ALL THE SAME TRADE
2016-12-12 11am EDT | #stocks #bonds #US dollar #Yen #Japan #gold
The mad dash run for US stocks has grabbed all the headlines, but some important stories are lurking in the background. Although much of the stock buying has been the result of anticipated governmental policy changes and poorly positioned market participants, that’s not the whole picture.
Over the past month we have seen relentless equity buying and bond selling. The trading between these two assets has been somewhat negatively correlated, but that shouldn’t be that much of a surprise given how overweight bonds many investors found themselves prior to the election. As the good economic news rolled in, stocks were bought and bonds sold. Not tick for tick, but there is a loose correlation.
But I would like to highlight the odd added correlation to both the Japanese Yen and the Chinese Yuan. The fact that the Yen is trading inversely to the stock market (Yen weakness brings about stock market strength) is not unusual, but CNY weakness used to spook the market and cause risk off selling. However, this has been tossed out the window. It is tough to deny that we are now not in a situation where USD strength against the Yuan and Yen coincides with US bond selling and equity buying.
Now to some extent you could argue the Yuan is pegged against a basket of currencies, so Yuan movements simply reflect US dollar strength. And yeah, I would tend to agree.
But what I worry about is whether the US dollar rise is the result of American stock and interest rate moves, or whether it is the cause.
Most pundits would argue the improving US economy and optimism surrounding the Trump government’s policies is causing US interest rates and stocks to rise. Whether it be from bonds with a higher yield, or higher expected returns from equities, capital seeking better returns is flooding into the United States. This tsunami of capital is causing the US dollar to appreciate. The projected improving American asset returns are fueling the US dollar rally. End of story.
Well I am not so sure that is the whole picture.
We know Central Banks are not adverse to monetizing their balance sheets with many different forms of assets. Whereas they used to stick to fixed income (and way back when, gold), more and more of these yahoo Central Bankers are buying equities. The Bank of Japan has been at the forefront of this insanity.
I have watched the trading in the foreign exchange markets during the past month, and what has amazed me is the constant Yen selling. It has been relentless. Every day it just keeps going down. Even when there is no fundamental news, it finds a way to decline.
Now to some extent, this should come as no surprise. After all, the Bank of Japan has been printing at a schizoid pace for some time.
But why the increased Yen pressure since the Trump victory?
My theory, and it’s just a theory, is the Bank of Japan is concerned a new Trump administration will be tougher on perceived currency manipulation. So instead of waiting and risk American policies changing, over the past month the Bank of Japan increased the rate at which they buy foreign assets (devaluing their own currency). Not only that, but I suspect they are also buying stocks and selling their bonds.
The day to day trading in the Yen just seems too interconnected to other financial assets to discount this possibility.
And before you dismiss me as some wacko that assigns too much blame on Central Bank balance sheet transactions, let me present you with the chart of the Yen versus gold, except gold is charted inversely.
Gold is trading almost tick for tick with the Yen. It’s almost as if the BoJ has pegged their currency against gold.
Now all these different correlations make my head hurt. The Yen’s weakness drives the US dollar higher, which coincides with stock gains and fixed income selling, while also pushing gold down. Thinking about which comes first, and how it relates to the other assets is more difficult than solving a Rubik’s cube. And to be truthful, I don’t have many answers.
But I know too many investors are ignoring the possibility these moves might be much more Central Bank related than most believe possible.
I don’t think Central Banks are the sole actors moving markets, but I suspect they are active, and their actions are causing stress on the financial system.
Let’s assume I am correct that the Bank of Japan is actively devaluing their currency through foreign asset purchases. That causes the US dollar to rise against all currencies. China tries to cushion the Yuan’s decline against the US dollar in hopes of maintaining a stable currency. Yet by not allowing the Yuan to fall fast enough, it encourages capital to flee China’s relatively overpriced currency. So the Chinese tighten their capital controls. Chinese citizens start scooping up houses in Australia and Canada as they desperately try to get their money out of China. So the Chinese authorities clamp down on foreign house purchases and other methods of capital flight. They even go so far to reduce the amount of money that can be withdrawn at Macau casinos. The butterfly wing flap of the Bank of Japan buying US stocks is felt both in America, Canada and Australia, but also all the way back in China.
Instead of predicting the direction or outcome from all these financial markets interactions, I want to simply highlight that right now, it is one big trade. Stocks, bonds, US dollar (especially the Yen) and gold - you might as well be trading the same thing. Since the Trump election, they have all been screaming one way together.
How much longer this will be able to continue is anyone’s guess. But the intense Yen selling is not nearly as benign as most participants realize.
At a certain point, even the BoJ’s monster tickets will be faded. When the Yen declines, and yet stocks still fall while bonds rise, that is the point where you want to lean hard against the recent trend. That will be the all clear to finally play for the end of this move. Watch for divergences in this mad scramble. They will be the clues to help with timing the end of this repositioning.
And in the mean time, be careful with your positions. Given the insane level of financial interconnectedness, they are all the same trade. Yet there is the added bonus that like a game of musical chairs, the game is setup in a way that ensures there will be loser. Picking which one is the tricky part.
Thanks for reading,