Shia Iran. The region almost ignited a new battle front as the Iraqi Government last week threatened to invade Kurdistan and retake the oil areas of Kirkuk from the Kurds. The sands are shifting and will have great impact of the global financial system. Imagine if the Russians move away from accepting DOLLARS for OIL or at least providing a similar ability to hedge currency risk away with GOLD.
2. In a tip of the cap to Peter Boockvar, MNI news reported last week that ECB member Jan Smets proposed that the ECB “lower the pace of its assets purchases but to extend the program for a relatively longer period.” There were others suggesting that the ECB would cut their QE purchases to 40 billion euros a month beginning in January, but extend the period nine months. Now the language of the October 26 meeting has gained in importance as the keys will be PACE and DURATION. If the ECB were to cut the program in half in terms of PACE, the impact OUGHT to be felt in the U.S. yield curve as the rules of fungibility will mean less buyers for U.S. bonds. This means the curve should steepen. But I suggest being patient, especially as the U.S. 10- and 30-year futures closed above their 200-day moving averages. Also, be careful in the BOND markets as enormous short speculative positions are in play.
3. In his last statement as German Finance Minister Wolfgang Schaeuble warned about a debt-driven global financial crisis. He said, “Economists all over the world are concerned about increased risks arising from the accumulation of more and more liquidity and the growth of public and private debt.I myself am concerned about this, too.” Many other authorities are also warning about increased debt levels around the world. The QE programs propagated by the FED, ECB, BOJ, BOE and SNB has flooded the world with ultra-cheap debt. This is similar to the mid-1970s when the OPEC nations had massive amounts of dollar deposits after the rapid increase in OIL prices. It is only the weakest borrowers who are in need of borrowing the greatest amounts. We have gone from the recycling of petro-dollars to the world’s financial system being overwhelmed with the FED‘s largesse. In times of great amounts of liquidity, money is like water: It congregates at its weakest point.
4. The IMF Communique has been released. I read these because sometimes there are policy changes buried in the paragraphs of platitudes. In October 2012 I noted that the IMF had changed its language about the YEN and believed that the IMF was giving a nod to the need for Japan to weaken the YEN. In this COMMUNIQUE I don’t perceive anything significant but I do note the following:
   

   “We recognize that excessive volatility or disorderly movements in exchange rates can have adverse implications for economic stability. We will refrain from competitive devaluations, and will not target our exchange rates for competitive purposes. We reaffirm our commitment to communicate policy stances clearly, avoid inward-looking policies, and preserve global financial stability.”

   This statement is devoid of reality as it fails to acknowledge the spirit of every central bank policy statement. The RBA, RBNZ, SNB, BOE, BOC, BOJ and ECB all discuss the relative strength of their currencies in determining short-term interest rate decisions. The TRUMP administration has frequently alluded the strength of the U.S. DOLLAR in citing concerns about America’s massive trade and current account imbalances. As in quantum physics, you can’t act on something and observe it at the same time.

Tags: BOE, BOJ, ECB, Fed, global macro, IMF, Jan Smets, SNB, U.S. Dollar, Wolfgang Schaeuble

This entry was posted on October 15, 2017 at 3:08 pm and is filed under Central Banks, Currency, IMF. 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.