In the current policy and media stoked market environment, anything is possible. It’s the wonderful, magical world of hands-on policy making. 5 years after the financial crisis, but still not enjoying a ramping economy like the good old (and long gone) days of the last great secular bull market (RIP 2000)? Just sit back, relax and let the man in charge control the image.
In light of today’s positive economic data out of China, I thought I would reproduce a segment from NFTRH 255 (9.8.13) that speculated upon the possibility of a new up cycle in inflation expectations based in large part on China and its credit growth cycle (on which central planners have announced a planned clampdown).
The Greenspan Fed provides a handy reference as to how long it can take for a withdrawal of policy to manifest in a new economic deceleration.
China, US & Inflation
The Shanghai stock market has declined steadily since the post-bubble rebound in 2009. Further, after a record amount of credit-based stimulus, central planners are promoting a withdrawal of credit.
China Record Drop in Credit Growth Puts Momentum at Risk –Bloomberg
“China’s leaders are extending a clampdown on credit, prompting analysts from JPMorgan Chase & Co. to Societe Generale SA to caution that the economy is vulnerable to weakening after the pickup so far this quarter.”
But with the SSEC at notable long-term support, it is appropriate to question whether a bounce in the global growth engine (China) is in the cards.
The China 25 found support and has been rising since early summer. After a strong rise last week 38 is now the key level by the weekly chart [ed: FXI broke through this level yesterday]. It is notable that this rise has taken place against a modest decline in many US markets over the last 5 weeks. Exceptions in the US are technology and to a lesser degree, semiconductors, which service a global customer base.
We all know that China is considered an engine of global growth, so if its credit inflation to date were to manifest in an inflationary growth cycle, there would be trade opportunities in US equities. But broader Asia and emerging markets would be expected to be part of the play as well and could actually out perform.
Returning to the question of sustainability posed by the fretting analysts at JP Morgan and Societe Generale, let’s note that Alan Greenspan’s famous bubble in commercial credit lived on well after his Fed began to withdraw official accommodation at the beginning of 2004.
So in consideration of the ongoing pull between the deflation and inflation arguments NFTRH simply wants to know what the next tradable cycle will be. While threatened policy tightening in the US and China paints the headlines toward an anti-inflationary stance, we consider a potential lag time between actual (never mind threatened) policy withdrawal and asset market response (which usually comes in the form of utter liquidation in the ‘Age of Inflaton onDemand’ ™).
Aside from being a road map potentially instructing about Chinese policy, the above chart tells us in striking detail just how desperately inflationary the Ben Bernanke Federal Reserve is and has been. Never mind the “taper” obsession, this Fed has routinely held ZIRP through thick and thin since 2008 with the only media noise I have seen coming last week from some Fed talking head going on about the first rate hike, out in late 2015!
Ha ha ha Charles, quit the Fed and hit the standup comedy circuit.
The Fed talks “taper” because interest rates are rising to challenge its image of authority and control. Why are interest rates rising? In large part because China is selling Treasury bonds. Why is China selling Treasury bonds? How would I know? I write a macro market newsletter and do not sit on the Central Planning Bureau.
But if I were to make an educated guess I’d say that the utility of funding US growth is no longer considered to be in China’s best interest [ed: as China has been using credit to fund its own growth; one wonders however, if China may settle in for a while as a net buyer of T bonds once again, given the interest rate hype in the US as T bond yields come to target??] and the US Fed’s bald-faced ZIRP (i.e. systematic inflationary policy) is, despite the global upset and deflationary pull of the Euro crisis and China’s slowdown, considered to be an inflationary act.
We are open to an ‘inflation trade’, which would be a trade only. In this week’s report we will check up on several elements that would be key to a cycle in which inflation expectations could start to emerge and manifest in certain asset markets appreciating in a cyclical up phase. Meanwhile, on the micro term we’ll continue to scout for the answer to the ‘will they or won’t they?’ question regarding a final near term decline to support, especially in US stock markets, prior to such an asset market rally [ed: it's not looking that way as of Tuesday morning, as the rally may already be started, led by two prime players, China and US technology].
Boy this is a macro market newsletter that dug and dug until it came up with a lot of possibilities for various markets going into Q4 and beyond. It also highlighted something significant going on in T bond yields that I don’t think is being considered by most people.
