Good Morning.. Rather mixed Asian markets with HK under pressure again and the Nikkei unchanged basically. GBP was a little higher and possibly on talk of VAT cuts from Sunak but nothing concrete yet and Cable on the charts seems to be building into a downtrend. EURGBP has broken above .9054 recent highs but needs to push on but I do see this cross higher still as for me the UK is going to be slow out of this crisis and still has the dark cloud of the Brexit deal looming large. I think investors are starting to look for signs of who will emerge first from all this but there have been some disappointing virus stats over the weekend again. But I think the US yield curve and the ability of the US economy to bounce, may see the USD attract as investors plough back into US assets and there is data suggesting that HFs are now back in and leveraged (see below). There also seems to be an interesting correlation between the USD and oil inventories (who knew?) A quiet start expected to the week but we are heading into quarter/month end so it may get a bit bumpy later as we head into the weekend. Equity vol likely to remain high.

Keep the Faith..

Details 22/06/20

Equity volatility into month/quarter end: Not just retail buying stocks and the USD stays bid.

–

For some time it has been the case that the large group of retail investors were blindly ploughing into US stocks; ignoring everything that may suggest that the rally may be unsustainable, like a global pandemic, a rise in geopolitical tensions and shocking data. But it seems that more professional traders in funds are now suffering their own form on FOMO as capital is shoved back to work in global equities. Goldman’s prime desk notes that there is now considerable buying across hedge funds and gross leverage of the overall book rose another +4.4% to 246.6% (93rd percentile one-year) while Net leverage rose further +1.6 pts to 75.1%, putting it in the 99th percentile, effectively the highest ever. Hedge funds are long and leveraged!

I am not sure how far or for how long this rally can continue but a look at the upper band of the range in S&P could be seen at 3250 but in the next few sessions we may run into some very unpleasant surprises as Pension funds start to rebalance for quarter/month end and supposedly have a huge amount of US equities to sell. The days when the last day or so of movements for these rebalancing programmes were seen are over as the amounts are so large that rebalancing starts a week before month end these days.

Interestingly, the buying has been centred mainly in the US and Asia and not the EU and I think goes some way in validating my view that fund managers see the US emerging from this crisis before that of the EU or UK and demand for US assets is sucking in USD demand. But we still do not have a vaccine and unlocked economies are seeing some disturbing rises in infections with many US States and Germany starting to show some serious second wave symptoms. In the US it seems they have totally given up with social distancing. In Germany the R rates is seen back above 1 at a worrying 2.88 from 1.06 on Friday. Spain too is seeing increases and is now about to allow British tourists back in with no quarantine. The EU is still to ratify the proposed joint bond deal and signals from last weeks video call were that this may take a lot longer than originally thought. The UK looks likely to be one of the slower recovery stories and the Brexit trade deal still hangs like a cloud over the UK’s future and GBP got hit hard Friday with EURGBP making new recent highs above .9054 and a new leg higher could now be developing. I still like this cross higher but am raising my stop to .8940

The close was right on the break point after an earlier breach and it looks like the MACD is crossing higher marginally. To my mind there is not much on the charts above and the UK is facing some really tough weeks/months ahead. To my mind and with all the problems also facing the EU, cable looks a more convincing trend developing and the MACD has clearly crossed lower.

The USD still looks like it may have further to rise against many currencies.

The Fed reacted strongly as the USD surged on what seemed a shortage of dollars or a massive demand and to be honest, with the repo action and swap lines, they dealt with the problem well but they are unwinding this as data clearly suggests and this may also be helping the USD rise again; also the steeper curve may be helping. Interestingly, it also seems that oil or rather oil inventories also have a role to play as can be seen from the chart below.

Looking at the chart above and the correlation, the USD may indeed still be cheap. I think with this, the steeper curve and the fact that US data may lead the world out of the crisis, may see the USD higher for a while. But I think we need to monitor the curve closely as if the curve starts to flatten, then it may be a signal that the market feels we have hit peak Fed policy impact. If we see that then I think the USD will reverse lower and possibly keep going. How long can the Fed keep this illusion alive?

For quite a bit I would think as their commitment to prop up the credit markets is enormous. The Fed is very aware that without that, stocks would be in huge trouble and fighting the Fed in the credit space is not an option right now. I think this is keeping many aggressive funds from selling US stocks; for now. The commitment to keep doing “whatever it takes” until unemployment starts to head back towards some normality is a huge call but it seems the Fed is prepared to go “all in” and stay there. What is an acceptable level of unemployment now? I would suggest if we start to see signs that we may get back to around 5%, the Fed would be happy to lift its foot off the pedal. The other issue is that the WH is pushing hard for more stimulus packages and possibly $1trn or more. If they get that passed, then stocks will like that. BIS data shows US & Australia lead spending (>10% GDP), Europe is using aggressive credit guarantees (e.g. Italy 32% GDP), while Japan/Korea are stimulating via government loans/equity injections. So, for the summer at least, we may see stocks hold but I am not sure how long for and the autumn may bring some colder winds to asset markets. Icarus is still dangerously close to the sun and we still have the rebalancing to factor in; it may be a wild ride into the end of the week.

