Notes From Underground: Strange Days Indeed

The market has several themes it is trying to digest, which made Tuesday’s price action interesting. Reported earnings have been as strong as whispered and with the Syrian bombing over the weekend, the markets had time to analyze the outcome (and as usual it was treated as a minimal event with no proliferation).

On Sunday night there was an immediate rally as the SPOOS gained 0.5 percent on the open. Strong earnings kept the rally in gear but what’s interesting that the financials failed to hold their initial rallies. This is important because most analysts were predicting significant growth in bank ROES, especially for the large Wall Street banks. Goldman’s FICC revenue increased by more than 20 percent as trading volatility provided an opportunity for one of the few remaining large prop shops remaining on the Street. The Goldman rallied fizzled and finished 2 percent down on the day.

The financials weakness did not affect the overall market as the SPOOS ended the session higher by 1 percent, the Nasdaq almost higher by 2 percent, and the German DAX rallied, challenging the 200-day moving average for the first time since early February. This week’s early rally is a positive development for the market as it will test earlier highs based on strong earnings. As traders we want to know if the retracement has staying power. If an earnings-inspired rally fails to make new highs it will signal that other concerns are rising. Those other concerns will be led by the flattening curve, geopolitical events, currency wars or tariffs and the November Congressional elections in the United States. But as these strange days proceed volatility will not see an early demise. Tuesday was one of the strange days indeed. And nobody told me but the markets are whispering.

Everyone’s a winner and no one seems to lose
There’s a little yellow idol to the north of Katmandu
Everybody’s flying and no one leaves the ground
Nobody told me there’d be days like these
Strange days indeed
While the SPOOS and Nasdaq rallied, the yield curves continued to flatten. The 2/10 curve flattened to dropped to 42.5 basis points and the 5/30 flattened to 32 basis points, the flattest in 12 years. If the reason for the flattening is perceived overzealousness by the FOMC to raise rates to prevent a rise in inflation, combined with an increase in quantitative tightening  then the flattening makes perfect sense. The concern over the FED inverting the curve will certainly GIVE PAUSE to the stock market rally because of the huge amount of debt on corporate balance sheets. Rising Libor rates will increase financing expenses, which may render the corporate tax cuts null and void, especially as the tax bill curtailed the write-off of some interest expenses.
The confusion over the yield curve increases when compared to the European curves, which are RELATIVELY steep even in the face of the ECB‘s ongoing quantitative easing program. The German 2/10 curve is currently at 109 basis points.  It wasn’t long ago that the German curve was flatter than the U.S. curve. This reversal is taking place even as the German economic data has been very disappointing as of late. On Monday, Dallas Fed President Robert Kaplan was making headlines with noise about the yield curve. His comments were somewhat contradictory. Kaplan said he does not have a problem with Fed policy being restrictive, but then followed with comments about he doesn’t want to create an inversion in the yield curve. Well Mr. Kaplan, a restrictive FED during the times of QT will provide a propensity for the curve to invert. Strange days indeed.
Also on Monday, President Trump mused about China and Russia manipulating their currencies in the face of the tightening of rising interest rates. Many analysts immediately cited the contradiction of the tweet. It certainly indicated that the President lacks a firm understanding of global macro economics. FED tightening OUGHT to strengthen the DOLLAR on a relative basis but after six Fed interest rate increases the Chinese Yuan has only appreciated. The recent drop in the value of the ROUBLE has been due to the impact of the Treasury Department’s sanctions on Russian oligarchs and corporations. It seemed that Trump was more concerned about the FED‘s interest rate tightening rather than the Chinese or Russians. The president was WRONG and his timing was suspect as it followed the Treasury’s semi-annual foreign currency report, which failed to name the Chinese a currency manipulator. Strange days indeed.
Tuesday’s action in the GOLD and silver markets failed to follow the predictable script. Better economic data–housing, capacity utilization and industrial production–beat estimates, which pushed yields higher. In response to the data, the GOLD dropped while the SILVER held up. By day’s end silver was 12 cents higher while GOLD rallied to close unchanged. Silver closed above its 200-day moving average for the first time since February, but the poor man’s metal has failed to hold any rally in a couple of years so this bears watching.
I frequently advise that a precious metal rally needs to be led by the mercurial, cheaper metal. There has been much discussion that metal markets are being “manipulated” by a consortium of hedge funds and possibly central banks in an effort to prevent the precious metals from instigating a rise in overall market volatility as investors fear the signalling power of GOLD. Former Fed Chairman Paul Volcker purportedly said during his tenure that gold was his enemy. I always juxtapose that with former Fed Chairman Ben Bernanke, who continually insisted he didn’t understand gold.
What make the metals rally more interesting is that it’s occurring in the shadow of another safe haven losing its luster: THE SWISS FRANC. On Tuesday, the Swiss currency closed against the EURO at its weakest level in over three years when the Swiss National Bank pulled the plug on its famous FLOOR OF 1.20 SWISS/EURO. (The Swiss/euro cross dropped to 0.8500 on January 15, 2015.) The Swiss/euro closed at 1.1950.
The SNB has reaped great fortunes through its efforts to keep the franc weak against the euro. The more Swiss it sold the more global equities it bought, making it a major holder of more than 3,500 global equities. Now that the Swiss/euro is approaching the previous PEG will the SNB begin to unwind some of the 785 billion balance sheet it has accumulated through the use of its printing press. The Swiss is weakening even as political uncertainty grows in Europe as the Italian elections continue to remain an uncertainty and the ECB still in expansion mode. Because of the haven status of the Swiss currency this recent price action needs to be on our radar.
The initial analysis has been that Russian money is leaving Switzerland because of the impact of U.S. and European sanctions. Maybe? But then where is it going? The Russians certainly have a proclivity for GOLD but there has not been enough strength to suggest a revitalized buyer of the longest respected global haven. Strange days, indeed.

