Europe - Dawn of the Dead or a Bad Ghost Train?

The trading background - 

We are in the last couple of days of the year where funds are most unlikely to do anything. First, because they don’t want to screw up positioning or performance in the last couple of days before benchmark fixing with respect to performance and, more importantly, bonuses. Second, because they are sipping sloe gin on a shoot or stuck in a traffic jam in the alps. Or if US based, they are in holiday homes in warmer climes. Bank desks, if they are now allowed to take positions on the relaxation of Volker rules, will be staffed by juniors whose simple instruction is not to mess it up and to quote everything defensively.

So who is left to play? Short term speculators and the noise.

The noise background -

Over the last couple of weeks the commentary towards the EU has turned from one of background resignation to one of imminent doom. The oldest and darkest reasons for a collapse in everything EU have come crawling out of the ground zombie-like having been buried two years ago. The arguments are not new but they are dusting themselves off and rallying around the colours of the Greek election.

The noise is getting positively apocalyptic from the US commentary where, with greatest respect dear US friends, opinions appear to once again consider Europe in black and white terms rather than appreciating its grey adaptive nature . The lessons of the pain felt when short Euro risk assets positions were torn asunder over the last three years has obviously been forgotten. Or perhaps there is a hope of pride being restored in a ‘there told you it would happen in the end’ sort of way.

Yet calling EU to break with no time frame reference is not a way to make money and can be put in the same (very full) camp of China permabears calling a credit bubble explosion as a reason to be short China stocks and long China bonds which, as an 18% rally in SHCOMP in the last month and a fall in bonds of 4% attest, would have been a very uncomfortable position. It’s a bit like holding gold at $1500 calling for the end of the world (or Bitcoin come to that) where one needs a decent alternative income to live on.

The Greek elections

Despite the noise today the greek elections are not as Euro threatening as the binary zombies would call. Syriza don't want to leave the euro now and there is a Euro firewall against internal problems. Even the massive Cyprus collapse and subsequent bail-in didn't rock the boat, a default on official lenders only hurts Greece not anybody else. What is more the consequences would serve only to refocus reform momentum in the likes of Spain and Italy. Greece looks to be running twin surpluses now anyway.

Let’s also consider that the polls show that the Greek Public didn’t want another election anyway. Syriza lead has shrunk to 2.5% and now that the presidential vote has failed the government parties can throw it back at the independents who forced the unwanted election. This is bad from a sectoral standpoint (ie for Greece) but doesn't mean it's a general Europe down trade this time. Especially with the QE carrot dangled for late January where I really can’t see the ECB holding back on anything they plan to do because of Greek politics.


So what’s the plan Stan?

The market always needs a victim to sacrifice on the altar to the Trading Gods at the start of the year in order to bring great wealth and fortune. Last year emerging markets were dragged off, dressed in the ceremonial robes of strong USD and high leverage and given a good stabbing only to get up a bit later and wander away. But this year the screaming for blood appears to be directed towards the EU. The sacrifice is being prepared predominantly by the US priests.

So for timing. Traditionally I have always held the 19th of Jan as a turn date away from the first moves, but with the ECB and Greek elections a few days afterwards it is safer to call a EU bounce after that. So the plan is to buy any dip in EU risk assets (only of there is a dip and this hasn’t already played out buy the end of the week) around the 19th Jan in readiness.

Moving on to a more general view, there was an interesting Bloomberg article a week or so ago. There has been a 12% S+P500 rally over 2014 vs a 6.5% fall in USD denominated international equities. The widest divergence since 1992. There have been four other instances since 1970 and each time the MSCI rallied the next year outperforming the US by 14%. Now of course I am usually the first to poo-poo ‘happened like this before, will again’ arguments. But as this supports my own beliefs I will of course shout it from the roof tops.

Europe is most probably not experiencing a zombie dawn of the dead,  we are rather experiencing a rather poor end-of-pier ghost train.

Happy New Year and may the noise of the markets not drown out your celebrations!

Financial Twitter Templates

With Christmas coming up this may well be my last post for a while as I get down to some serious not doing anything. But before I go, I thought I'd help out all financial twitter users by providing some ready financial twitter templates to save time and effort during this socially busy time. If used sensibly they should provide the appearance of superior financial twitterance whilst you are actually inebriated and trying to defuse family bickering.

Just cut and paste a line from below inserting where prompted - I hope they come in useful.

------------

WOW!! [insert asset] hasn’t been this [insert high/low] since [insert last time]

The [insert yield curve] is [insert bp] [insert flatter/steeper] after that.

[insert number] #[insert acronym for upcoming data release]guesses

If [insert asset] goes through [insert price] then it’s really in [insert trouble or take off mode]

That's that then

[insert central banker] says that monetary policy will remain [insert tight or loose] for [insert period of time]

Picketty on [insert any social science] [insert a not working link]

[insert fund manager] has had drawdowns of [insert %] and hasn’t made any money since his [insert fund manager's only winning trade] call

Booom.

[insert name of someone you think people will listen to] says [insert anything they say that supports your view]

Am I the only one that thinks [insert something obvious]

Germany's Weidmann says [insert something that will not rescue Europe]

[insert asset] breaks [insert price] *NOTE - VERY IMPORTANT NOT TO INCLUDE ANY OTHER INFORMATION SUCH AS WHY THAT FACT IS RELEVANT.

Must read! - [insert a link to a 2000 page document of mind numbing stupor]

Ha, [insert someone clever], not looking so clever now after [insert only market move to have gone against the clever person ever]

Hi, I'm doing a sponsored [insert something fun you've always wanted to do] can you please give generously at [insert your Just Giving webpage where all the existing contributions are at least $500]

[insert bank name] say [insert asset] goes to [insert price] in 2015 [insert link to bank report]

This is interesting [insert link to a subscription only site costing $20k per month]

#ff [insert 7 people you want to follow you]

[insert any twitter handle] hey that's funny dude!

[insert asset price] approaching [insert support/ resistance] at [insert any number between 1 and 100] fibonacci level

[insert asset] is going [insert up or down] as [insert a random asset] is [insert lower/higher].

Woooooooaaahhhhhhhh. * NOTE - CAN BE USED AT ANY TIME BUT MOST SUITABLY AFTER A DATA RELEASE.

I’ve just had lunch with [insert important person], what a really decent person.

Thanks to everyone at [insert large institution] for hosting my talk on [insert a subject that sounds complicated]

Jeezz [attach a twitter picture of random intersecting lines]

[insert random news headline] * NOTE - ONCE AGAIN DO NOT CONFUSE THE TWEET WITH FURTHER EXPLANATION AS TO ITS RELEVANCE.

Happy Christmas!

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That last one was meant from me but also makes an ideal tweet.
New templates gratefully received in the comments section.

If I Were a Russian Leader

If I were a very proud Russian leader I would default on all non-ruble debt. Or at least threaten to do so. Who's it going to hurt? Only those putting the financial pressure on me in the first place. Buyers would be back soon after anyway. Yield is a drug.

If I were a scheming, power hungry Russian leader I’d enjoy the economic squeeze as it will depower the oligarchs and give me an opportunity to ‘rescue’ their businesses by taking them into State (my) hands.

If I were a chess playing Russian leader I would sit it out and wait for my opponent to make their next move having already thought eight moves ahead.