I think, as we start to look forward to what kind of global economy we shall see when all the virus dust settles, it is important for us to remain focused on the functioning of global trade and the global economy. Things are not going to be the same with Trump walking away from globalisation and that is a fact that few seem to factor in. Global economies are run on credit expansion or consumers and businesses using debt to maintain lifestyles, sustain and grow businesses and generally keep the flow of capital moving around the global economy. As we have seen in major economies like China, take away the credit impulse and things fall away quickly. So where are we currently, now that in just the past 3 months we have seen a gargantuan $18+ trillion in fiscal and monetary stimulus, equivalent to just over 20% of global GDP? How hot is the global economy going to run on that, I hear you ask? It is absolutely massive; but the big question now is will it be taken back when the global economies recover? One would assume that this credit injection would see growth shoot higher very quickly but at present, things are moving rather slowly. Yes, we shall see better data now that unlocking economies are seeing spending again but will/can they return to normal; what damage has been done to the consumer, many of whom have lost their jobs or see them at risk? This is no ordinary slowdown and there is no historical precedent to look back on for guidance; we are flying blind and so are the central banks.

So, is the pent-up credit impulse about to unleash a massive growth spurt or have things changed? I think this is one of the big questions now for global investors as an economy drowning in debt with no growth is a disaster. It would be mighty strange if the stimuli had little impact on spending or growth so maybe it is just a delayed reaction or that all the money is being shoved into equity markets; surely not! One of the problems we face is that it now takes much more debt to create the same growth and is a disturbing trend.

It seems modern monetary and fiscal policies are not generating the growth they once did, which is why we see no signs of inflation (yet). The reason for that is central banks do not directly inject to the real economy, they give cheap/free money to banks who are expected to lend but if there in no demand they happily buy stocks it seems; and Main St sees little of it. If we take a long hard look at QE, it really does seem to have passed its usefulness now that rates are so low but central banks are still slow to reverse it. Without money hitting the real economy, growth will struggle and the Fed has even started becoming more directly involved in circumventing the banks now and is clearly tapering bond purchases. But the Fed has an issuance problem facing it as the WH spends like there is no tomorrow.

The Fed is very aware of its failings when using monetary policy and is screaming for more fiscal support. All the inflation that one would expect from all this money printing is seemingly residing in asset markets. QE increases money supply which is meant to spur consumption, which is the same desired effect of lower interest rates; a good thing. In a sense, money supply increases are synthetic interest rate decreases (and synthetic capital market increases) but this is no longer the case as the money is NOT channelled into the broad economy and there is no demand for more debt. As QE leads to a direct increase in bank reserves, only a fraction is translated into money supply growth, and thus potentially consumption and investment. This is the dilemma but what happens if the monies are released into the broad economy? There is no way that it will not impact and inflation is likely to take hold even if that idea is almost impossible to fathom right now. If so, then everything changes and debt will matter and all those who have embraced MMT will find themselves kept awake at night.

The fact is that Money supply that doesn’t translate into consumption must result in higher financial asset prices until defaults result in wealth destruction. What does this mean for the recovery? The central bank is displaying reduced capacity to further generate real economic activity as a result of accommodative policy over the past twenty years. This means that recovery is unlikely until r* increases significantly, which only happens alongside fading virus uncertainty. This will take a long time and high unemployment is not going to help. Basically, the Fed drugs are still not going to the right patient. The government has a huge and expensive task here to fill the void but it may be a void that needs filling for a very long time. Taking back these schemes will not be easy and asset markets are now totally reliant on Fed stimuli and liquidity; almost at the expense of all else! If the recovery does take hold and consumer spending returns, then the real problems may actually still be ahead of us. Right now the market believes the Fed can and will stave off any collapse in asset markets but it may well be tested severely at some point. But price pressures seem to be headed lower for the next 12 months but after that I am not so sure. For how long and how much can we borrow from the future? We may be close to finding out.

—————————————————————————————————————-

Strategy:

Macro:.

Long EURGBP @.8978 added @ .8940. Raising stop to .8940

Brought to you by Maurice Pomery, Strategic Alpha Limited.

—————————————————————————————————————-

Strategic Alpha Report Disclaimer

Doo Prime endeavor to ensure the reality, adequacy, reliability and accuracy of all the information provided, but do not guarantee its accuracy and reliability. All the information, analyses, comments, statements, and/or data provided in this report is for information purposes only. Client’s use of any contents of the report as the basis for the transaction, the client shall fully aware of the risks and agreed to bear all the risks. Client shall cautiously judge the accuracy of the information. Doo Prime has no liability for any loss caused by any inaccuracy or omissions of the contents and subjective reasons of Client.

Risk Warning

This information is powered by Strategic Alpha. Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice.