Yes, Fed Governor Lael Brainard actually delivered Tuesday’s speech, “Cross-Border Spillovers of Balance Sheet Normalization,” AGAIN. This time it was to the National Bureau of Economic Research Summer Institute in New York City. Of course I jest as to why she redelivered it. Brainard was overshadowed by Chair Yellen’s testimony to the Senate Banking Committee, even though the Fed Chair deviated very little from Wednesday’s House testimony. The interesting thing was that Yellen backtracked on her hubristic statement she made last week about not experiencing another systemic financial crisis in her lifetime. A brazen statement like that is Greenspanish but certainly out of character for the demure Janet Yellen.
The FED chair did basically support Brainard’s speech on cross-border spillovers and the global equity markets sustained the rally that began Tuesday afternoon. The 2/10 yield curve held it recent steepening but failed to break through the 100 basis point short-term resistance area. However, the 5/30 (more speculative-based curve), did steepen a bit. After making a low of 93.8 basis points on July 5 the curve is poised to challenge several coiled moving averages. Thursday, the 5/30 closed at 102.5, just below the 50-day moving average at 105.2, the 100-day at 107.5 and the 200-day at 112.8. This coiled area will provide a very credible test for the Fed’s attempt to steepen the U.S. curve. The 2/10 curve has more work to do to break out of overhead resistance but I will continue to monitor its movement.
The markets performed as expected in response to Brainard’s speech, especially as global equity markets breathed a sigh-of-relief that the FED will be reticent to raise policy rates while shrinking the balance sheet, or what Peter Boockvar has labeled QT: quantitative tightening. The only deviation was in the U.S. dollar’s reaction, which saw the EURO selloff on Wednesday and again today. But while the EURO weakened other currencies did gain ground versus the dollar, resulting in the DOLLAR index closing unchanged today from Tuesday’s close. Unexpectedly, the heavily shorted Japanese yen has staged a two-day rally, which has caused angst for currency traders.
THE BIGGEST SURPRISE FOR FOREIGN EXCHANGE TRADERS WOULD BE IF THE BOJ WERE TO HINT AT CHANGING ITS POLICY OF YIELD CURVE CONTROL. If BOJ Governor Kuroda were to decrease purchases of JGBs the YEN would rally as the FX market would be forced to short cover. Kuroda has recently been ADAMANT that 2% inflation is the target for the BOJ and with recent soft inflation data such a move by the BOJ is highly unlikely.
There were rumors today that ECB President Mario Draghi would be speaking at the Jackson Hole Conference this year and that in such a major speech he would pre-announce a move by the ECB to commence tapering its QE program. This rumor led to a sell-off of all sovereign debt, but most significantly the European debt market. The Italian 10-year note yield rose 7.2 basis points. I AM NOT OF THE MIND THAT DRAGHI WILL ANNOUNCE TAPERING FOR HE STILL SEES MUCH TO BE DONE TO PROMOTE GROWTH THROUGHOUT ALL OF EUROPE, but this rumor should add to market volatility as we head into the very thin holiday markets of August.
***Another important point to support the German equity markets: In response to Tuesday’s blog post, a long-time reader and commenter to Notes From Underground (hello, SHOCKED) asked me how I had suddenly turned bullish the DAX when at the end of June I posited that a monthly key reversal had rendered a bearish signal. My readers are well aware that many trades I discuss are relative value trades and for six months I have noted that because of negative interest rates, current and trade account surpluses, a budget surplus and a very weak currency (EURO) provided Germany with the most bullish fundamentals backdrop for global investors. If the U.S. equity market turned negative it might indicate that all equity markets were going to correct but I believed that Germany would still be a much better relative value.
Remember, the U.S. equity markets significantly outperformed the DAX as the Germans were dealing with the existential issues of the eurozone while Ben Bernanke was providing vast amounts of liquidity in pursuit of his portfolio balance channel. In Tuesday’s Financial Times, there was an article titled, “German Liberals Push For Deep Tax Cuts.” It said the push by the Free Democrats for deep tax cuts and an overhaul of immigration policy may help them in September’s election. The FDP had been a previous coalition partner with Chancellor Merkel’s CDU party but were knocked out of Parliament in 2013. If the FDP’s platform resonates with German liberals who favor “… open markets, personal freedom, a small state and low taxes ….”
The article noted that the FDP “… promises to slash taxes by 30 billion euros through the 2017-21 term, far more than the 20 billion euros or so pledged by Ms. Merkel’s bloc, with cuts funded by forecast tax revenue increases.” If the FDP is gaining in the polls it will be deemed a positive for the German economy and push Chancellor Merkel for greater fiscal stimulus. Just another variable to be aware of as we proceed to the German election.