Notes From Underground: The Same Old Song, With a different Beat (Since 2017 Be Gone)

After a sharp selloff late on December 29 the market has regained its mojo and rallied 2%. While the first two days of trading for the European markets were not confirming the S&P rally, the DAX and Euro Stoxx 50 rallied with the EURO STOXX 50 closing back above its 200-day moving average on Thursday. The consensus from Wall Street analysts is for emerging markets and Europe to be better alternatives to U.S. investment prospects. Many quality strategists believe the U.S. equity markets are stretched in its valuation while Europe’s recovery is gaining momentum and emerging economies should be the major beneficiary of a synchronized global expansion.

Europe’s recovery will continue to be supported by ECB interest rate policy, which is still conducting large-scale asset purchases and deploying a negative deposit rate. Jim Cramer said the European economy was on fire and he couldn’t understand why the ECB was not raising rates. Again, the failure to understand President Draghi is a result of the narrative that the ECB has a singular mandate of INFLATION. Hey, Cramer (and all the others who presume to know everything): Draghi perceives his mandate as the PRESERVATION of the EURO and the EU project.
This means that Draghi feels it is incumbent upon the ECB to forge the creation of the eurobond, which would put an end to fiscal fragmentation and force the harmonization of fiscal policy and a centralized European banking guarantor, or what has been dubbed the European Monetary Fund. For Europe, economic data is a side-show meant to distract. As Carmen Reinhart’s recent Project Syndicate piece reflected, the interest rates for the peripheral countries need to be much lower than for the overheating German, Dutch and Irish economies.
But the KEY QUESTION remains: Whose currency is the euro? As Reinhart stated, based on the Taylor Rule the Germans have always directed EU policy by dominating the discussion using a Bundesbank model of economic stability. Reinhart says to ignore Germany and meet the needs of the other nation-states of Europe. This is of course the correct economic course but will it be a sustainable political result? French President Macron is pushing for greater harmonization of EU banking and fiscal policy but the French do not have enough financial credibility or wherewithal to make it happen.
THE SUCCESS OF THE EU IS DEPENDENT UPON THE GERMAN CREDIT CARD. As Germany drags its feet in response to Macron, Draghi continues to create a massive stockpile of sovereign debt that will have to be secured by Germany, for to do anything else would result in a massive global debt deflation. This is the world we face as we begin 2018.
***Unemployment Friday: The U.S. economy continues to motor along and with the recent tax bill it is expected that firms will increase investment resulting in increased hiring. The ADP released its data Thursday, which showed a 250,000 gain in private payrolls. This number was far above street consensus of 190,000 but for tomorrow’s BLS release the consensus remains 190,000. The average hourly work week remains at 34.5 HOURS.
The most important data point will be average hourly earnings (AHE), which is estimated to be 0.3%. If wages are 0.5% or higher I would look for the immediate result to be a flattening of the yield curve as the market will push short-term rates higher believing the FED will be prone to a hawkish tilt, especially as 2018 brings a politically mandated rise in hourly minimum wages in many state and local  jurisdictions.
The question will be how will the dollar respond as yields rise in the U.S. Robust DATA will also pressure the GOLD/SILVER markets but the spastic algo-driven headlines will be meaningless as the closes will be far more important. Some analysts believed the FOMC minutes were somewhat hawkish yesterday and the headlines sent GOLD prices $10 lower. But by the close of today the GOLD has recouped all its losses and closed $20 above last nights lows.
Be patient and wait for the speed merchants to burn the headlines and see how the market assesses the composite of all the data points. The S&Ps will also need to be watched if the data runs hotter than consensus as the fear of a more hawkish FED will impact an equity market reaching very elevated  historical valuations. PATIENCE AND PREPARATION are critical. Have your technical levels ready if you trade support/resistance levels rather than a longer-term investor.
***The Canadian employment data is released at the same time as the U.S. Last month the Canadians had very robust jobs report—a rate of 5.9% with jobs growing 79,500—which was much higher than expected. I watch this data because Canada is a major trading partner with the U.S., especially in regards to the automobile sector.
When the U.S. is running hot the manufacturing sector in Canada shows robust jobs growth. Friday’s Canadian consensus is for jobs to BARELY INCREASE (+2,000)and for the unemployment rate to increase to 6.0%. Even if you don’t trade the Canadian dollar it is something to watch. Also, if the COMMODITY STORY BEING DISCUSSED has authenticity the Canadian economy should be a major

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23 Responses to “Notes From Underground: The Same Old Song, With a different Beat (Since 2017 Be Gone)”

  1. David Richards (@djwrichards) Says:

    “Draghi perceives his mandate as the PRESERVATION of the EURO and the EU project … the interest rates for the peripheral countries need to be much lower than for the overheating German”

    ^ Analysis that leads the pack. To hold it together, political implications apparently reign supreme. How does Draghi reconcile German and Italian needs in the event that Italians and Germans are simultaneously headed back to the polls this spring?

