“Get Ya Popcorn Ready” RBC Says: “Markets Are Paralyzed With Uncertainty” As “Spook Story” Arrives

In a post that in retrospect was timed perfectly, yesterday we first warned that the BOJ may be about to unleash a bond “VaR shock”, one that would promptly lead to a global asset contagion, as a result of Kuroda’s surprising eagerness to steepen the yield curve, a move which would lead to an accelerated selling of the long end first in Japan, then across the entire world where some $13 trillion in bonds trade at negative yields. We also explained how “with cross asset correlation soaring, not to mention with risk-party and CTA funds approaching record leverage, the risk is that investors frontrunning a perceived change in the BOJ’s policy in two weeks time could lead to a dramatic selloff in JGBs, which then spreads across to global fixed income markets, all of which trade like connected vessels.”

The warning did not stop there: as we explained previously, in early June, Goldman warned that a sharp 1% spike in rates across the curve in the US alone, would result in MTM losses of $2.4 trillion. That excludes the crossover impact into stocks, as a selloff in bonds
leads to a correlated liquidation across equities, as a result of record leverage for Risk-Parity and other quant funds…

… for whom coordinated selling in both asset classes could lead to dramatic deleveraging, and a positive feedback loop of even more selling.

Our conclusion was simple: just as central banks had pushed the markets higher, so they could – and would – be the catalyst that send everything plunging as a result of dramatic changes in trillions in bond positions.

* * *

Overnight we were delighted to find that RBC’s head of cross-asset strategy, Charlie McElligott not only read our analysis but appears to have agreed with everything we said.

* * *

Here is McElligott’s note released this morning.

COMMENTARY: Markets don’t like getting hit four sides at once…

The “Draghi Disappointment / Brainard Bogeyman / BoJ NIRP-ier / IG Supply Tantrum” we shall call it—elegant right?!  Global rates markets continue to bear-steepen on account of four “developments”:

1. Draghi’s ECB presser disappointed the crowd with no increases, no extensions and no tweaks—“ECB did not discuss extension of asset purchases plan.”  There also was a very slight “upgrade” to inflation as well, as the 2018 forecast was NOT dropped as expected, while stating the expected inflation will be more stable than before.  Geez.
2. The bizarre Fed / Brainard speech episode, where an (initially understood to be) “impromptu” scheduling of Fed’s Lael Brainard to give a speech next Monday evening—immediately before the Fed’s blackout period—was interpreted by the market (and conspiracy theorists) as a sign that Yellen was rolling out the increasingly high-profile and UBER-DOVE Brainard (remember, she was the “international factors are impacting US rates” proponent who helped start the R-Star discussion) to actually be the person with the best chance to communicate a HAWKISH message on the September meeting.  In turn, by having the “person least likely to speak hawkishly” then make a case / at least say that the committee is confident on achieving its mandates, that you could get market probability north of 50% “required” to pull the trigger.  From speaking with folks close to the situation, there is a real belief that the Fed is adamant on at least one-hike this year, data be damned.  Apparently they are keenly aware that they could be driving financial asset instability.  : /  Nonetheless, it came out later in the afternoon that Brainard had been scheduled at the event in question for weeks…so head-scratching abounds.
3. The point I made reference to in yesterday’s “Big Picture” w.r.t. the BoJ being equally adamant on going even MORE negative with rates while also investigating “curve tweaks” (from a change in the composition of their JGB purchases to the potential for a reverse operation twist) has gained steam, with multiple media outlets floating these “trial balloons” ( http://reut.rs/2c4zgi5 ).  The concerns here are many: even more negative rates is an enormous risk after the way the market treated them post the initial move, which saw a counterintuitive strengthening of Yen and a flattening of the JGB curve which sent the Topix Banks index -25.5% to its current  YTD performance.  And again, as stated yday, an outright “reverse op twist” could be interpreted as a “backing-down” from a market that knows the BoJ is married-to the perma-stim / perma-easing path for the rest of its days.  If markets smell weakness, “things could get weird” (flipside of course being a potentially very POSITIVE reaction to a steeper curve, esp w/ banking sector…I know it’s noncommittal, but we simply can’t gauge how mkts respond).
4. A final factor driving the move in UST (absolute) yields (and as noted a few weeks ago as a risk to what had been low rate vol) is the insane supply being pumped out of both US IG corporates, now standing at $52B on the week….and then next week, with a HUGE calendar of Treasury issuance, with potential of ~$100B in bills, ~$50B in coupons and another $50B in more US IG!  For those of you keeping track at home, that’s potentially ~$200B of supply.  Per IFR, Monday alone could see $76Bt-bills at 11:30am, and then $24B 3s plus $20B 10s both at 1pm ET.

