Archives: October 2016

There is only one story for The Day Today. Flash crashes are back and you better believe it

There is still some debate about the low in GBP/USD following its flash crash. Reuters, which used to be the primary trading venue for Cable, printed 1.1491. With FX being a delightful over the counter market, where traders at banks can no longer talk to one another, we will never really know what the “official” low is. But for sure it was indeed a flash crash, coming at the most illiquid time of day, just after the Sydney open.

Various stories circulated, not least the one regarding Francois Hollande’s threat that: “we have to have this firmness … if not, we would jeopardise the fundamental principles of the EU. Other countries would want to leave the EU to get the supposed advantages without the obligations … there must be a threat, there must be a risk, there must be a price … the U.K want to leave and pay nothing, it’s not possible”.

But the truth is that GBP has been under threat for some time. The fiscal position and external deficit are even worse than they were when the UK had to go to the IMF for a bailout in the 1970s. The UK relies on capital inflows and there needs to be a risk premium put onto GBP assets for that.

Sterling has been under pressure all week, ever since Theresa May fired the starting gun on Article 50. Now we know that the 2 year negotiations kick off in earnest by the end of Q1 2017. In five months, we will be well on our way out of the EU. This has clearly focused minds. Hence stories in the WSJ yesterday that “Firms Beef Up Contingency Plans Ahead of Brexit Deadline”, noting that ‘When Japan’s Daiwa Securities Group Inc. heard the British prime minister pledge on Sunday to prioritize controlling immigration in the coming Brexit negotiations, it didn’t wait to act. The next day, staff accelerated contingency planning for the bank’s London investment banking unit and began to contact other European cities, according to a person familiar with the matter. While Daiwa doesn’t have a definite plan yet, it could involve relocating some operations to the Continent’.

We already know that the BOE and the government are relaxed about GBP depreciating; both have said as much in earlier statements. Back in August when the new government arrived and the BOE cut rates alongside publishing their Inflation Report, there was an exchange of letters between Governor Carney and Chancellor Hammond, with the latter saying:

‘You make clear the MPC’s judgement that fully offsetting the persistent effects of sterling’s depreciation would lead to an undesirable loss in output and employment and would be less likely to generate a sustainable return of inflation to the target beyond the three-year forecast horizon….Alongside the actions the Bank is taking, I am prepared to take any necessary steps to support the economy and promote confidence’ – in other words, don’t act to offset GBP’s decline.

The real surprise about Sterling’s fall is the speed and timing of it. That, however, cannot be pinned upon the new government. That is a much bigger issue beyond the UK, beyond Sterling, beyond currency markets. It is a reminder once again of the fragility of the current market structure. There is already a lot of talk about algos. Funny how they are always to blame. But don’t be fooled that “nothing traded”. It’s tough to get volume numbers in FX, but here is a chart of the volumes traded on the Reuters platform. Bear in mind that this is only a small part of the market these days, but something did trade at 1.1500 and a fair amount traded below 1.2000.

So, it’s not as if the market was “dysfunctional” in the sense that it was not showing the right price. Rather it became like EUR/CHF after the removal of the floor, where no-one quite knows where anything is trading, but trading they must do, and the prices become evident later. The difference is that the EUR/CHF market was always skewed up for something nasty, given all the option barriers sitting below a level that the SNB said they would defend until the death with their “unlimited” intervention. If we have now seen price action that is similar to that period, without such a skew in the market, then it suggests the underlying market is even more fragile than it was then.

This would tie into the view that liquidity is an illusion, with the absence of banks as warehousing risk takers, and the increase in high-frequency trading. Note that the official report into the US Treasury flash crash noted an unusual amount of “self-trading” when the 10yr yield crashed – that’s algos trading with themselves.

The point then is that the world is now in uber risk-seeking mode, with various risk indicators such as the VIX trading at benign levels; there has been a loading up into yielding assets; but we now have signs that “Lower Forever” is coming to an end. The BOJ needing to sell JGBs for their Yield Curve control, with a sniff of ECB tapering, and a Fed hike in Dec priced at 60%. This GBP flash crash is a reminder that the endless liquidity is coming to an end much sooner than the market cares to realise.

Let’s Get Fiscal

I’ve been patient, I’ve been good, as Olivia Newton-John once crooned. Now we need to get Fiscal, the world’s governments seem to think. They’ve played the austerity game, the world didn’t end, and if anything yields are so low, and debt so sustainable, it would seem foolish not to tap into it… wouldn’t it? That seems to be the market’s main takeaway from Theresa May’s maiden Conference speech. Headlines spewed onto Bloomberg that she went on a ‘surprise attack’ of the Bank of England’s monetary activism; that Keynesianism and some kind of Labourite Tax and Spend is just around the corner. Meanwhile this morning we hear that Germany, the beacons of fiscal rectitude, have announced a 6.3bn EUR tax cut. The anti-austerity brigade must hardly be able to contain themselves!