If I were a pragmatic Russian leader wanting to sort things out sensibly and was willing to swallow my pride then I would do the following. As the size of my domestic money supply is about the same size as my FX reserves (Hat-tip @barnejek) I would set up a currency board pegging the ruble to my reserve currencies. I would lose control of my domestic monetary policy in the process but hey, I’ve pretty much lost it anyway with 1 month implied rates currently trading around 41% which is a complete disconnect from the CBR. This may not mean much to the man on the street but as his banks have to do chunks of their funding through the cross-currency then it will pretty soon. If I was then to look at my current exchange rate and plot it in real terms back 14 year against brent crude then I might suppose that my currency is cheap all the way down to $25 Brent.

Brent in Orange the JPMRUB index in white with the down arrow showing where it's expected to be when next monthly published including the recent ruble falls.  

If I was to think that sanctions would warrant 25% of that weakness then ruble is still pricing brent at $35-40. I would consider that my imports are going to collapse anyway but even taking the higher historic October number there is still 15 months import cover. Considering the undervaluing of the ruble, with a currency board peg, or even a cap at say RUB70/USD, I may still gain some domestic credibility. Doing this would halt my domestic outflows, stabilise inflation expectations and provide a nominal anchor. As a little side swipe I would allocate a few billion to buy oil swaps from an investment bank in order to get 10x leverage in non-deliverable oil. Which should crucify all the CTAs who are mega short oil, killing two birds with one stone.

And finally if I were a rich man Russian leader I'd fiddle on the roof.

In the Bleak Midwinter

In the bleak midwinter

In the bleak midwinter, investors gripe and moan,
Oil and stocks and yield sank, faster than a stone;
Ruble had fallen, low upon low, how far can it go?
In the bleak midwinter, only losses show.

Dear God, CBs cannot hold them, nor growth sustain,
Buyers bids shall flee away, I can't bear the pain.
In the bleak midwinter. a stable price sufficed
But no, oh God Almighty, Jesus Christ.

Enough for they, who calls things down, screaming night and day,
“Just look at all the technicals, It's going all the way"
Enough for they, who missed all the longs before
Who mock the bull and disaster adore.

Bears and shorts and doomsters, all have gathered there,
Emerging Market chaos poisons the air;
And a madman only, would dare to buy this
As like into a gale, is taking a piss.

Yet I want to buy here, poor as I be.
After stop loss dumping, oversold is all I see
If I were a Wise Man, I would not take part
Yet I’m about to go long, it is in my heart.


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We have had a nigh on 10% fall in the FTSE over as many days, a 5% fall in SPX, Oil has continued down its mad Cresta Run of descent and emerging markets are finishing the year much as they began, with the whole world convinced that all the EM chickens have come home to roost. It is probably worth noting that if there was a winning model to trade the EM FX by this year it was simply a ‘coffee price in a local cafe’ PPP as demonstrated aptly by TRY and RUB. On that basis it is debatable as to whether RUB has actually reached fair value yet.

But price falls been notable, so notable that they are the news. 'Price is News' is amongst us. Positions have been tested to the extreme and the falls that we have been looking for with respect to stresses on vulnerable year-end positions have occured. The level of screaming would now suggest that the worst is over after the ‘That shouldn’t have happened, that never happens in December’ rout has run its course and leveraged runs for the finish line have been right royally tripped up.

But apart from prices in the falling knife department, other news isn’t that bad. EU data was strong this morning and there isn’t any EM news to make me think their world is about to end despite the mood today being similar to early February. Before anyone mentions that growth in China might fall to 7.1% please remember that it's 7.1%. What would you give to have 7.1% growth in your portfolio?

So having got out of my European equities and most of my US on 'ECB/Putin Thursday' 12 days ago and having nursed various entry/ tight stops on oil related things to some pain, it is probably time to look at buying back some of these falls. It being a Tuesday as well makes it all the more tempting to call this a 'Turnaround Tuesday’. With most fast money portfolio year-end positions now forced out, it would be amusing if we now close the year at stock levels last seen 2 weeks ago.

And if you think that is all too much on sentiment and not enough fact then read my friend @GMacTrading 's great quant look at it here  at  https://globalmacrotrading.wordpress.com/2014/12/15/recap-2014-12-15-time-to-btd

So at the height of this bleak midwinter, I’m in.

---------------
Added 17.00 GMT

And, your honour, I call upon the following witnesses as 'spikes du jour' in the case of a Turnaround Tuesday

EURNOK 

USDRUB 

EVEN SPX 

AND USDJPY 

Falling Oil - The New Banker for Blame.

There is always one. The poor sod who takes the wrap for everything. In the case of the 2008 global crash it was bankers and in the case of all my friends' bad behaviour, in the eyes of their spouses it was me.

But today sees a new scapegoat on the block. A convenient muster point for all things bad. A flagpole up which to run the colours of doom, no matter what their nationality. A kitchen sink into which to throw all personal failings. A mass grave in which to bury all loose ends, even if they are still alive.

What is this new black hole of bad news? Well if you've read the newspapers this morning then you couldn't have failed to notice that it's oil.

The FT kicks off the lynch mob with this story (article here) that manages to blame oil for not only high yield but also all equity falls but also a collapse in global growth, which is ironic as I am pretty sure that when oil prices were doing exactly the opposite 6 years ago they were getting the same blame.

Even the Scottish press has finally woken up to the fact that 0il prices have a) fallen b) aren't going up and c) may have an effect on an independent Scotland's budget. But this story in the Daily Record is more notable for the brevity of it acceptance, with the whole article running to a length only 5 words longer than its headline. Is that a record held by the Record?

Though I am not convinced that oil is the sole culprit, it just being a casualty of its own Bauhaus Chair-like supply and demand curve, with everyone else now blaming it for the High Yield collapse, stock market melt down, global instability, the death of the dinosaurs (actually wasn't the death of the dinosaurs more likely to be responsible for oil), the rise of fascism and the loss of Flight 19 in the Bermuda Triangle,  I assume that oil will take the place of bankers in the lexicon of hate. Not of course completely replacing them, but appear a more in touch, informed modern day excuse.

In the courts

At sea

At home

On planets far away

 CERN

Wimbledon

 Transport

 Prime Ministers Question time.

On the ranch 

And finally in the banks.

Oil Supply and Demand - The Bauhaus Chair Model .

Oil. It's all supply and demand isn't it. Yes it is and of course when we talk about supply and demand economics 1.0.1. supply and demand curves appear in our brains. Neat crosses or gentle curves that intersect at the efficient price.

The oil market is currently over supplied, so theoretically prices will fall until there is no longer an over supply. Demand must go up or supply down.

But the supply side in oil has turned into a great big game of chicken. The mexican standoff, the staring game or perhaps more aptly a breath holding contest because as with a breath holding contests, the breath is held because though you are underwater you know that you are about to surface and so can take the sufferance in the short term... or until you run out of air. It doesn't help though when you are being held underwater by your competitors strong hand.

In oil it looks as though everyone is toughing out lower prices and there hasn't been a glimmer yet over who will cut production first to lower that supply. In the meantime  oversupply remains at a steady level even as prices are falling. Someone needs to crack and I wouldn't be surprised it will be at a time where lots of people crack, at which point the referee lifts the Saudi’s arm in the air, announces him victor and prices can rise again. To confuse things further supply can actually go up as  prices fall as extra oil is pumped by a producer to try to maintain overall income (volume x price).

