• Weekly Comments for April 11, 2016

    Once again we find ourselves in a strange situation: equities are almost at a high, but money does not seem to be leaving, even though the rate differentials (UST versus Japanese and German bunds) would favor money moving out of US equities.

    You can see below that the 20DMF - being an oscillator- should be moving down. But this is not the case, which implies that money continues moving into US equities.



    Using the February 1 differential levels as a benchmark, the S&P500 should be much weaker. However, compared with differentials from November, the S&P500 is well priced.



    Below, we can see that 20 Year US Treasuries are still attracting money, even though it's rather slow. Therefore, basically all US assets are attracting money. My theory is that this money, or at least a big chunk of it, comes from Japanese pension funds in search for yield. Japanese NIRP has forced cash out of the Japanese financial system and hence is pushing the Yen higher (cash hoarding for private Japanese citizens and investments in non-Yen denominated assets for institutions.)



    We can see below that all the large US equities Futures have been attracting money in the past days (positive LEV patterns), while the VIX shows that sellers have been very active.



    We then have to consider the very weak US$ (and the resurgence in gold and oil.)
    If some large foreign bank such as the DB was really in a state of illiquidity, the US$ would be serving as a safe haven: investors would hoard cash and protect assets. This is not what the above figures are telling us. Also, if the TBTF banks knew that the Fed was about to raise rates, they would be buying US$ and selling gold and oil. This is not the case either.







    A look at the large industry groups shows that Tech, Financials and especial retail are weak.



    However, housing, health, energy and especially industrials look rather strong.



    Then, we have this Fed special meeting of tomorrow for rate discussion. What could have triggered that meeting? This is not an emergency meeting à la Bear Stern. It looks like a "preemptive move" whose objective will be to keep money in the system while offering the prospects for further rate hikes.

    I think that what has triggered the meeting is the combination of weaker GDP and weaker expected earnings. Hence, the Fed will discuss "what if" scenarios.

    I believe that a NIRP in the US is out of the question because the Fed still wants higher rates (but "prudently" so). Higher rates are also out of the question as per the Fed's own language.

    This then only leaves the Fed with the short term repository rates combined to overnight reverse repo operations) and the longer-term (7days) excess reserve rates.

    Here is an interesting document that explains how these different instruments can be used in order to control the flow of money.

    https://www.fas.org/sgp/crs/misc/RL30354.pdf

    Let's look at the level of excess reserves and how these reserves moved when the Fed raised the discount rate on Dec 16 and then when it raised the excess reserve rates on January 1rst.

    The rate hike of December 16 pushed about 300 B$ of liquidity out of the excess reserves (supposedly into the markets.) Indeed, banks could not earn money anymore on the excess reserve by borrowing at a 0.25% discount rate and placing that liquidity back to the Fed to earn an identical 0.25%.

    Then, On January 1, The Fed raised the rates on excess reserves to 0.5%, and banks almost crashed the markets by withdrawing 300 B$ and more just to be able to earn that secured 0.25% differential.



    I am sure that the Fed is well aware of this dynamic. Hence, if the Fed wants to raise interest rates in a market that is NOT crashing (and lower GDP/lower earnings are bad news for equities,) then the Fed would have to free some of this excess reverse, probably by lowering the rates on excess reserves.

    Below is the Figure of the 20DMF at the end of December of last year. We can see that the Money flow was slightly negative even though equities were bouncing. The Fed's coming decision on excess reserve rates was maybe already being priced in.




    Conclusions:

    Today's MF points to a move that would be equities bullish. This scenario is almost "curve fitting" in order to give some sense on the above Figures. In reality, I have no idea how money will really move around.

    It would certainly make the Fed's life easier to raise rates later this year if the general market is in an inflationary bubble. How to "unleash" this bubble without going into NIRP and QE4? The logical answer will be to free excess reserves. Of course, that would put pressure on the TBTF's earnings, but at least that would free money for the refinancing of the distressed debt that is anyway on the banks' balance sheets.
    Comments 1 Comment
    1. PeterR's Avatar
      This weeks comments were very enlightening to me - even more than usual.

      e.g. the congress PDF is a great resource.

      about the Yen & Euro:

      I envy your thought about the Yen as an asset class and that people park money in it for now.
      I was thinking about the Yen over the weekend, but missed this argument myself.

      For the Yen strength I came up with:
      - repatriation of Japanese overseas investments (mainly from china)
      - MF of Chinese to Japan (e.g. via M&As, like Sharp)
      - synthetic bonds (via credit spreads) for people with USD cash flows; they buy negative japanese bonds (source Gavekal ? - I lost the link)
      - TA argument: we rally off a trend channel bottom (BoE data) Attachment 35548

      in all cases (ex TA), I dont know the size and net effect versus the outflows from Japan.

      Now of course I think that part of the recent Euro strength is similar to the Yen:
      People escape negative rates and park money in cash.

      Further this is a big pool of energy/Money in the Euro and Yen - waiting to be placed.
      My bias is into any US assets, mainly Equities.

      The sentiment seems overly pessimistic.
      And if we rally a bit more in US equities, I expect people start chasing the move (the pool will be applied).