Woaaah there a second, you crazy cats. German GDP is 3 trillion, so 6bn is a drop in the ocean. Or as Handelsblatt put it with their headline, “Two Cappucinos a month”. Equally when it comes to the new government, we should not be surprised that Theresa May chose this speech to set out her philosophy – but that the details will only be forthcoming in the November 23rd Autumn Statement (h/t to my BR friend for reminding me of such key dates!). Prime Ministers are the figurehead, that’s precisely why they say things like how they are standing up for everyone “not just the privileged few”; but the reality of policy doesn’t mean that translates one-for-one into a wealth tax hike and free jobs for the unemployed [insert other unfundable socialist policy here].

For all the screaming about Theresa May being a new Communist, or as the Guardian put it, “UKIP meets Ed Miliband”, she cannot help but be populist. For a start, she is responding to a popular vote; secondly, a new leader needs to broaden their support; and thirdly, Blondemoney finds it hard to disagree with statements like these:

“While monetary policy – with super-low interest rates and quantitative easing – provided the necessary emergency medicine after the financial crash, we have to acknowledge there have been some bad side effects. People with assets have got richer. People without them have suffered. People with mortgages have found their debts cheaper. People with savings have found themselves poorer.”

Blondemoney in fact blogged on this topic months ago, as it’s exactly these reasons that have fuelled the rise of populism. In fact, even central banks have spotted that easing forever is not the answer.

For all the jumping up and down, not a lot has changed. Monetary policy is still over and Fiscal policy must step in. The degree to which it does will depend on the government in charge.

The Day Today 6 October 2016

* Germany plan 6.3bn eur of tax cuts

* Sources say German officials are meeting with US DOJ officials over Deutsche

* BOE Broadbent warns Brexit could have “insidious” impact on investment

* Stiglitz sees Italy leaving the Euro

* Fed Fischer: “We could be stuck in a new longer-run equilibrium characterized by sluggish growth”

* Fed Lacker: “By the end of a president’s term in the White House, it has typically been the case that the majority or every member of the Board of Governors was appointed by a president of the same party….The views of Governors may not be as diverse as intended”

* He also thinks “there are signs that inflation is heating up”

* Japanese govt wants companies to raise wages

* Australia trade deficit narrows

The End of Monetary Policy Part 3

So the ECB denies that they have already discussed tapering their QE programme, just as every about-to-be-sacked football manager announces they have the full confidence of the board. A Bloomberg article released yesterday afternoon casually reported that ‘The European Central Bank will probably gradually wind down bond purchases before the conclusion of quantitative easing, and may do so in steps of 10 billion euros a month, according to euro-zone central-bank officials’. The ECB have habitually prepared the path for rate decisions with these kinds of leaks, so it’s interesting to note that the market reaction this time has been to believe the denial rather than the leak. Partly this is because there are few fast-money positions in the Euro or European rates that were predicated entirely on “QE Forever”. Partly it’s psychology, with many speculators burnt to a crisp by trying to follow Draghi’s announcements and pre-announcements. But more importantly its symptomatic of the current market hiatus: “Rates will be lower-for-longer; inflation is dead; curves are flat; buy yield wherever you can get it”. This story just doesn’t have enough vigour to shake that – not yet anyway. It’s rebuffed as madness: Blondemoney wouldn’t have written pieces such as “Put Your Hands Up if You’re Easing, Part Infinity”, if we weren’t now schooled in the lower-forever construct.

But it’s not madness. QE cannot go on forever. Yield curves cannot be manipulated forever, despite the BOJ’s Spanx-like devotion to Yield Curve Control. The very fact that a central bank, at its wits’ end, would announce a policy that is specifically called “Yield Curve Control” is a sign that the jig is up. The Jedi Central Banking is reaching its Han Solo crossing the bridge to Kylo Ren moment.

Monetary Policy is dead. Even if the ECB were not going to taper eventually, the market should teach them that they need to. They will have to at some point. Curves cannot be flat forever, and now we are starting to see some steepening emerge once again:

Now, eventually fiscal policy will take over. But as we’ve already seen in the volatility of Sterling during the Conservative Party Conference, the adjustment to understanding the prognostications of politicians who may not even be talking to YOU the investor, but actually YOU the voter, is going to create a bit of a blow up as the realisation filters through.

So yes we are still in a carry-happy hiatus. But as the curve steepening continues it will be a sign that the cracks are starting to show.

The Day Today 5 October 2016

* ECB denies it is already discussing plans to reduce its bond purchases

* Bill Gross said the taper news caused him to “basically reverse positions from long duration to short”

* Fed Evans is “fine” with a Dec hike

* Oliver Wyman: Hard Brexit could cost UK financial firms 38bn GBp

* Brexit Minister: “Now, that of course will be different for financial services than it will be for a motor car manufacturer…but it won’t be a separate deal, there are no separate deals”

* IMF downgrades US growth for this year from 2.2% to 1.6%, sees UK as fastest growing G7

* U.S. heavy truck orders post worst September in seven years

* 90% of an ETF assets were liquidated in one day