On the other side oil demand does not necessarily rise with falling prices. Oil is already a social pariah so a fall in oil prices is most unlikely to see a surge in the  purchase of less fuel efficient engined cars, the building of new oil fired power stations to replace wind, solar or gas, or even an increase in the demand for plastic bags. Green issues effectively cap the lower end of the demand curve turning it flat. However there can be a temporary boost in demand as strategic reserves are boosted, but then this oil isn't being used, more rented.

So I have had a stab at drawing my own  supply and demand curve as I see it as prices are falling.  Far from being a simple X,  it is a rather nice designer Bauhaus chair with supply in blue and demand in orange. Yes the Price is on X axis in this case, otherwise it wouldn't look like a chair

We are now traversing gently left between the parallel tracks  only expecting to stop when someone finally cuts production.  As everyone knows, though I would be very surprised if anyone has ever expressed it like this before, that point is where the front of the seat meets the legs. 

Market Cycle Crash

Well it’s all going much as expected.

2014 has been another year of tail chasing with most macro and discretionary traders finding it hard to make money, so coming into year end the clock has been running down and the sprint for the finish has getting more and more dicey with positions that would have preferably been put to bed for the year having to be run to the line. November trends normally extend into December so those desperate for last minute reprieves would logically look to join the nicest of these and lever up to make the line. Long equities, having given up on the bear case through 2050 on SPX, and of course the ‘what could possibly go wrong’ long Nikkei / short yen trade together with a catalogue of other 'if you can't beat them join them' trades.

So we end up with the portfolio managers going hell for leather to cross the year-end line ahead of target but as with a cycle sprinter going flat out for the finish, it doesn’t take much to upset their balance, with the smallest stone or bump in the road tipping them up. At which point things start to go wrong pretty fast. Those around are swiftly caught up and those coming up behind jam on their brakes and get off and walk rather than risking their own health. In other words, if you have any form of profit and you are running up to year end bonus/performance finish lines you are not going to want to risk what you have and will get out of positions pretty fast at the first sign of trouble.

I have managed to persuade a French street theatre group to enact what I am talking about using metaphor, simile and some bicycles. See the video clip of them below



And just as the commentators of that scene didn’t really have a large overwhelming story to pin the cause of the crash on, neither do we need a huge cause for the last three days action other than positional stress and attempted profit protection.

But if we were to labour the cycle crash analogy, then it would be interesting to pass that clip to various media to imagine what they would come up with as the reason for the crash. Some suggestions below.

Bloomberg - Cyclists crash the most since last time as chicken sales fall in Indonesia.

CNBC - Cyclists crash but surely Dan, isn’t this just a correction and opportunity to pick up your bike down here and get back on it?

Zero Hedge - Cyclists crash due to bicycle manipulation, as we always said. The race is fixed so there’s no point in competing, just buy gold.

Reuters - Cyclists doing fine - CORRECTION Cyclists crash.

The Economist - Cyclists crash due to embedded structural problems within the global bicycle industry, cycling popularity could fall to zero.

FT - Cyclists crash as take overtaking manoeuvre is forcibly rejected by majority. Boardman resigns.

Bank Strategists - Cyclists crash due to a slowdown 3 years ago in Debt/GDP ratio correlations with rubber prices as outlined in this chart on page 74 of the powerpoint presentation. Did I say chart? Sorry I meant ‘exhibit’.

Technical Analysts - Cyclists crash due to bicycle continuing to fall over once it had started to fall over.

Sell Side Advisors - Cyclists crash due to stop losses.

Goldman Sachs - Cyclists crash due to something we can’t talk about due to conflict of interest.

The Sun - CYCLISTS CRASH DUE TO CONFLICT OF INTEREST!

BBC - Cyclists crash due to Government cuts in funding of road surface research.

Russia Today - Cyclists crash due to Keiv government refusing to respect the will of the cyclists yet Russia is sending puncture repair kits protected by a battalion of T90s

FCA or SEC - Cyclists crashed today and we will be conducting a full investigation as to why. Any cyclist found in breach of regulations or moral duty will be suspended or face criminal prosecution. We advise all bicycle teams found not to have enforced codes of conduct to prepare for significant fines.

New York Times - Cyclists crash in Europe but it’s their own fault.

FOX news - Cyclists crash due to Obamacare and maybe Ebola.

Daily Mail - Cyclists crash in a foreign country due to foreign people riding the bikes and eating potentially carcinogenic tomatoes. Something must be done.

Vogue - Cyclists crash due to clash of colours

Singapore Times - Cyclists crash due to littering and antisocial behaviour. Cycling to be banned in Singapore.

Australian Financial Review - Cyclists crash just temporary and long term demand for new bicycle iron expected to soar. Ain’t Australia Great!

'Twas The Night Before Christmas - Markets Style

'Twas the night before Christmas, when all through the house
Not a keyboard was stirring, not even a mouse.
The portfolio stocks were all picked with care,
Knowing Santa's Rally would leave profits there;
So happy, were we, with our views of the EDs;
That visions of profits danced in our heads;
With a late market rally as sure as could be
A bonus so large would be coming to me.
When out in the markets there arose such a clatter,
I ran from the bar to see what was the matter.
Away to the screens I flew in a flash,
Tore open the charts and saw oil crash.
The red candles of doom showed a newly made low
And a horrible vision of no bids below,
When what to my wondering eyes did appear,
But deflationary pressures that filled me with fear
My High Yield structures were looking quite sick
I knew in a moment I should sell ‘em real quick
More rapid than eagles things went insane
As I whistled, and shouted, and sold them in vain
Damn, contagion’s kicked in. Just look at the VIX
Not Spoos as well? And look at the BRICS!
Oh my poor profits! Just look at them fall!
Now dashed away, dashed away, dashed away all!
Even long Nikkei short JPY,
Now turned into losses, oh why did I buy?
But In central bank halls, the concerns, they grew too
Growth was now falling, what could they do?
And then, in a twinkling, I heard on the wire
They promised a plan, as they knew things were dire.
As I mourned my losses that weren’t turning around,
Down the chimney came Draghi with a great bound.
His clothes were all tarnished with soot, ash and snow
As he cried out ‘Sod Weidmann, come on! Let’s go!"
'Unconventional methods' he had flung on his back,
And he looked like a pedler just opening his sack
To buy any old junk, he just didn’t care.
Anything to stop deflation’s nightmare.
And with him was Abe, who as everyone knows
Plans to print money 'til his country grows.
His balance sheet open to yet more QE
As he sprayed me with yen and bought JGB
And then down the chimney came Fed Chair Yellen
Who restated low rates despite Hilsenrath’s yelling.
She was blowing a bubble that threatened our health
But I laughed when I heard her, in spite of myself.
A wink of eye and twist of the curve
Soon gave me to know I should hold my nerve
They spoke not a word, but went straight to their work,
Buying up debt. Prices rose with a jerk!
Then laying a finger aside of his nose,
And giving a nod, up the chimney they rose;
Draghi sprang to the sleigh, to the team gave a whistle,
And away they all flew like the down of a thistle.
But I heard them exclaim, ere they drove out of sight -
“Happy Christmas to all, and to all a good night!”

