1. Central banks will never publicly admit that they screwed up or that their policies are faulty or are not working. Their game is one of managing public confidence. In times of panic, such as in 2008, they seek to prevent bank runs as there never is enough available liquidity if everyone demanded an immediate withdrawal what they show in balances in their accounts. This is partially explained by the concept of derivatives whereby the same assets/balances are repackaged and sold over and over through different products. Banks are prime holders of these derivatives and hence the 2008 mark to market intervention was so crucial to prevent a complete collapse of the financial system.
So confidence is crucial. In order to maintain confidence an illusion has to be created: All your money is safe. Not only that, but you need to employ your money, lend, borrow, invest to make it grow to stay ahead of inflation or your money shrinks. In a structural weak economy debt is used to create the illusion of growth, by borrowing growth from the future with the notion that organic growth will eventually overtake the need to borrow and that debt can be paid back.
The problem with this concept is that it hasn’t worked in the past 6 years. Growth is stalling across the globe and central banks are more aggressive than ever in cutting rates and running QE programs desperate to get growth going.
Watch what they do and not what they say. Since they will never admit that they boxed themselves into a corner they are doubling down.
And not only central banks, governments as well. The GDP growth figures of years past are really fictitious since they have been partially financed with debt and balance sheet expansion. In the case of the US you don’t go from $5.5 trillion in debt to over $18 trillion in 15 years without overstating your GDP figures. Deficit spending shows up in official GDP figures after all.
Here’s then is the current state of affairs of our happy little planet:
Swell. Who’s leading the pack?
To which the IMF has this to say:
The IMF said the world must brace for a sudden jump of 100 basis points in 10-year Treasury yields, combined with a soaring dollar. “Shifts of this magnitude can generate negative shocks globally. Emerging market economies are particularly exposed: they could face a reversal in capital flows,” it said.
The Fund said markets have been lulled into a complacency by the lowest bond yields in history and a strange lack of volatility – “an illusion of liquidity” – seemingly based on trust that central banks will always come to the rescue.
“A sudden shift in market views that unwinds compressed premiums and sends yields higher could trigger a market liquidity shock,” it said. The ‘flash crash’ on US bond markets last October was a first tremor, a warning of just how quickly liquidity can vanish.
Behind it all is debt. The whole world has been drawn deeper into a Faustian Pact. Total public and private debt levels have reached a record 275pc of GDP in rich countries, and 175pc in emerging markets. Both are up 30 points since the Lehman crisis.
Nobody knows for sure whether this is benign, or how it will end. The haunting fear for the lords of global finance at IMF headquarters this year is that it may never be repaid. Caveat Creditor.
And this is bottomline truth to it all: The reason the FOMC is conducting this pathetic dance about even considering moving from zero to 0.25% interest rates bring us to assertion #2:
2. If the FOMC were to raise rates by even a quarter basis point tomorrow the $DJIA would get hammered 1,000 points in an instance and probably much more in the days following.
The reason they are going through this elaborate dance of when and how or maybe they could possibly ever raise rates for a minuscule amount is that they are scared that it all falls apart and they want to let the air out of the balloon out gently. The notion that after 6 years of rates at zero they still can’t bring themselves to do it speaks volumes about the reality on the ground.
I’m stating all these things to convey to you why I’m getting more macro bearish by the day. This doesn’t mean either I or Mella won’t trade long. We bought lows even on Friday. It doesn’t mean we can’t make new highs on these markets or reach Mella’s high targets on the $SPX. Doesn’t mean this at all. We will continue to trade long and short these markets as we always do, but I’m outlining the macro backdrop as a strategic risk assessment.
If these central banks fail to keep this exercise going this land of make believe will become a valley of tears and darkness in a hurry. And this is the big elephant in the macro risk room.
In my view the risk is very much to the downside while the upside remains along the path of the autopilot trend lines we’ve been discussing over the past few weeks.
However, given the urgency of central bank action in recent months my personal sense is that the risk is greater than they are letting on.
Take the desperate action by the PBOC this Saturday. Someone is clearly worried about margin debt in China so they tried something on Friday and it immediately backfired with stocks dropping hard. The fix? An immediate 1% cut on deposit rates. Really?
Europe’s stock crusher on Friday? The Bloomberg outage apparently prevented some ECB QE operations from being conducted. The bounce today? All is working again.
Really? This is how thin this thread is?
Overnight we are seeing another V bounce and our decision to cover shorts on Friday and even go long a bit was clearly the correct one as complacency wins out again.
So does this mean markets will never, ever see a correction again?
No, it just means we need to stay flexible trading this chop until a break becomes apparent. Remember the 2000 period of excess took literally over a year to resolve itself to the downside. See July 1999-September 2000:
One could argue that we are in a very much similar period of consolidation and chop that does not exclude new highs and is rewarding not only the most disciplined, patient and flexible of traders, but will also eventually crush the complacent that have adopted the most dangerous trading habits informed by years of living in the land of make believe.
Don’t hate, appreciate. It is the environment we are in and we must constantly adapt.
Trade strategy will be outlined in the member stream today.