The spook story for low-volatility equities for years has been a spillover of rate vol—see all of our various “tantrum” episodes.  Why?  Because of the painful grind higher in cross-asset correlations as the market has become more macro–thanks to both 1)  global central bank policy that is essential based around controlling one asset (USD) and tamping-down volatility through unprecedented asset-purchases…along with 2) the enormous growth of systematic strategies, especially those which target volatility and / or use leverage to “balance risk” across asset classes based on historical volatility. 

Risk-Parity as you all know has been a favorite “bad guy” to mention during these episodes (otherwise the strategy is a ‘home run’ the rest of the time in a global QE environment), because (being painfully simplistic here) they run leveraged long fixed income as it is a historically “low volatility” asset.  But under certain economic condition “buckets” (inflation / growth) you too can run very long risk assets too…ESPECIALLY with HISTORICALLY DEPRESSED TRAILING VOLATILITY.  I.E. RP / target vol / CTAs are most likely REALLY REALLY long equities right now bc of this, which is SPX 30 day historical vol sitting at its 10 year lows, with 50 day historical vol on the same cusp:

So the punchline is that many systematic macro, risk-parity or vol targeting funds are very long both equities and fixed-income (helping drive the recent correlation)…and when a “butterfly flaps its wings” in one leg of the trade, suffering a “macro drawdown,” we have seen in the past “VaR shock” selling episodes as other positions are taken-down as well. 

In turn, the long-end of fixed-income took it in the face yday and today, from Bunds to Gilts to Treasuries:

TWO DAY MOVE IN GERMAN 30Y BUND YIELDS A 5 STANDARD DEVIATION EVENT:

Markets are paralyzed with uncertainty—and I’m not even including Trump’s recent resurgence.  How can you get more aggressive with your growthier / reflationary / cyclical outlook when not only is global economic data turning south again, but you have a month ahead with so much event risk–btwn ECB / BoE / BoJ / Fed / first US Presidential debate?  Pile-on four different banks downshifting on growth / saying to get more defensive this week (most notably Trahan  / Lazar at Cornerstone), you have a real pivot forming….especially as so much performance has been “gained back” (certainly within the equities complex) on the shift back into the “reflation” thesis.

EQUITY L/S HF PERFORMANCE SEES GAIN OF +4% SINCE SHIFTING OVERWEIGHT CYCLICALS / UNDERWEIGHT DEFENSIVES: Upper panel shows correlation of “high hedge fund concentration” equities holdings basket against the ‘cyclical / defensive’ equities ratio.  In turn, the below panel shows the % performance in the HFR Eq L/S HF index.

…THIS THEN GETS PRETTY SCARY WHEN YOU LOOK AT THE SWOON IN GLOBAL DATA: Global developed market surprise index plummeting, against the same ‘cyclical / defensive’ equities ratio from above, which is trading back at extremes.  Ruh-roh.

So here we go: BoJ seemingly ready to commit to go deeper negative rates and experiment with their curve, the Fed is seemingly locked-and-loaded on a hike as global growth rolls over, a deluge of supply into a suddenly wobbly rates backdrop (and a world ‘stuffed to the gills’ on duration via NIRP and QE forcing real money / AML community into deeper “yield seeking” / “yield compression” behavior), and a loaded-coil of synthetically low volatility across asset classes…as cross-asset correlations trickle back near multi-year / crisis extremes.