ABS From Me to the ECB

Well I read the events of last Thursday very wrong. By the end of the day there was nothing to make me think that Europe was a better place to be than when the sun had risen that morning, so I trimmed my European equity holdings and saw them frustratingly rally. I still can't see the attraction but it hasn’t taken long for the market curve of QE expectation to steepen out of sight. The chances of immediate QE may have fallen to zero but the expectations of QE in January or February had gone stratospheric. This compression of all hopes into a single day payoff has Draghi’s next meeting much like the final visit from the Kray Twin’s or Corleone's debt collectors. No more excuses. If he doesn’t pay up there's going to be blood not only on the streets but up the walls and on the ceiling. However, for now, European assets have gone QEtatsic. 

I'm beginning to feel very sorry for the ECB. The EU has kitchen sinked them with having to solve all the problems that the structure and fiscal impositions of member states are creating. The poor ECB is expected to administer aspirin to the obese smoker EU patient without the EU giving up any of their vices. The only effort the EU are contributing towards their own recovery is homeopathic. My original concern that the €21bio they are putting up as loan guarantees is not enough has been heightened further by this article by Frances Coppola that drills down further  to identify that in fact NO new money is being allocated with the €21bio just being redirect from other stimulatory measures. So as with other homeopathic remedies, the active ingredient is being diluted beyond detectability and the remedy only contains the memory of stimulus.

But back to the poor old ECB. They have said that all assets have been up for consideration as QEable, except gold, which had me thinking just how far they could go and rather than dithering along the credit path to buying junk they should they just get on and buy it. But not just financial junk as that is soooo discriminatory towards those who don't own it. With this egalitarian ethos in mind I have drawn up a list of things the ECB could consider for QE that puts money straight into the pockets of the average public end-user without it being first syphoned off by banks, large corporates or asset rich grandees. 

So lets see what we have here, ah here we go -

- The gordian knot of tanged wires associated with chargers of long lost electrical devices in the plastic bag in the study, 

- The pile of housekeeping and cookery magazines that a member of the family resolutely refuses to throw away. 

- The special peculiar shaped bits of metal in a box in the garage belonging to power tools from bygone eras. 

- The half rusting and nearly broken gardening tools in a cobwebby mess in the garden shed together with broken hose attachments. 

- The old suitcase of CDs, DVDs and VHS tapes. 

- The shelf of bottles of multicoloured fluids associated with cleaning and maintaining various vehicles, past and present. 

- Shelf upon shelf of half used pots, tubs and tins of semi-set or leaking paints and decorating materials in the garage.

- All the miniature sized equivalents in the bathroom branded as ‘makeup'.

- The collection of all things bicycle. Yards of rubber tubing, bits of plastic that no longer clip on things, pumps that don’t fit current valves, Lights that batteries no longer fit and digital displays that long ago forgot what they were meant to display. 

- The massive box of clanky crockery stuff, old plates and china ornaments that is certainly not displayable but may come in handy for the kids one day or a charity shop. 

- The crate of plastic things that the kids used to play with for 3 minutes after Christmas before discarding for new bits of plastic.

- And finally the man drawer contents of batteries, bits of string, bloomberg fingerprint readers, radiator keys, solid superglue, broken torches, lighters, airgun pellets, micro-screwdriver kits missing the fittings most often needed and ticket stubs to matches and concerts once considered life changing.

Of course should all of the above not be considered of good enough credit they could be repackaged into a large skip as Asset Backed Securities and delivered to the ECB in exchange for cash under their current program

Putin + ECB = Urghh

What a depressing day.

Putin moves further towards isolationism in the face of Western pressures. Well perhaps it’s worse than that. He’s not anti-everyone, just the West as he’s planning to build further ties with the rest of the world. It has so many parallels to the Cold War it is depressing. Nationalism is pulling Russia together whilst, ironically, in Europe nationalism is pulling it apart. If it comes down to toughing it out I'll have my money on Russia. They have a hell of a track record in the face of adversity.

ECB - For people who enjoy correlations here’s a massively negative one for you - ECB days and my serotonin levels. So no QE but a commitment to the ABS program and a suggestion that they think it will work when it hasn't so far. No change. The German camp have effectively waved the rule book under Draghi's nose and he stated clearly that he will not break the law as there was no hint of a ECB two fingered salute to Germany.  Consensus is solid, though no longer unanimous, and once again fails to produce action.

I do wonder if a solution to today’s problems would be to swap presidents. Make Draghi the President of Russia and Putin the President for the ECB! A bit of decisiveness in the ECB exchanged for a bit of consensus moderation in the Duma would be a great trade.

Was the market really looking for QE? Well since the announcement periphery bonds are off (having lost a potential QE bid) and European bank stocks have all slumped. So yes they were. Peripheral banks take a double whammy from local bonds falling and less likelihood of growth.

Having been long European stocks, especially growth stocks, since late October, adding today's events to concerns expressed two days ago about capitulation from equity bears I am going to change camps and move to the short side and see how it goes for the next couple of weeks. This could be enough to tip the US too.

Liquidity meltdown? So what's the problem?

Before we get onto liquidity just a couple of other thoughts-

Russia - Must be one of the only countries where oil prices are rising in local currency at the moment. But the lower oil goes the more likely it is that Putin will have to step in to ’save’ the large local oil companies by taking them into State ownership. Depowering the oligarchs. No wonder he doesn’t want to cut oil production. Meantime the Ruble is making imports more and more costly helping domestic suppliers. Default on Russian bonds? Well if you know you aren't going to get refunding from the West then why not indeed default on any non-Ruble issued bond. As for Ruble issued? Well you can always print more Rubles to repay them. I am still worried that the more the West squeezes the stronger Putin gets, like one of those Star-trek alien beings that feeds on negative energy. Stop firing your phasers at it, it just grows stronger.

Osborne's Autumn Statement - If any member of the banking profession were to leak such financially sensitive information (as new building and infrastructure plans most certainly are) they would be in court. Why is this stuff allowed to be leaked?

Oil - There will come a point when there is so much to lose in correlated leverage plays that it would be cheaper for those facing such losses to buy oil itself to get the price up. I remember talk of a famous fund buying gold when they wanted to offload a massive gold mine holding as they could move gold prices with ease due to gold's low liquidity relative to the liquidity in the mining stock.

Protectionism - Opec is allowed to manipulate prices on Oil, De Beers are in a similar position with regards to diamonds (by the way have you ever tried to get a bid on a second hand diamond?) and yet financial markets can’t be seen to be moving a price a pip.

Ok now on to Liquidity - There is a lot of concern, correctly, that liquidity in some markets is so dire it could lead to some serious meltdowns. Eyes are on High Yield via the energy sector. But should we be concerned about a meltdown caused by low liquidity? The normal response is "Yes of course! Prices will collapse and there will be high volatility and and and" but am I allowed to ask “So what? Does that matter?"

If there is a meltdown in something it's triggered by an adjustment in perceived value. When there is no liquidity then prices pass through where people think fair price sits (otherwise they wouldn’t be moaning of no liquidity) to prices which they feel are unfair or downright silly and don't reflect actual probabilities of default or yield outcome. So why are they selling at values that they think are absurd and moaning that it's due to lack of liquidity?

