Finally, one asset seems to be peeling away from the everything-up-against-the-USD trade, as bonds have seen a bit more back and forth again despite the threat of imminent Fed buying and a reasonable auction result today. What does this mean for USDJPY and the current market paradigm?
Chart: Saxo Bank Carry Trade Model
First, our daily check-in with our carry trade model shows that underlying risk factors continue to support the general upward trajectory in risk appetite – even more strongly than in previous days now that FX volatility has come off further today with the latest slowdown in USD depreciation. This begs the question, of course, on the degree to which the USD move is leading risk indicators and vice versa – and the possible answer is that this is a reflexive process.
First, our daily check-in with our carry trade model shows that underlying risk factors continue to support the general upward trajectory in risk appetite – even more strongly than in previous days now that FX volatility has come off further today with the latest slowdown in USD depreciation. This begs the question, of course, on the degree to which the USD move is leading risk indicators and vice versa – and the possible answer is that this is a reflexive process.
An endlessly fascinating article from Artemis posted by the hyperactive Zerohedge staff discusses the meaning and risks of the highly correlated markets and the potential this creates (or risk this reflects) of systemic risk. Also a good look at the everything up trade and compares this market to selling pineapples at a farmer’s market. Highly worth a read.
Chart: VIX vs. VIX future
Along the lines of the correlation and volatility discussion from the above article – click on the chart below for a look at the spread between the “spot” VIX and the 5th VIX future vs. the S&P500 to see how unusual this market has become relative to the last few years.
Along the lines of the correlation and volatility discussion from the above article – click on the chart below for a look at the spread between the “spot” VIX and the 5th VIX future vs. the S&P500 to see how unusual this market has become relative to the last few years.
Bond markets to spoil the party?
If the “Everything up” trade is all about the potential for currency devalution meaning appreciation in asset prices, at some point the bond buyer has to wake up and say, “Why should I own bonds when the currency in which they are denominanted will mean negative real rates versus other asset classes? Shouldn’t I rather own stuff or a company that makes stuff and services on which they can raise prices to reflection inflation?” Let’s not presume to claim that bonds have hit the wall here – but at some point, the logic of this market falls apart and not everything can go up simultaneously, regardless of Fed actions. The last couple of days have seen a slight break in the everything up trade as bonds show some sign of weakness - which harks back to more normal market conditions when yields tend to rise as risk appetite rises as well. But in a market where the logic was formerly that Fed actions are supposed to support ALL asset prices, then this is a sign that the power of the Bernanke put is fading somewhat.
Chart: USDJPY and 10-yr rate spread
Regardless of our discombobulated attempt at unraveling the markets – we should consider what a rise in bond yields might mean for the Japanese Yen. Has everyone forgotten that the BoJ has already leapfrogged the Fed in bringing out QE2, that the it is practicing unsterilized currency intervention and that its long run debt problems are even worse than those in the US? If yield spreads head the wrong way for Japan relative to the US, it is hard to understand what force – besides emotional ones – would keep the JPY on a depreciating path, unless it’s the idea of Japanese exposure to the Chinese growth mir(age)acle. The chart below shows that the yield spread out where the Fed would supposedly be intervening has actually widened slightly in favor of the USD lately. Another extension in the bond bull from this consolidation could put the pressure back on the USDJPY – but at present, this looks interesting. Of course - just as we finish writing this and as we are on the cusp of sending it out - treasury futures rallied smartly, taking away most of the day's losses. Regardless, we are at an important inflection point around 2.50% on the US 10-year heading into Friday's speech from Bernanke.
Regardless of our discombobulated attempt at unraveling the markets – we should consider what a rise in bond yields might mean for the Japanese Yen. Has everyone forgotten that the BoJ has already leapfrogged the Fed in bringing out QE2, that the it is practicing unsterilized currency intervention and that its long run debt problems are even worse than those in the US? If yield spreads head the wrong way for Japan relative to the US, it is hard to understand what force – besides emotional ones – would keep the JPY on a depreciating path, unless it’s the idea of Japanese exposure to the Chinese growth mir(age)acle. The chart below shows that the yield spread out where the Fed would supposedly be intervening has actually widened slightly in favor of the USD lately. Another extension in the bond bull from this consolidation could put the pressure back on the USDJPY – but at present, this looks interesting. Of course - just as we finish writing this and as we are on the cusp of sending it out - treasury futures rallied smartly, taking away most of the day's losses. Regardless, we are at an important inflection point around 2.50% on the US 10-year heading into Friday's speech from Bernanke.
Chart: the “eventually this all goes wrong” trade – 10/30 slope
Despite the bull market in bonds, the longest end of the market has been a reluctant participant in the bond bull, as the 10/30 part of the yield curve has steepened sharply as the currency devaluation trade plays out, as the market recognizes that it can’t end well in the long run when central banks are bent on destroying their currencies. Note that the Japanese yield curve was the first move on this theme and therefore might be worth following more closely in the future since the long term fundamental bond investor should be most suspicious of JGB’s.
Despite the bull market in bonds, the longest end of the market has been a reluctant participant in the bond bull, as the 10/30 part of the yield curve has steepened sharply as the currency devaluation trade plays out, as the market recognizes that it can’t end well in the long run when central banks are bent on destroying their currencies. Note that the Japanese yield curve was the first move on this theme and therefore might be worth following more closely in the future since the long term fundamental bond investor should be most suspicious of JGB’s.
Foreclosure-gate
Obama vetoed a bill that would have allowed banks to get through the foreclosure issues more easily – leaving the legality of many foreclosures in question. At the same time, Obama refused to call for a moratorium. This issue is worth following in the weeks to come due to the risk for massive legal action and fallout from the mess – especially on the part of the largest banks. The largest banks’ equities have been tightly rangebound well almost everything else has been rallying.
Obama vetoed a bill that would have allowed banks to get through the foreclosure issues more easily – leaving the legality of many foreclosures in question. At the same time, Obama refused to call for a moratorium. This issue is worth following in the weeks to come due to the risk for massive legal action and fallout from the mess – especially on the part of the largest banks. The largest banks’ equities have been tightly rangebound well almost everything else has been rallying.
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