This as 10-year yields have just about hit the 3% target we established back in May in NFTRH 239. The 30-year is closing in on its target of 4.2%. But there is something going on in yield relationships that I really need to think more about and get on top of. Anyway, even the little promo blurb for this letter is getting too involved.
Got to love the markets; never an easy answer nor a dull moment. NFTRH 255 out now.
While the MSM instigates reasons why we should give a damn about what people who have little control over the T bond market were thinking at the last meeting, why don’t we just tune it all out and manage the markets instead?
The top panel shows the 30 year yield marching toward the traditional limiter AKA the 100 month EMA. The pattern measures to 4.5% or so, so there could be a spike above and a hell of a lot of hysteria at some point. That’s the collective markets; 98% hype, hysterics and emotion and 2% rational management. Either the 30 year yield is going to do something it has not done in decades (break and hold above the EMA 100) or it is not. Simple.
The relationship between long term bonds (30) and short term bonds (2) in the middle panel is currently negatively diverging gold as the ratio has dropped this month. Again, we wonder is gold (bottom panel) leading the curve this month or should gold bugs take caution? I think gold is leading the curve, but it bears watching. The relationship became distorted in second half, 2012.
As for gold, it probably bottomed at the end of June. That is because the sold out condition of the sector (read: Paulson puking GLD, hedge fund net short positions, India’s antagonism toward its would-be gold buyer citizens, etc. etc. etc.) was simply historic.
Really, just dialing down all the noise of the last 2 years it was a grand and climactic panic IN to gold in 2011 by the global public in the face of the Euro’s supposed Armageddon. Everyone had bought and then it was time for the bleeding out of this emotional money.
The bleeding went on longer than I originally thought it would, but that is why we do ongoing work to interpret things every step of the way. Hey, no harm no foul. A little patience and ongoing perspective and now we have what appears to be a purified asset class, free of unhealthy sponsorship.
Back to the chart’s top panel. China is a net seller of T bonds. Japan is a net seller of T bonds.
As we have been noting every step of the way T bond yields are a function of supply and demand. The global system endured a solid decade of net inflows of global funds into the T bond market. Now it appears the tide may be going out. Hence, interest rates all along the curve – save for the officially manipulated ZIRP on the Fed Funds – are going up.
It is all normal to free market participants; just another phase. It is only abnormal if you buy in to the idea that the Fed is in control and can remotely operate the financial markets indefinitely; if you buy in to the idea that the Fed decides when the cycles are to change.
If you look at it a certain way, it’ll tickle your funny bone as you listen to Huey, Dooey and Louie jawbone ‘Taper’ in the media or as you review what a bunch of bureaucratic clerks had to ruminate about at the last FOMC meeting at 2 PM US Eastern today.
Here is the chart we have been using in NFTRH, showing inflation protected T bond fund TIP vs. regular T bond fund TLT.
This ratio has been bottoming for months now and in the last few weeks had made some failed efforts to break out. Last week it closed above the bottom pattern neckline.
From NFTRH 252:
“TIP-TLT can be thought of as a barometer to ‘inflation expectations’. That could be what the precious metals, led by silver, are indicating in tandem with the above ratio. At the very least, it looks like a ‘deflationary expectations’ phase – which helped feed Goldilocks and croak precious metals – may be ending.”
Goldilocks lived by the deflationary pressures that Europe’s meltdown and China’s slow down exerted upon the world. Now, with the latest TICS report showing China and Japan selling T bonds we suddenly have the Fed’s Huey, Dooey and Louie jawboning a ‘taper’ of bond buying in the media. Ha ha ha… as if they have a decision to make.
The Treasury TIC data are only through June, which just happens to be the month we observed the breakout from bottoming patterns in 10 year and 30 year bond yields. But the play always (and I am talking nearly a decade since we began following this dynamic) been that America’s voracious consumption habits would be used to build out the Chinese economy on credit. They would not let us abuse our ability to inflate without consequence forever.
Do they perhaps feel built out enough for the time being? We’ll find out in future TICS reports. But I’ll just say that everybody thinks they know that there is no inflation and in this market what everybody thinks they know could well stand to be wrong. I have rarely seen so many of the right people on the wrong sides.