Most likely it can all be boiled down to money management rules creating large gaps between actual outcome probabilities and priced probabilities. this is particularly true in systems that use price as an input of probability in the first place, as we saw with CDS prices being quoted, wrongly, as actual probabilities during the EU crisis. So we could argue that any huge swings in pricing because of lack of liquidity will punish those who have to employ short term money management rules over those that can take a sanguine long term view. So rather than all being bad, it creates opportunity and acts as a feedback hopefully moving fund management away from the, sometimes cretinous, short term consultants tight risk rules back towards a more balanced macro big picture world.

But what about the losses? Well if the true price that reflects future outcomes has indeed moved then tough. That is nothing to do with liquidity. For those that are being forced to sell below what they see as the  real price, due to no liquidity,  their loss must be someone else’s gain as those selling must be selling to someone else who is picking up a bargain. So the negatives due to bad liquidity are offset by someone else’s positives.

So if there is to be a High Yield meltdown  due to poor liquidity I look forward to buying some at stupid levels caused by some VAR calculation deep in a fund saying  'spew at any cost'. Thank you.

Of course the wealth destruction argument is different. If leverage is involved, which of course it is, then book values will tank and no doubt the value of that book has been used to borrow to fund some other asset, which then has to be sold. Now THAT is the transmission risk to other asset classes.

It's not liquidity that is the problem, it's once again leverage.

Capitulation Count.

Today’s action in commodities, well oil and its associated bed mates, looks like it and all said bed mates have fallen out of said bed. The question is do they now roll across the floor, through the door and down the stairs or wake up.

The last leg down post-OPEC has seen towel chucking and associated price dumps to match. One stock I watch specifically for oil with a mix of Africa is Tullow (report here if you want some details). Now this isn’t about Tullow but more the delay in its price action to the latest oil fall. It held in for a long time and then finally caved in over the past 2 days. It looks like capitulation. The same can be said for the Russian Ruble (-9% down within the day).

With it has come an explosion of commentary about what will happen to the oil sector and how all the leverage in energy will catalyse a collapse in High Yield and hit everyone who has invested in the sector. But the way it is expressed is with a pregnant silence at the end, as if we are to imply this will lead on to a crisis in everything else. Sorry, as far as I’m concerned those getting their fingers burnt in the energy sector aren’t going to pull out of everything. Money will be lost but there will be equally benefitting High Yield sectors. This will not precipitate a global melt down in everything financial. It will promote rotation between the net losers to the net beneficiaries with a greater net benefit to all.

Low oil prices lead to the  QE’dom of the proletariat (to badly paraphrase Marx).

But lets get back to capitulation. Having mentioned before that the price action through 2050 on SPX has seen greater capitulation in commentary from the bears, it feels like a lot of rotation has taken place above that level leaving things not so sure and a good chance that the internals of the market will break through to the externals. Black Friday wasn’t a bundle of laughs anywhere. In the US it saw sales down 11% and in the UK it saw fist fights as hordes fought over meagre offerings (why the heck Black Friday sales have hit the UK is beyond me). Equity prices have stalled and with US holidays traditionally marking turning points it is worth being twitchy and leaves me looking for price falls now that we have had the capitulation of the bears.

We have already seen capitulation on the Europe trade. Since the Economist Cover Alert gave us the strongest signal that European assets were going to bounce along with the data (thank you), European growth assets (as measured by the ‘we make things’ Dax) has seen a dramatic turnaround.

Below is the Dax with the date the Economist was published with an assumed one week lead time marking where they probably thought up the story.

Assuming the delay in the Economist getting round to actually publishing their covers, I will safely assume that the next publication will be about commodities. It would be wonderful if they went full in with a cover about oil but after their famous call for $5 oil saw the base back in 1999 I doubt they will be that brave. I have however backed my assumption by buying some Tullow Oil (unnecessary disclaimer for Mr Regulator. - I am long Tullow Oil).


So where next?

I can’t help but question the positioning in the Japanese trade. Though I have happily been playing the long Nikkei short Yen trade on the basis that Mr Abe is going to firehose his way out of trouble and that there is a chance of a bounce in GDP at next data point, the trade is stalling. Falling oil should have been a boost to Nikkei yet there is little impact. USD/JPY made new highs overnight but gave it up. Even though I don't take much notice of the Jeremy Bentham of Japan, Sakakibara (see footnote), has mentioned today that USD/JPY shouldn't go much further. And finally, do you know anyone who is short USD/JPY and short Nikkei? If you do then you, or they, are a rare species. It is a long term trade I know, but on the rule of capitulation then, as they say on ‘Dragon’s Den’ - I’m out.




footnote - 

Sakakibara as the Jeremy Bentham of Japan refers to the founder of utilitarianism who had his body preserved once he was no longer influential (dead) and was, allegedly, wheeled into council meetings to be recorded as 'present but not voting'. 

At the end of the South Cloisters of the main building of University College London stands a wooden cabinet, which has been a source of curiosity and perplexity to visitors. The cabinet contains Bentham's preserved skeleton, dressed in his own clothes, and surmounted by a wax head. Bentham requested that his body be preserved in this way in his will made shortly before his death on 6 June 1832. The cabinet was moved to UCL in 1850. Not surprisingly, this peculiar relic has given rise to numerous legends and anecdotes. One of the most commonly recounted is that the Auto-Icon regularly attends meetings of the College Council, and that it is solemnly wheeled into the Council Room to take its place among the present-day members. Its presence, it is claimed, is always recorded in the minutes with the words Jeremy Bentham - present but not voting. Another version of the story asserts that the Auto-Icon does vote, but only on occasions when the votes of the other Council members are equally split. In these cases the Auto-Icon invariably votes for the motion. Stories of the Auto-Icon's regular attendance at Council meetings are, however, myths.


Postscript Dec 7th -

Economist cover 6th Dec 2015 - I'll mark that as a successful call, they even went for oil, but with no price prediction.

EU Add a Magic Money Multiplier to their Liquidity Diagram

The EU has announced a program to pump €315bio into the economy of Europe via a loan guarantee scheme. The actual amount they are stumping up is €21bio.
Full announcement here.

Assumptions.

- That corporates want to borrow.
- That corporates are not lent to when they want to borrow.
- That corporates will spend borrowed money on things that are of benefit to others rather than just themselves.
- That if they are lent to and they spend on the right things the gearing for the economy will be 15x.

As I often have to say - "Assumption is the mother of all f**k ups"

It would appear that the sticking point is still within the corporates, who will be the recipients of this facility, where they need to spend on expanding their businesses. Providing yet more cheap credit for them to probably divert to M+A and share buy backs will be great for stock prices but doesn't necessarily mean that they are going to employ more people. The proviso that the loans are targeted at specific projects doesn't guarantee that project or finance substitution isn't going to take place within the recipient companies.

So here is the latest EU plumbing diagram with the EFSI and Magic Money Multiplier included.

Original diagram and explanation here

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Post script.

I do hope that any natural recovery in the European Economy is not mistakenly labeled as the successful application of these homoeopathically small doses of EU quackery.

Dark Matter and the Silent Majority.