Get ya popcorn ready….

7. EMERGING MARKETS

Ten years ago, South America was witnessing the rise of what came to be known as the “pink tide.” Characterized by an allegedly kinder and softer version of socialism than the “red” communism of Castro’s Cuba, the pink tide had begun with the election of Hugo Chavez in Venezuela in 1998, followed by the election of Lula da Silva in Brazil in 2002, and followed by the rise of the Kirchners in Argentina in 2003. The tide continued to roll in with the election of Evo Morales in Bolivia in 2006, and Rafael Correa’s election in Ecuador in 2007.

As these new leftist candidates gained traction, their success was said to herald a new era of leftist politics in South America that would bring to an end the “neoliberal” consensus and impose a new, more humane economics on Latin American society.

Eighteen years after Hugo Chavez’s inauguration, things haven’t gone quite as planned.

The economy of Venezuela is in seemingly terminal decline with riots, shortages, and enforced slave labor imposed in an attempt to force more production out of the population. Meanwhile, the economies of Brazil and Argentina — while not comparable to Venezuela — are among the worst in Latin America, with Brazil heading for its its worst depression since 1901.

As economies worsened, corruption and authoritarian tactics worsened as well. Venezuelans have gotten the worst of it with citizens groaning under the weight of a police state that shuts down small business and persecutes even the smallest entrepreneurs for alleged economic “crimes” such as being a “class traitor.” In her final years, Kristina Kirchner became increasingly autocratic and paranoid, going so far as to prosecute and impose fines on economists who made economic forecasts the Argentinian state found to be be unflattering. Meanwhile in Brazil, corruption reached new heights as President Rousseff — the pink-tide successor to da Silva — attempted to save the economy and her political career by showering her political allies with “stimulus” cash.

The Hard-liners Give the Worst of It

Much of the most serious damage has been limited to Venezuela, Brazil, and Argentina, however, as it seems the pink tide was never quite as deep or strong as many suspected it to be.

Correa and Morales, for instance, while spouting Marxist rhetoric, proved to be more pragmatic rather than ideological, opting for more restrained reforms that still left room for the more standard fare of so-called neoliberalism, such as expanded international trade and relatively restrained government budgets.

In contrast, Venezuela’s regime committed itself to revolutionary changes in its economic and political systems while the Kirchners clamped down on free trade, manipulated exchange rates, imposed capital controls and persecuted political enemies. Brazil expanded government spending to new highs.

Over the past decade, we saw the rise of two different blocs in Latin America. There were the more market-oriented economies, found in Chile, Colombia, Peru, and Uruguay. In some cases, these countries elected avowed leftists as well. But, even these center-left governments tended to lean toward expanded trade or benign neglect toward informal economies and the business sector.

Some countries — Chile, Colombia, Peru, and Mexico — after years of consistent growth and stable politics, were even christened the “Pacific Pumas” in a play on the “Asian Tigers” moniker of the 1990s.

The general trend continued into 2015, as the two blocs of South America show two very different trajectories:

Of course, this is just a snapshot of a trend that has continued for several years. The committed pink tide countries have foundered while the more pragmatic, restrained, and trade-oriented regimes have seen far better growth trends:

Source: IMF calculations and estimates.

The next graph shows trends in GDP per capita since 1990. In this case, I have taken the same per capita GDP values and indexed them, with a base year of 1990 to give us a view of growth over the past 25 years.

In this case, we find that countries that were less committed to the pink tide experienced the most growth. The top three countries for growth by this measure are Chile, Peru, and Uruguay. Argentina had been keeping pace with Peru, but has gone into decline since 2011, and now is about equal to Colombia in terms of growth.

