Twas the Week Before Christmas, Amidst Powerful Trends

<br /> Twas the Week Before Christmas, Amidst Powerful Trends – Marc to Market<br />


The capital markets
have been buffeted by political
developments and central bank policies.  
direct influence of high frequency data seems to have diminished in recent
weeks.  With less participation in the year-end markets, this is likely to
continue to be the case over the next two weeks.  

There are
several powerful trends in the global capital markets. 
 The trends appear to have begun at the start of the
fourth quarter.  Three trends have been particularly
robust.  The dollar’s climb against the yen, the rise in US 10-year
yields, and the rise in Japanese stocks.  The three have risen in nine of
the past 11 weeks and six in a row.  
The Dollar
Index has risen, as have two-year US Treasury yields, and gold has fallen in
eight of the past 11 weeks. 
 The euro has risen, alongside the Dow Jones Stoxx 600 in seven of
the past 11 weeks.  What may surprise many is that the FTSE All-Shares
Italian Banks Index has also risen eight of the past 11 weeks,  including
the past three weeks.  MSCI’s Emerging Market equity index and its Asian
Pacific Index has fallen in seven of the past 11 weeks.  The light sweet
crude oil futures price has risen in seven of 11 weeks, but Brent only rose in
six weeks.  
Due to the
China’s national holiday, its markets were opened a week less this quarter. 
 However, powerful trends are also in place.
 China’s 10-year yield has risen in seven of the past 10 weeks. Although the Shanghai Composite has
risen in six of ten weeks, it has fallen three in a row now and four of the
past five weeks.  The dollar has risen against the yuan in eight of the
past ten weeks and 24 of the past 32 weeks.  
A key issue now
is whether the trends are extended or a
profit-taking phase is seen into the
It is a question of psychology, and
perhaps a subject for game theory.  Arguments that things have gone too
far too fast are several weeks old, though it is true, of course, that
technical readings are even more stretched.
 And if the market was exaggerating the likelihood of the kind and
magnitude fiscal stimulus that is likely to pass a more conservative Congress,
then it similarly overreacted to what appears to be relatively modest changes
in the average (rather
than the median) Fed’s forecast.  The average for next year, for example,
increased by nine basis points, though the
median is increased by 25 bp.  
The direction
of market overreaction is itself an important tell or indicator of the
underlying pressure.
 At the same time, the structure of
ownership of government bonds has changed.  Central banks own a lot more
than in the last cyclical increase in yields.  Many private sector
investors hedge. Officials typically don’t.  The same is true of the US
mortgage-backed securities.   The MBS on the Fed’s balance sheet is not being
hedged.  If they were in the private sector hands, Treasuries or
some derivative thereof would have been used, leading to even greater pressure
on US rates.  
The dollar’s
appreciation against emerging market currencies would be expected to spur
intervention to slow the depreciation,
especially by those countries with large or quick pass-through to domestic
inflation or, are already experiencing rising price pressures.  
It is unexpected then that the Federal
Reserve’s custody holdings (of Treasuries and Agency bonds) have risen for the
past five weeks.  The counter-intuitive increase of $42 bln compares with
a draw drown of about $213 bln in the year up until then.  
companies, and investors have different exposures, risk tolerances, and
  Their ability to cope and the
changing investment environment will vary.  China is having a particularly
rough time even though growth appears to have stabilized.  Indeed, the
stabilization of the economy allows officials to try to curb some excess, and this is pushing in the same way as
a rise in US rates–forcing a
deleveraging.  The benchmark 10-year Chinese government bond yield rose 18
bp last week to bring the increase since the end of October to 66 bp.  The
US 10-year yield has risen 76 bp in the same period.  
conditions and market participants may be somewhat less prepared cope with the
surging interest rates.  
Pressure came to a head before the weekend.  Estimates
suggest that the PBOC provided as much as CNY600 bln ($$86.5 bln) in loans to
financial firms over the past two sessions and encouraged the large banks to
extend credit to non-bank financial institutions (shadow banking?).  
The pressure is being exacerbated by year-end considerations, and many institutions are preparing for
the New Year when individual quotas on taking money offshore are renewed.
  The idea is that banks are amassing
liquidity in preparation for this anticipated demand at the start of 2017.
 At the same time, China is also
tightening and expanding formal and informal capital controls. 
The Bank of
Japan and Sweden’s Riksbank hold policy meetings.
  There is potential for both central
banks to surprise the consensus which is looking for unchanged policies.
 The surprise could come from the BOJ in the form of tweaking its goals.
 Its new declaratory goal is to keep
the 10-year yield near zero.  It has crept up to 10 basis points at the
end of last week.  It had intervened in the longer-end of the curve,
according to reports, and this seems to
yield favorable results.  The 20-year bond yield reached 68 bp on December
13 and following BOJ efforts; the yield
finished the week 10 bp lower.  
Most expect the
Riksbank to leave its deposit rate at minus 0.50%. 
 The central bank put investors on notice in October
that the probability of a rate cut had increased.  However,  of the
16 “qualified economists” in the Bloomberg survey, only one expected
a cut now.    The idea is that the Riksbank may not be in a hurry to deliver a rate cut.  Deflation forces have not only been beaten back, but price pressures are
accelerating.  The 1.4% year-over-year
pace in November contrasts with the 0.5% pace at the end of last year.
 The CPI measures that adjust for
fixed rate mortgages rose to 1.6% in November from 0.9% at the end of
Of note, Canada
unveils its new measures of core inflation with the CPI.  
These are a trimmed, median, and common
measures.  Its previous core measure was 1.2%.  October retail sales
are likely to bounce back strongly from the flat reading in September.
 However, it might not be sufficient to prevent the October monthly GDP
Less attention
than usual may be paid to the minutes
from the recent Reserve Bank of Australia meeting. 
 The day after the meeting, the government reported
the economy contract more than expected (0.5%) in Q3.  
Some observers
are playing up the importance of Yellen’s speech on Monday in the US afternoon. 
 It is the first appearance since the FOMC meeting.
 We make two points. First, she rarely goes beyond what is FOMC
statement and her press conference.  Second, she is delivering a
commencement speech at the University of Baltimore.  It is hardly the
forum to get into the nuances of monetary policy, the Fed’s balance sheet, or
the implications of a fiscal policy that does yet


Twas the Week Before Christmas, Amidst Powerful Trends
Twas the Week Before Christmas, Amidst Powerful Trends

Reviewed by Marc Chandler

December 18, 2016

Rating: 5

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