The recent rally in stocks has seen a mood swing in commentary that would suggest the break of 2050 in the S+P 500 has seen a form of capitulation. We are left with a mood of resignation that ‘everything is just wrong’ but don’t fight it and just accept that the ‘Santa Rally’ is what to expect for the rest of the year. To the point that 2014 has been effectively written off with the focus moving on to placing new chips on the table for 2015 (as indicated by the proliferation of 2015 trade ideas hitting the circuit).

The stream of calls for tops in equities has diminished and those that remain are turning to more exotic arguments that are more witch doctor than convincing. They normally involve a chart of what happened in the past overlayed with a chart of now.

With so many failing examples of what happened 'last time' being used to argue what will happen 'this time', perhaps we should instead be using the 'this time' to reprogram our metrics for future 'next times' instead of always looking backwards and assuming 'last time' is 'this time'.

Financial commentary is terribly focused upon how wrong everything apparently is. Equities shouldn’t be here, bonds shouldn’t be there, you name it and there is a blast of noise from somewhere declaring just how wrong the current situation is. But the inescapable fact is that however wrong it may appear, it is right. It is there staring you in the screen. So where is the dark matter of argument that is needed to explain the difference between the theory and reality?

There is always a bias in what we hear from any quarter (and this applies to politics, environmental issues, justice or I suppose just about anything) as those who think things are just fine tend not to say anything. There is a pain threshold that needs to be breached in the levels of discomfort before the screaming starts. The fact that things that are said to be wrong appear to remain wrong is perhaps proof that the majority is usually silent. If the majority were in discomfort then as a majority they would have said and done something about it. The silent majority is the dark matter.

I have wondered if this idea of the noisiest tending to be the minority could be used (or perhaps we do use it) as a reverse indicator. The more yelling about an issue either on social media or in the news, perhaps the more representative of the issue being one of a minority concern. This can’t be applied to short term events, such as terror acts, where everyone is rightly shocked about it, but where an issue has had time for something to have been done and yet nothing has, then perhaps the idea of it being a minority interest can be applied as the majority don’t care enough to do anything about it. As the market is the sum of the wisdom of crowds, perhaps the noisiest people are reverse indicators when trying to work out what will happen next.

To test the theory we could sample Twitter and see if a majority of tweets have been about the dangers of something happening that subsequently doesn’t. I leave that for you to do as I have already made my own mind up on that point. Unfortunately the most likely outcome is usually the most dull and is the result of slow process rather than shock event (back to the outcome of our dark matter silent majority).

This could also be applied to regulation as well. The loudest screaming about the FX fix fixing scandal has hardly been from professionals but from people in comments columns who often prove no deep knowledge of the situation other than expressing a propensity to scream about bastard bankers, whilst meantime happily paying 15% spreads in the local post office for their holiday money. 'Tis they that should be ignored and the quieter opinions of those that understand the issues taken into consideration.

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Never short a quiet market, but as 2014 has shown, never short a noisy one
either.

A Guide to Making 2015 Financial Predictions.

We have started to see and hear the first glimmers of the 'calls for 2015', with Goldman kicking off the season.  I would imagine that various other institutions and departments have been asked to start preparing their top trades and financial calls, so here is a somewhat cynical guide to the whole process with some top tips for practitioners.

WHY

First, there is absolutely no point in this process because who said an exact year, with no positional adjustment during it,  is the way anyone trades these days? If it were then the financial internet, press and even markets or exchanges would not have to exist between Jan 2nd and Dec 1st. Perhaps that's a good idea?

This process is much more like a yacht show where forecasting agencies can show off their shiny products of intricate design and process, wrap them with a glitz of gravitas and sell you a dream that you can sail off into 2015 aboard. If it doesn’t hit any rocks and sink then they hope you will be back to buy a bigger one next year.

HOW

The usual first rule of forecasting is never to put a price and time frame in the same forecast. For example ‘Oil will be over $100’ gives you an infinite time run within which to be right and 'Oil will be lower than here in 2015’ gives you a very high probability of being right unless you have unfortunately hit the absolute low at time of prediction.

With this in mind, make sure your predictions are not for where prices will be at the end of 2015, just somewhere during 2015. This leaves you with a year of optionality to either get out or take profit, GS style.

Only publish your exit trades way after the event. For example, you called oil down, oil went down until Jan10th then up for the rest of the year - You cut the winning trade on Jan 10th. Of course you did.

WHEN

If you have to publish before 2015 then don’t do so until Dec 31st. Doing so in November wastes a month of information to consider. Preferably publish your trades for 2015 in March 2015, or even later. The first few months of the year nearly always go the wrong way and you will have three months extra information to trade on. You also have the advantage of everyone else’s trades looking pretty stupid by then and investors looking for alternatives.

If you can, make the predictions for longer than 2015. Perhaps until 2020. This gives you an extra five years of optionality with regard to the above methods but also has two other advantages. First, you give off a greater air of authority having a six year view rather than a one year view. Second and more importantly, after five years everyone will have forgotten your predictions except you, so if they are wrong it doesn’t matter. If you are right, you can wave them around in success and write a best selling book and set up a large hedge fund doomed to lose all its assets.

WHAT

Of course what people actually care about is probabilities of outcomes and though I have often suggested that forecasters publish their own probability curves of price outcomes they still seem to stick with razor sharp defined price targets that, by definition, they are bound to miss. So best to put your 1 standard deviation range around a call. No one will mind and may prefer it. Either way it won’t matter but does give you a wider chance of success.

Write exactly the opposite of the GS forecasts. If framed under the conditions of the first point you will still have opportunity to get out at a profit at some point and if you can show a profit against GS your views will be spread wide and far and you will appear on Financial TV,  more because most people enjoy seeing GS look like a mug than your views being spectacularly right.

WHO

Pick eight prices you are going to call, they can be as varied as you like, calling long or short for each. Then set up 256 new forecasting identities. Using all the available permutations (2^8= 256) one of them is going to nail it exactly. This is who you now are. Wave this one around, write that book and set up that hedge fund.

WAFFLE

All forecasts are now couched in as many pages of declaimer as there are forecast. Why not embed a clause within it specifying that these forecasts cannot be maligned and if they are then the maligner will be liable to pay the forecaster $1m. If a Blackpool Hotel can try charging £100 surcharges for bad trip advisor reviews then why can’t you?

REPEAT

If all of the above is too complicated then just repeat the trade ideas that you put out last year, or if you are feeling very adventurous, just write down all the trades that worked during the previous year. It seems to be what most people do.

Dr. Aghi's A&E Department - Part II - The Qefibrillator

We last visited Dr. Aghi in the Accident and Emergency department when Dr. Abe had just released a cylinder of laughing gas and led all of the patients, like the Pied Piper,  intoxicated into the night. The first part of the story can be read here Japanese Laughing Gas. Here is the next chapter.

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Dr Aghi had finally dozed off, his head on the formica table and the styrofoam cup of half drunk (and now cold) coffee perched at the end of his fingers perilously close to toppling off onto the vinyl that covered floors that met the walls in curved uplifts that make the mopping up of blood easier. The blue-white light of the energy efficient strips bathed the room in a sterile glare but Dr. Aghi's slumbers continued undisturbed.