    Dollar sentiment and price action is clearly sour. Nothing stops the dollar meltdown. Not big tax cuts near year end, a surprise win by Catalonian separatists in the election do-over, strong ADP data yesterday, bullish Fed minutes, and now potentially a huge corporate debt default (at HNA in China which ranks around #100 on the Forbes 500 list of world’s largest companies).

    But I hear noise that they’re actually likely to impeach Trump? I don’t understand politics. Is this for real? US political turmoil of that magnitude should drive a dagger into USD and US assets, potentially as bad or worse than that seen in the Eurozone in recent years until its populist wave receded a year ago. Perhaps impeachment is the fundamental backdrop to a much weaker dollar?

    Finally, do keep tabs on whether the aforementioned HNA defaults and if China rides to rescue or lets HNA fail under the weight of its debt pursuant to the recent policy hints from the Chinese leadership. The EM has been the proxy for the global economy and HNA might be its proverbial canary in the coal mine if it defaults – with JPM & others having many billions in loans exposed to it I believe. I’m expecting HNA to default this year with no rescue from the Chinese regime, as they’ve already stood idly by despite large HNA job losses after President Xi’s coronation (folks now must/can find work elsewhere). This is an example of good old creative destruction capitalism, not much tolerated in the West anymore, but maybe now sprouting up in communist China, lol.

  2. asherz Says:

    Draghi’s mandate is what you say with a Eurobond as his goal, to tie the ribbon on the package he has put together ever since his famous “Whatever it takes” declaration.
    I would posit in a similar vein that the Alan/Ben/Janet/Jay mandate has been the preservation of the bull markets. If one can remember that far back of a 10% decline, the previously threatened Fed hawkish comments went poof, and benign soothsaying followed. QT and normalization of interest rates will likewise go poof at the first sign of a serious “correction”. Triple digit daily gains do not make the poo-bahs very happy because the genie has been unleashed and we are witnessing a meltup of unprecedented proportions. When the market trajectory begins to resemble the Bitcoin chart, nervousness can be felt at 1850 K St. in DC.What happens when overheating comes to a boil? Raise rates a la Volcker? The global balance sheets look a little different than they did over 35 years ago. Rocks and hard places.

    • kevinwaspi Says:

      With no disrespect, I echo your mention of no memory of a 10% decline (in our great leaders’ minds), but believe that they actually delight in seeing triple digit daily gains because they believe in the silly “portfolio balance channel”, and wealth effect stimulus nonsense.

  3. David Richards (@djwrichards) Says:

    Curious that the wealth effect theory is still in vogue, even while the public becomes increasingly aware of the harm to society caused by a massive, growing wealth and income gap. I guess it’s because soaring equity prices (mostly in nominal terms after *true* inflation) helps alleviate various crises such as pension funding shortfalls. It is becoming increasingly apparent that policymakers are deciding to “solve” these problems and the big debt overhang by destroying the currency. As has been typical throughout history.

    • David Richards (@djwrichards) Says:

      Headline in 2030: Chinese treasuries soar in global flight to safety

    • kevinwaspi Says:

      If we could liquidate pension assets at these lofty levels and use the proceeds to pay off the liabilities, I may be in favor of the strategy. However, the wealth effect myth not only exaggerates the income and wealth divide, but lofty assets portend lower forward rates of return for continually growing pension liabilities, further damaging those precarious plans. Just a thought…..

      • David Richards (@djwrichards) Says:

        Absolutely. So pity the younger workers who are just starting now to save & invest for retirement at these rich prices in almost everything everywhere. What does a conscientious advisor recommend to them? Even if you think, oh well, they’re still young so stocks for the long run, we’ve seen a few instances in living memory for some when it can take 2-3 decades to recover your initial investment (especially after inflation), which is much of your working career if you’re unlucky in your timing.

        I’m concerned that the political situation in the US has the potential to spin out of control and usher in another dark era. But I don’t understand the politics nor the investment ramifications of a really ugly political/constitutional crisis, except that volatility will almost certainly rise. Imagine if such problems were to co-exist sometime in both the US and Europe.

      • David Richards (@djwrichards) Says:

        To elaborate a little (as I said I don’t understand it), I recently saw Raoul Pal on RealVision opine that Robert Mueller might well be able to successfully convict not just Mr Trump but also most of the US administration, as well as many democrats which is getting much less attention but nevertheless in play too. So this is perhaps much bigger than Nixon/Watergate; it’s potentially unprecedented in US history. Just saying…
        Something to perhaps throw into one’s global macro mix?

    • yra harris Says:

      David–believe me that is in the mix.So much is in my mix and as of yet the market complacency keeps it out of the discussion.

    • Chicken Says:

      Yep, Financial Engineering is a heavy industry.

  4. S Says:

    Hi Yra,

    I love your posts! They are incredibly useful and educational. I just saw your interview at Topstep Trader and I love your enthusiasm for the markets and trading.

    I have a question I hope you could answer. I am a successful technical trader and hoping to incorporate more fundamentals in my trading. How would you advise me to begin?

