“I am a sick man. I am a wicked man.”

So opens the Dostoyevsky novella Notes from Underground. Sometimes I seem to be caught in a similar existential trap as I analyze the global macro data and fundamentals. I am sick because I continue to pursue the opportunities that explode before me. I have taken a turn for the worse and become sick because of the constant flow of manipulated headlines crafted to purposely activate the trading algorithms. Tweets and headlines with no context have become the coin of the realm, especially for high frequency trading operations. But their role in the market jungle does little to dissuade me  from honing my craft. The bottom line: Greater preparation and more patience is needed.

This view was succinctly summed up in an October 2017 Barron’s article by John Curran, a former partner at the great firm of Caxton Associates. The article, “The Coming Renaissance of Macro Investing,” was written in response to the frustrations of trading in the world of headlines rather than the deep perspective of political economic fundamental analysis. Curran concludes the piece with this nugget of wisdom:

“As my mentor Bruce Kovner used to say, ‘Nobody rings a bell at key turning points.’ The ability to properly anticipate change is predicated upon detached analysis of fundamental information, applying that information to imagine a plausible world different from today’s, understanding how new data points fit [or don’t fit] into that world and adjusting accordingly. Ideally, this process leads to an “aha” moment, and the idea crystallizes into a clear vision.”

This is what NOTES FROM UNDERGROUND strives to do. It is where we thrive to discover the unbalanced world of 2+2=5. You do the math.

***Let me proceed with my screed against the bumbling Treasury Secretary Steve Mnuchin. After I wrote my last post, Mnuchin proved his ineptitude by panicking in the face of stock market weakness and leaking to the press that he had called the CEOs of six major financial institutions inquiring about their financial and liquidity situations. All provided a rosy outlook providing Mnuchin to announce that there was no fear of a financial crisis. Stock markets were in the thralls of “fake concerns.” The problem that Mnuchin failed to understand was two-fold: One, it was not a financial crisis concerning the Dow but a crisis of confidence in the executive branch. And two, by raising the issue of a financial crisis Mnuchin himself was exacerbating the situation.

The Treasury secretary was attempting to take a page from the Greenspan playbook of LONG-TERM CAPITAL MANAGEMENT when the markets were needed to be secure in believing that the Fed and Treasury were managing a potential liquidity crisis. In this case, it was the wrong strategy, which immediately caused the markets to fall. Mnuchin felt he had to do something and that resulted in the most negative of outcomes.

One last thing about the Treasury secretary. There was a Bloomberg story on December 18 titled, “Mnuchin Blames Volcker Rule, High Speed Trading For Volatility.” The Secretary incorrectly promoted the idea that a rollback of the Volcker rule along with greater SEC control over HFT would lessen the recent volatility. Mnuchin said, “In my opinion, market structure has led to a lot more volatility. Part of this is a combination of the market presence of high-frequency traders combined with the Volcker Rule.”

The Bloomberg article points out that these two elements have been in place for at least five years and it there has actually been less volatility. The danger here is that Mnuchin threatens to use his position as the head of the Financial Stability Oversight Committee (FSOC) to investigate and possibly ameliorate. This is Mnuchin merely trying the to do the bidding of money center banks to try to recreate the prop trading shops that existed prior to the Global Financial Crisis. It is not the Volcker Rule causing the volatility but the executive branch’s use of tweets to sound off on so many various exogenous events that plays havoc with the financial markets. Mr. Mnuchin, we have met the miscreant. It is you. The lack of a qualified Treasury secretary in times of rising global and domestic uncertainty needs to be corrected. Being a former partner at Goldman Sachs is not a prerequisite for competency. Now about that trillion-plus deficit ….
***The turbulence in the Japanese YEN last week was no fat finger error because the currency remained elevated for 24 hours. After the poor Apple forecasts the Asian markets were in turmoil as long-held positions in the YEN carry trade were unwound in a post-holiday flight to safety. Japanese investors were spooked by weakened U.S. data, coupled with increased negative news from China. The strong YEN is causing problems for the BOJ, which has based its entire QQE policy on elevating inflation to 2 percent.
A strong YEN will act as a deflationary drag of prices and force the BOJ to deploy a more aggressive asset purchase program. On Thursday night there were reports of the MOF and BOJ meeting about ways to counteract the recent YEN strength, which resulted in a selloff in the YEN on all the crosses (EURO, SWISS, Aussie, pound, dollar). There is little left to buy of JGBs. The BOJ owns so many that the 10-year Japanese debt market has almost no liquidity. Thus, if the BOJ increases liquidity it will have to buy more Japanese equities or begin the open market purchases of FOREIGN BONDS. Unfortunately for the BOJ and ABE GOVERNMENT, the purchase of foreign paper would result in a weaker yen and raise the ire of the G-20 that Japan is manipulating its currency.
This dilemma for Japan will have me paying very close attention to the gold/yen cross to evaluate the efforts of the BOJ to continue to monetize its policy of 2 percent inflation. Sigh, another Central Bank close to losing control of its policy ambitions.
***On Friday, Fed Chairman Jerome Powell walked back his comments from the FED press conference on December 19, when he maintained that the FED‘s balance sheet reduction was on auto-pilot. In a panel discussion with former chairs Bernanke and Yellen, the current FED chair changed directions by asserting that “the Fed WOULD CHANGE BALANCE SHEET RUNOFF POLICY IF NEEDED.” Powell’s comments were in-line with comments by two FED regional Presidents,Robert Kaplan and Loretta Mester. The volte-face helped propel a strong market reaction that had already become based on overnight news that the PBOC was cutting its reserve requirements in an effort to stimulate loans in China and a strong JOBS number in the U.S.
It was the AUTO-PILOT comment at the Powell press conference that caused the SPOOs and NASDAQ to sell-off on December 19 and close out the year very weak. The BONDS on Friday were sold as the search for havens was reversed as it appears that the FOMC is not tone-deaf to the demands of Wall Street for liquidity to finance the colossal pile of debt on private and public balance sheets. The FED may have found it is closer to normal/neutral than previously thought as it tries to comprehend the impact from the double-barreled approach to shrinking bank reserves in an effort to keep the economy from overheating.
In addition to the strong gain in payrolls was an increase in average hourly earnings (0.4 percent), bringing the average to 3.2 percent for the year. Will the good news on jobs and Powell result in lessened criticism from the White House about the FED? We can only hope. If the FED really slows the liquidity drain the proof ought to be found in a weaker dollar, steepening yield curve, higher commodities and stronger precious metals. The GOLD has performed very well against all major currencies as the light continues to shine on possible flaws in the exit strategies from QE policies of the last decade.
In the U.S., will the FED allow jobs data to run hotter for longer in an effort to allow some long-awaited rewards for the stagnant wages of the American worker? The House Financial Services Committee under the Chair of Maxine Waters will certainly want the FED to slow its effort to contain wage growth, a stance in line with President Trump’s desires.
This promises to be an interesting year for a sick, wicked man finding satisfaction in a world that celebrates that 2+2=5.