Indeed, there has been generally unabated growth for all countries shown here except for Argentina, Brazil, and Venezuela. All three of the leading “pink tide” countries show distinct downtrends in recent years, with no growth at all over the past five years. Venezuela is in the worst position with no net growth at all in 25 years.

For help in reading the graph, here are all countries by index value in 2016, and by percentage growth since 1990 (GDP per capita):

• Chile 2.5 (151% growth)
• Peru 2.3 (125% growth)
• Uruguay 2.1 (110% growth)
• Argentina 1.9 (86% growth)
• Colombia 1.8 (77% growth)
• Bolivia 1.6 (59% growth)
• Ecuador 1.6 (55% growth)
• Brazil 1.4 (42% growth)
• Mexico 1.4 (41% growth)
• Paraguay 1.3 (34% growth)
• Venezuela 1 (-1.2% growth)

Naturally, not everything can be explained simply by the politics of the past decade. There are always other major institutional issues, and even military issues, as in the case of Colombia’s recently-endedconflict with FARC rebels. Mexico’s War on Drugs continues to be a significant drag on growth.

Moreover, it is also too simplistic to slap easy left-right labels on regimes, since the brand of socialism practiced in Venezuela is significantly different from that practiced by the Peronists in Argentina. Clearly, political institutions in Brazil are relatively less authoritarian than those in Venezuela. Even worse would be to go off mere political party labels as in the case of the Socialist Party in Chile, which currently controls the presidency in that country. The “Socialist Party” in Chile is best described as mildly center-left by modern standards, and party members should obviously not be lumped together with the Chavismo socialists of Venezuela.

Nevertheless, whether called Peronista or Chavismo, regimes more committed to populist, third-way, and socialist political action in practice are, not surprisingly, coming up against some of the disastrous economic side effects of their policies. 

Of course, we can’t prove anything by demonstrating correlations, which is why we must rely on sound economic theory as well.

Your early morning currency/gold and silver pricing/Asian and European bourse movements/ and interest rate settings FRIDAY morning 7:00 am

Euro/USA   1.1267 DOWN .0007 (STILL  REACTING TO BREXIT/REACTING TO BRITISH CUT IN INTEREST RATE TO .25%

USA/JAPAN YEN 102.57  UP .271(Abe’s new negative interest rate (NIRP), a total DISASTER/SIGNALS U TURN WITH INCREASED NEGATIVITY IN NIRP/JAPAN OUT OF WEAPONS TO FIGHT ECONOMIC DISASTER/KURODA:  HELICOPTER MONEY  ON THE TABLE BUT DISAPPOINTS WITH STIMULUS

GBP/USA 1.3313 UP .0007 

USA/CAN 1.2952 UP .0029

Early THIS FRIDAY morning in Europe, the Euro FELL by 7 basis points, trading now well above the important 1.08 level FALLING to 1.1267; Europe is still reacting to Gr Britain BREXIT,deflation, announcements of massive stimulation (QE), a proxy middle east war, and the ramifications of a default at the Austrian Hypo bank, an imminent default of Greece, Glencore, Nysmark and the Ukraine, along with rising peripheral bond yield further stimulation as the EU is moving more into NIRP, and NOW THE USA’S NON tightening by FAILING TO RAISE THEIR INTEREST RATE / Last night the Shanghai composite CLOSED DOWN 17.10 POINTS OR 0.55%    / Hang Sang CLOSED UP 180.36 POINTS OR 0.75%     /AUSTRALIA IS LOWER BY .71% / EUROPEAN BOURSES ALL IN THE RED 

We are seeing that the 3 major global carry trades are being unwound. The BIGGY is the first one;

1. the total dollar global short is 9 trillion USA and as such we are now witnessing a sea of red blood on the streets as derivatives blow up with the massive rise in the rise in the dollar against all paper currencies and especially with the fall of the yuan carry trade. The emerging market which house close to 50% of the 9 trillion dollar short is feeling the massive pain as their debt is quite unmanageable.