    • yra harris Says:

      S—if you are a successful technical trader you understand the use of support resistance levels to express potential profit.The fundamentals can screw you up as it may effect your time horizon but it done correctly may provide greater opportunity when you combine technicals with a basis of understanding especially on important data releases.I suggest reading the FT on line to get a global perspective and when you get more immersed you will be able to weed out the b.s.——-stay tuned to this blog as i use a combination but i begin with fundamentals and then proceed.I was never a good scalper because my view was too big but i did have some great day trades because of my preparation.When you have more specific questions post the blog and many of my readers will certainly aid the cause—find out what you comprehend and build on it and you can successfully weed out the false narratives or weak analysis that fills the internet and airwaves you will be on your way

      • Arthur Says:

        Beyond Yra Harris’ great insights…”To source my stories, I read a tremendous amount of books and papers, I subscribe to research services, and I read The Economist religiously.”

        Jim Leitner
        Founder of Falcon Management

      • S Says:

        Yra, David, Arthur. Thank you for taking the time and answering. The advice is being acted upon. You will see me here posting stupid questions but I need to be an idiot for a while before learning something.

        Eventually what I would like to do is create a model that can keep track of real time flows. This is kind of what I do in terms of technicals right now and look for relative value trades. Hopefully as time goes by I can incorporate fundamental data as well and I find this blog a great place to start. Thanks again.

    • David Richards (@djwrichards) Says:

      Fundamentals tell me what; technicals tell me when. I’m a big believer in technical levels and patterns, both classic and elliottwave. My investing improved significantly as I adopted technicals. Fundamentals provide a background/bias but, maybe surprisingly, I find them more difficult than technicals because the world is big and complex, and much what you hear about fundamentals is lame. I just read-read-read and think critically.

      One objective is to find where price & sentiment is inconsistent with the (changing?) fundamental reality, such as USD a year ago. IMO that is only do-able with a combo of fundamental and technical analysis. As there are always market inefficiencies to exploit; the challenge is finding and timing them.

      Mastering the fundamentals requires many years of reading, studying, critical thinking and experience. It’s a gradual process. I’m always still working on it with much to learn yet, so join the club.

      I’d recommend you include the free weekly Macro Voices podcast (and supporting charts) in your fundamental analysis regiment. Google it. Most recently, it was a special 5-part series about the USD end game and a discussion among four top fund managers about how it may play out. By listening to this program, you may encounter other money managers whose ideas pique your interest and from there build out your list must-follow analysts in the fundamentals. Similarly and in addition, RealVision services provide exposure to a wide range of analysts including on occasion topnotch institutional managers unavailable to retail traders, but this is a pay-for service primarily targeting those in the industry. SeekingAlpha is a famous free US website chock full of analysts but it’s very big and difficult to find good substance amongst all the fluff and half-baked opinions there, in my opinion. Hope that helps.

  5. Stefan Jovanovich Says:

    A country with strict exchange controls and positive balances for its trade and current accounts can price its currency at whatever “value” (sic) it chooses as long as it willingly accepts its customers’ money in payment. We have very little idea of how China’s legal tender would price as an international unit of account. No one outside of China holds any sizable balances and there is not offshore credit market in which people can borrow or lend now against future payment obligations. They can do that for BitCoin and the New Zealand dollar but not for Chinese money. For countries and blocs to maintain perpetual positive external balances, domestic credit markets have to be truly “free”. The central banks have to be willing to provide never-ending discounting and credit rollovers. ALL sovereign IOUs – those of the foreign customers AND those of the government-guaranteed domestic financial intermediaries – are always money good. And, indeed, they will be in China because there are no redemptions in any currency other than the one already on deposit.

    Yra’s note explains for me how Europe’s credit markets can manage to follow a similar path, even though trade in the Euro is “free and open”. Trump is the key; the likelihood that he will succeed in having Congress adopt his MAGA platform, wall and all, is an assurance to holders of Euros that it is safe and profitable to stay long. There is nothing in Trump’s campaign promises that suggests that the U.S. will want or seek a “strong” dollar. As the U.S. demonstrated in the last third of the 19th century, a country can have use tariffs for revenues, have a negative trade and current account and exceptional economic growth with flat and (during panics) declining exchange rates. No one in London, Paris, Berlin or even Vienna in 1880 thought they should flood American banks with deposits; they bought U.S. railroad bonds but kept their money at home.

    • yra harris Says:

      Stefan–another wonderful and as Michael Pettis sums it up in the spirit of D’Estaing—is it an exorbitant privilege or burden—as pax Americana enters its twilight it is assuming the role as a burden

    • Chicken Says:

      Unfortunately, the decline of the pax-Americana MIC hasn’t begun.

  6. Stefan Jovanovich Says:

    Thx for the kind words, Yra. Now I have to ask – do you mean Valery or his ancestor the Admiral, who said, “After my head falls off, send it to the British, they will pay a good deal for it.”?

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