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17 Responses to “Notes From Underground: Strange Days Indeed”

  1. Robert Zimmerman Says:

    John Lennon “Nobody told me”

  2. Asherz Says:

    A flattening yield curve, a weaker dollar in the face of QT and a relatively steeper Euro curve in QE Times, a stronger yuan, a weaker Swissie, PM in a five year trading range losing its safe harbor status, Bernanke not understanding Gold, etc. Strange indeed.
    That’s what Belshazzar said when he looked at the writing on the wall. His and his wise men’s problem was that they were reading the letters horizontally instead of vertically.
    Analysts are focusing on yield curves, technical charts and traditional analytical tools. They should be looking at debt and deficits, relative currency vitals, Central Bank equity exposure, credibility in pronouncements Paul and Ben, market manipulation in a commodity, and other such secondary and seemingly less important analytical signposts. Three card Monte is the game in play.
    Mene Mene Tekel Upharsin. .

  3. Chicken Says:

    Aren’t central banks paid to buy high and sell low? 🙂

  4. Pierre Chapuis Says:

    How does the metal Palladium fit in? It seems to be breaking up.

    • yraharris Says:

      Pierre–I don’t have an opinion on Palladium–it has perplexed me for many years as the Russians had a huge influence and some hedgies did try a corner of the market–so I have left it to others–I watch it because of its role in the global economy but I will express it in other ways

  5. Kevin Says:

    Yra the Comex silver net open interest is the lowest in 25 years, it has collapsed from some 80,000 contracts net long in December to 4600 now. Historically such a huge position unwind would have hurt prices, but the silver market has absorbed it unphased. If we get a technical break up backed by that positioning could be very powerful.

    • yraharris Says:

      Kevin–good points but I also believe there is a massive short position supported by the idea of continued low volatility

  6. Mike Temple Says:

    Yra
    You are absolutely right that there is an extraordinarily large short position in silver supported by the outlook for continued low volatility.
    Would be happy to elaborate on this further with you offline, if you wish. Silver has a lot of “catching up” to gold in the ensuing bull market

  7. Rob Syp Says:

    With Stanley and Kevin Warsh throwing their hats into to the ring of cryptocurrency how bout a Notes from the Underground blockchain or cryptocurrency?

  8. Stefan Jovanovich Says:

    Those of us in the bleachers at Wrigley are wondering when Yra and Maddon are going to add the U.S. dollar LIBOR-OIS spread to ther sabremetric analysis.

    • yraharris Says:

      Stefan–now that I am no longer a season ticket holder I will be meeting you in the bleachers where we can have a beer and further discuss this significant issue

      • Stefan Jovanovich Says:

        Yra- I gave up my Giants’ seats after they won their Championship. The journey was, as I assume it was for you, fascinating; the arrival just meant that the fans were replaced by the the front-runners in suits. But, then, what else can be expected of a Fama fundamentalist who thinks Cliff Asness is wrong no matter how much money he makes? We all look forward to what you can tell us about the spread that is not the TED.

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