He was officially still on duty in Accident and Emergency having pulled a double shift. Dr Ben was no longer around having been relieved of his duties and replaced with Dr. Yellen. Dr Yellen had not been long qualified but had been employed on the recommendation of Dr. Ben under whom she had done her tutelage and, some would say, was a little too keen on Dr. Ben’s sometimes questionable treatments. Her bedside manner had also raised questions as it would often leave patients more confused than when they arrived. Having said that, she had proven successful in the addiction clinic having successfully weened the American patient off the morphine that Dr. Ben had all too eagerly prescribed.

But Dr. Aghi had had a long night. He’d coped with a major European road traffic accident, many of the victims being close friends. He’d fought hard and if it hadn’t been for his cajoling of Mrs German into giving blood then Mr Greece would definitely be in the morgue. The rest of the Peripheral family had survived and the incredible work of the plastic surgeon who rebuilt their faces meant they now appeared near normal, though the damage to their underlying bones left them susceptible to further injury.

The lull in casualties since the first release of Dr. Abe’s laughing gas had left Dr. Aghi to tidy up and get on with the associated paperwork of which there were reams. Policy had to be changed after the last debacle but getting policy changed in this institution was no easy feat. The urgently assembled hospital committee had at first been keen to adopt exciting new up-to-date practices but Herr Dr. Weidmann's vehement opposition, citing historic health and safety regulation, had left Dr. Aghi at his wits end.

It was then that it started. One by one the patients started to return to A&E. Dr. Aghi stirred and opened an eye. "Oh no. Not again".

France was first, having refused basic treatment, Dr Abe’s laughing gas was never going to mask the symptoms for long, the quack cures suggested by their mad Uncle Hollande together with the self-administered acupuncture had only made things worse. She looked terrible.

Australia was back too, a can of Irn Bru in his hand. He’d been out drinking again and typically had got into a fight in the queue at the local Chinese after bragging about the size of his exports. He’d had the seven bells kicked out of him and had his wallet stolen but was still mouthing off about how great he was and how his broken legs, bust nose, confusion and probable ruptured bladder were 'just scratches mate' and he’d be alright.

And then, forlornly, Spain and Italy traipsed in. Dr Aghi gave them a quizzical look. Their chronic fatigue syndrome was looking worse. He’d better screen them for cancer.

What was more worrying was that Germany was there too. Germany was never ill but there she was. Always a toughie as her religion meant that she would accept no medication other than a glass of water.

UK was back too, which confused Dr Aghi. On the outside he looked just fine and his personal nurse, Nurse Osborne, was telling everyone just how fine he was. But UK was complaining of a deeper malaise he couldn’t quite put his finger on. Dr Aghi asked a few questions but the answers that came back changed constantly. He immediately referred them to Psychiatry. He really couldn’t handle a delusional schizophrenic right now.

And then the man from the Chinese arrived complaining of a general slow down and slight upset in his, ahemmm, 'hong kong’. Dr. Aghi filled in the appropriate referral forms for the man's local STD clinic but really this guy wasn’t his responsibility, so kicked him out.

And then Dr Aghi’s crash bleep went off. 'Oh shit, I thought he was stable’ he muttered under his breath as he sprinted to recovery. European Growth was in spasms. Yellen was already there with the Qebrillator ready 'Here you are sir’. Dr. Aghi hesitated. "Where did you get that from? They haven’t been passed for use in this hospital". “Sir, you have little choice”. She was right. European Growth was already flatlining. ‘OK, what do I do?”. “You hold these against his financial instruments, press the button and a huge shock of QE will get him going again, Dr Ben is the expert though, I haven’t used one recently”

Dr. Aghi, reached forward to take the paddles when a voice came over the tannoy. It was Herr Dr. Weidmann who had been watching proceedings on the CCTV link. “Dr Aghi, you are forbidden from using the Qefibrillator, put those paddles down and step away from the patient”. “ But he’ll die" screamed Dr. Aghi. “No he won’t, Dr. Aghi. Well, perhaps he will but it will be to everyone's good in the long run. Best to let him sort himself out”. “Where the heck are you from Weidmann? Sparta? Leave the sick on the slopes in the snow so only the fittest survive?”, “ Exactly Dr. Aghi, Spartan medicine is simple and very selective”.

Dr. Aghi turned to Yellen, “Look I’ve bypassed the Qefibrillator. we should be able to get something from the transfusion machine. It will take the poisonous liquidity out of him and replace it with a better liquidity. Give it a go, it may keep him alive until I can get back. Stay there and keep the Herr Doktor away from him".

At this point Dr. Aghi noticed the patient in the bed next to European Growth, who treated him with a bold confident “ Hi, I’m US Growth and though some say I’m a bit peaky, I'm just dandy. Dr. Yellen has given me every support she can, haha”, “My, you’ve grown" muttered Dr. Aghi enviously whilst noticing the sly wink Dr. Yellen gave the patient. "Hmm", thought Aghi, "I wonder if she’s actually screwed him. No one knows yet".

Dr. Aghi arrived back in A+E just in time to hear the sirens. 'Blues and twos, doctor we have a JPFrog coming in”, "Just plain croaked it?' “Yup, declared dead at the scene by the paramedics but the attending doctor wasn’t having any of it”.

The doors to the department crashed open and what looked like a corpse was raced in on a gurney with a doctor administering fevered CPR. A nurse chasing them. “Nurse what’s her name?”, "Japanese Growth”, "what happened?”. "Hit a brick wall”. “At speed?" "No was hardly moving at the time but looks like the wall fell on her. Crush injuries, contusions, no sign of life”

"Ok, you can stop now doctor, the patient's dead”. But the maniacal pumping went on. It was only at the point that Dr Aghi leant down to see the doctor’s face that he realised who it was. "Oh no! Dr Abe, you madman! Nurse, security! Get this doctor off the patient and take him away, He’s caused enough chaos for one day”.

Dr. Abe lunged maniacally. “You don’t understand! She s alive! Alive I tell you! All we need to do is give her one more shot of of of .. where's the Qefibrilator?  I know you’ve got one, it was me that invented it! Don’t worry, yours won’t be powerful enough, I’ll make my own!". With that he raced off down the corridor chased by the nurse and security staff.

What a night, it couldn't get much worse, but a cloaked figure darkened the doorway and entered the department. It was Russia. Dr. Aghi had heard of Russia, he was a homeopathic doctor whose own remedies were at best temporary and at worst lethal. Dr. Aghi had been involved with his patients before. Some had recovered, such as the Eastern family, but Ukraine was still receiving some of his vile medicine despite warnings from the authorities, yet no one dared intervene. Russia had been struck off as a proper doctor some years back. "Can I help?” Dr. Aghi enquired, "No thank you, I'm just here to take back what I left behind".

There was screaming from the corridor. Dr. Abe sprinted back in pushing a huge contraption of pipes and wires in front of him. “This will do it!” and with that he attached his monstrous Qefibrillator to Japan, leapt for the nearest socket, plugged in the mad machine and ..

There was an explosion. The room went dark.

Emergency lighting flickered on casting an eerie glow through the smoke filled room. Miraculously everyone had survived the blast. Except for two. Dr. Abe and Japan lay motionless under a sea of smouldering paper.

