Davos, Dollars and Dead Men Walking

02/09/2018 6:00 am EST

Focus: CURRENCIES

Nell Sloane

Principal, Capital Trading Group

Why is the dollar moving lower when our rates are higher?  Shouldn’t that make our debt more attractive?  One would think, but in a globally coordinated central bank world, the banks are not working independently but in unison, writes Nell Sloan of Capital Trading Group.

We have talked at length on the sinking dollar and at Davos the “Mnuch” stated that “the weak dollar is good for the U.S. as it relates to trade and opportunities.” 

Gee thanks, Mr. Secretary, but what do you guys really mean?  We will tell you what it means…it means that the Fed cannot have its cake and eat it too. It cannot on one hand raise rates and on the other sit idly by with an ever-sinking U.S. dollar.  

Now, all econ fundamentals aside, one should be asking, why is the dollar moving lower when our rates are moving higher?  Shouldn’t that make our debt more attractive on yield vs. another countries’ debt? 

One would think, but in a globally coordinated central bank world, you have to realize that the central banks are not working independently but in unison.  

We will dig deeper into that at another time, but the crux of the statement is every nation cannot be an exporter. And when countries go to war with their currencies, the outcomes globally are usually disastrous and swift. 

Are we there yet?  Yes, we tend to think we are. How long the markets will continue to ignore this is anyone’s guess. 

Anyway, the problem with the Fed raising rates coupled with the U.S. fiscal support means a whole bunch of debt is going to have to be swallowed and higher rates have to attract such unwilling participants.  

The last decade will go down in the history books as the decade the central banks hijacked global financial systems and decided that it’s in everyone’s best interest to work together.

That is, obviously until it is not. 

Who will be the first to balk? Our guess is the Chinese. They have the most to lose, domestically and internationally, and it’s why they have been so reticent in shoring up their gold reserves and trying to internationalize their financial exchanges. 

However, their underlying distrustful fiscal policies and their too good to be true WMPs--no not WMDs of the good old Bush era--but potentially a synonymous acronym nonetheless as these WMPs will be like economic weapons of mass destruction.

WMPs are Wealth Management Products, which basically package deposits and attract buyers with higher rates of interest. We hate to say it, but they sure do look a bit Ponzi in nature.  Then again, isn’t the entire leveraged, rehypothecated, fractional reserve system, exactly just that? So let’s get to some other recent market news:

--Starbucks (SBUX) was out this week saying it’s going to spend $250m on new employee benefits.

--Credit Suisse (CS) was out stating the Pension Funds sector should be a natural seller when it rebalances this month.  No doubt equity outflows will benefit bond inflows, but in realty how big of a dent will this be?

Goldman Sachs (GS) out with an economic report which covered the equities growth and its relationship to increasing GDP.  The report focused on a sharp correction where stocks fall 20% in Q1, hmm, some interesting timing considering the rebalancing coming up.  Also, we noticed Goldman’s year-end S&P 500 (SPX) level is 2850, a level that is lower than last Friday’s settlement price.


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The ECB meeting produced some interesting developments as Draghi was calling out the U.S. for currency manipulation rhetoric…see the wars have already begun.

As for German 10-year yields, it seems as if 60 basis points some 212 basis points lower than corresponding 10-year U.S. yields is the line in the sand.

So an astute observer asked, why not just buy U.S. and sell German 10 years? Well, good point and if we were the likes of G&G (Gross & Gundlach) we most likely are, but we can’t telegraph it right. 

Anyway, there are other forces at play, most notably the currency risks and a whole host of short-term basis funding issues, not only with the euro but the yen as well.  But hey, at least some are thinking astutely! 

So we simply replied to their question with this, “Cross basis currency swaps are expensive, meaning dollar funding is expensive and there is no compensation for yield pickup for foreign investors. And the flip side to QE is dollar weakness which should continue. And if they don’t get ahold of the short rate from rising to far too fast, the dollar will get smoked and U.S. 10s will be plus 3%.”

We also believe the crypto space (BTC) is pulling some real capital out of leveraged markets and into the global economy, so money is being funneled out of the U.S. and who knows where it goes from there...so if this continues, then leverage has to fall because the banking system is being drained of cash. So it will be interesting to see how raising rates into a cash shortage moves markets...Our assumption would then be the dollar falls vs. all other fiats...This would be the natural progression and of course, U.S. equities would be the next likely culprit to tumble. They will lose 30% by summer is our guess if they continue to raise rates.

BofAML (BAC) put out their “Bull & Bear” indicator which has a 100% successful hit rate on its signals since 2002, with the average peak to trough of 12%. They warn that the S&P 500 has a potential pullback area of 2686 by March or some 10% lower from last week’s highs.  

Not to add more fuel to the bearish fire, but then there is this from John Hussman which is a must-view for our readers and we will link it here, but we will indulge you with the following quote, “I expect the S&P 500 to lose approximately two-thirds of its value over the completion of this cycle.  My impression is that future generations will look back on this moment and say … and this is where they completely lost their minds.” –John Hussman

We certainly won’t disagree with his thesis!

Q4 GDP missed expectations of 3%, rising only 2.6% as imports surged. Overall 2017 was decent with a 2.3% rise in GDP on the heels of good consumer and business spending.

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