Dr. Aghi surveyed the scene in resigned capitulation. He had done his best. He had given it his all but this was the end. Someone else could tidy up this mess. He let out a sigh, took off his name badge and carefully attached it to the disfigured corpse of Dr. Abe. With no further ado Dr. Aghi picked up his now empty medical case and threaded his way through the debris strewn room towards the doors, ducking through the now twisted frames into the cool night air.

His hand dropped into his inside jacket pocket and he pulled out a cheroot and he checked himself for a light but was lacking. Stepping back towards the door he picked up a smouldering piece of paper and put it to the tobacco. The remnants of the new 10 Euro note glowed hard as he inhaled and lit the cheroot before tossing the worthless paper to the ground and ambling off into the dark, dreaming of the fresh Italian mountain air a world away from the chaos. "Who know's what the world now holds for me,  one day I might even be President".

Japan. Well that's what happens when you pick the wrong benchmark.

The Vapours song has been done to death with respect to ‘Turning Japanese’ but it has to be put back in its vinyl sleeve (if you own a scratched original like me) as any hints that the West was getting close to Turning Japanese have just been flummoxed as when it looked as though convergence of growth was on the cards - Ka-Bang. Japan hits warp drive and vanishes into its own hyperspace of negative growth leaving the West languishing behind with its growth looking relatively similar to a bamboo shoot on a balmy day.

Back in Spring 2013 I remember writing a string of Japan linked posts and going back over them it really doesn’t feel as though much has changed. Back then our greatest scepticism was that targeting inflation was a poor choice as inflation is a symptom of growth rather than a cause, especially in Japan. The post The Japanese Grand National highlighted the  hurdles that Japanese QE had to overcome and our scepticism towards it doing so. That view has so far been pretty much vindicated. We can have a review of the points made then.

1) The cash injections are indeed huge and as a proportion of GDP, dwarf the US actions. On this basis alone decrease in the cost of money through the huge cash injection will dilute the money/goods ratio. But global connectivity spreads the flood increasing liquidity everywhere just as the US actions did. The melting of the Greenland ice sheets means sea levels in New Zealand rise a bit. Japanese banks may be queuing outside the study of the BoJ ready to have their orders to lend spelled out to them, but TMM wonder how much of it will ultimately remain domestic as the real demand for credit is in the West "Roll up, get your cheap funding here", rather than within a domestic culture that saves rather than borrows. The flow out of yen to achieve this moves the affect to FX (2). We are already seeing the liquidity tsunami with Japanese lifers hoovering European bonds at the expense of JGBs. Check France / Japan 10 year spreads today. (Note - remind Eurogroup to write thank you letter)

 No reason to believe that this isn't still the case though the yield differentials have narrowed dramatically so the pressure for leakage is lessened. 

2) FX driven inflation tends to be a one off shock, unless you can get your currency to crawl lower but then the incremental moves are just smaller. It's all good, but do it too much and things start getting bad quickly, either due to a lack of investor confidence or trade partners setting up tariffs. FX driven inflation can be seen as the wrong type of inflation if it doesn't drive wage demands higher but locally stifles purchasing power.

As suggested this appears to be what is happening and the lead/correlation between FX rate and inflation is real. Indeed it looks like growth tracks usdjpy, but not straight usdjpy, it tracks the rate of change of usdjpy. If usdjpy stays flat for a while growth falls. Perhaps this latest fall in growth is the  106-109 usd/jpy pause and we are seeing it reveal itself laggardly. Which if true, should see the new spike to 116+ reflected in a rise in next quarter's GDP figures. Which might be why Abe pulled the trigger early.

3) Expectations of inflation rising will most probably first be seen through the FX function, which as we said could be transitory (unless this goes Weimar). So once the FX starter motor of inflation expectation is done a continued domestically driven inflation has to take over. As with the west this will have to be associated with wage inflation which we know can be extremely stubborn and culturally even more difficult to kick off in Japan. 

Yup, wage growth has been extremely stubborn and it isn't good inflation unless it comes with wage growth. And nope, there doesn't seem to be anything apart from FX led inflation around.

4) Propensity to spend now rather than later. If, as we gather, the BoJ is hoping to increase inflation in the service sector we wonder how increases in inflation expectations will increase demand, as most services are not hoardable. A consumer who anticipates the cost of haircuts going up cannot go and get his hair cut 20 times now in order not to have any later. The same applies for most of the service industries that we can think of. Entertainment, accountants, lawyers, medical services, transport, maintenance - it's all time spaced. So what do you do if you are a consumer who thinks inflation is going to go up. You don't buy tech as that depreciates faster than jpy can. Once you have bought a car a year early, and the furniture you were putting off, maybe had a holiday, there is little else apart from putting on financial hedges. Property? Japan considers property as a depreciating asset and "An unusual feature of Japanese housing is that houses are presumed to have a limited lifespan, and are generally torn down and rebuilt after a few decades, generally twenty years for wooden buildings and thirty years for concrete buildings" and is taxed as such. However this could imply that the price of the land that they are built on rises. 

The dread part about this function is maybe that early growth was just this. The Householder stocking up on single purchase durables and now is done. Day to day services cannot be purchased early and hoarded. So what next?

5) Real rates are very important to the investor as a measure against returns, but TMM would suggest that to the man on the street the cost of a loan on something he isn't going to sell again (so won't consider for asset growth - see furniture, household stuff) is the cost of loan against how much more he thinks he will earn in the future. Wage inflation rather than CPI. So if wage inflation stays flat (as it has in the UK) then his real interest rate will not be negative. This is where the investor, who is always looking at resale value is very different to the consumer, who as a "consumer" by definition won't have anything left to sell on. 

No wage inflation to devalue debt. So borrowing not perceived to be cheap. No joy here.

6) And where do they save? Overseas where the yields are and you are hedged against the expected FX driven inflation. BoJ policy change does not remove the incentive for Mrs Watanabe to borrow locally and buy Aussie bonds. It may even increase it.


If you know the next wave of JPY is about to hit then US Treasuries look damn attractive, especially as your neighbour who bought them a year ago is sitting on a 17% return in yen terms.

7) Domestic investment will react to FX moves as wage costs become more competitive. We see no problems with this last fence. In fact once this occurs the finish line of growth is clearly insight. We just have to hope that all the other fences have already been cleared.

Well we couldn't see any problems at the time as global competitiveness in a world of growth would have been expected. But the world is slowing and there is no sign of a race to switch production to Japan.
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As said at the beginning of this post, the primary problem we saw and still see with Abenomics is the assumption that a symptom of growth (inflation) is a cause of growth. It now looks as though the result of Abenomics is higher inflation (success) but no growth (fail). Which is of little surprise.

It would look as though Abe is either going to have to go further than backing down on sales tax and issuing further Yen tsunami alerts and do something about the culture of Japan where 'saving' is an Olympic sport, and demographics would suggest that a healthy dose of immigration would be like a shot in the arm for balancing both the demographics and also diluting cultural habits. It's either that or a one way trip to the cabinet with the family sword in it.

But there is a glimmer of laggardly hope. The rise in USD/JPY seen over the last few weeks and the collapse in oil prices may be storing up a surprise lift in GDP for the next quarter.

Finally it really does feel that we are due a follow up to the 'Japanese Laughing Gas' post too, now that Dr Aghi has been proven correct and all the patients are back in A+E after they have come down from their Abe laughing gas high.

Maybe tomorrow.