2, the Nikkei average vs gold carry trade ( NIKKEI blowing up and the yen carry trade HAS BLOWN up/and now NIRP)

3. Short Swiss franc/long assets blew up ( Eastern European housing/Nikkei etc.

These massive carry trades are terribly offside as they are being unwound. It is causing global deflation ( we are at debt saturation already) as the world reacts to lack of demand and a scarcity of debt collateral. Bourses around the globe are reacting in kind to these events as well as the potential for a GREXIT>

The NIKKEI: this FRIDAY morning CLOSED UP 6.99 POINTS OR 0.04%  

Trading from Europe and Asia:
1. Europe stocks ALL IN THE RED

2/ CHINESE BOURSES / : Hang Sang CLOSED UP 180.36 POINTS OR 0.75%  ,Shanghai CLOSED DOWN 17.10  POINTS OR 0.55%    / Australia BOURSE IN THE RED: /Nikkei (Japan)CLOSED IN THE GREEN   INDIA’S SENSEX IN THE RED 

Gold very early morning trading: $1304.80

silver:$19.46

Early FRIDAY morning USA 10 year bond yield: 1.627% !!! UP 1  in basis points from THURSDAY night in basis points and it is trading WELL BELOW resistance at 2.27-2.32%. The 30 yr bond yield  2.342, UP 2 IN BASIS POINTS  from YESTERDAY night. 

USA dollar index early FRIDAY morning: 95.03 UP 4 CENTS from THURSDAY’s close.

This ends early morning numbers FRIDAY MORNING

IMPORTANT CURRENCY CLOSES FOR FRIDAY

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This afternoon, the Euro was UP by 15 basis points to trade at 1.1253

The Yen FELL to 102.47 for a LOSS of 64 basis points as NIRP is STILL a big failure for the Japanese central bank/HELICOPTER MONEY IS NOW DELAYED/BANK OF JAPAN NOW WORRIED AS AS THEY ARE RUNNING OUT OF BONDS TO BUY AS BOND YIELDS RISE 

END

WTI CRUDE OIL PRICE 5 PM:45.65

BRENT: 47.86

USA 10 YR BOND YIELD: 1.678% a huge move upwards in yield 

USA DOLLAR INDEX: 95.32 UP 33 cents

The British pound at 5 pm: Great Britain Pound/USA: 1.329616 DOWN .0045 or 45 basis pts.

German 10 yr bond yield at 5 pm: +0.011%

END

Bondmageddon Sparks Crude Carnage & Biggest Stock Slump In 7 Months

Oops…Compared to recent lack of volatility, today was indeed a bloodbath and the week was the worst week for stocks in 7 months…

Dovish Rosengren’s confidently hawkish comments seemed to spark this, sending rate hike odds notably higher (and not sparking confidence in the market)…

And rate hike odds are rising as macro data dumps…

But blame Draghi for starting it…

Before today’s tumult, realized volatility had collapse to a 45 year low…Volatility has rarely been lower. We can argue about the cause but the facts are clear: S&P 500 one-month trailing realized volatility has dropped to 4.8, its lowest level since 1971.

Some context for today’s move – Equity market at post-Brexit cliff-edge…

Stocks catching down to fundamentals?

Today’s moves were impressive… Dow -392 points!! *S&P 500 SINKS 2.4% IN BIGGEST SELLOFF SINCE JUNE 24, *DOW AVERAGE LOSES 392 POINTS IN BIGGEST DECLINE SINCE JUNE 24

On the week it was ugly, worst week since February…

“Most Shorted” stocks plunged… (biggest drop since Brexit)

On the day, homebuilders lost the most ground, but this was the biggest drop in financials since Brexit..

Financials and the yield curve have begun to converge…

VIX soared…

Jumping most since Brexit…surging above its 200-day moving-average…

Notably most ‘risk-parity’ indices are end-of-day only, we found one fund in Canada that trades – The Horizons Global Risk Parity ETF – and today was ugly (as we expected)…Bonds & Stocks slammed on the week

Total bloodbath in bondland today with the long-end getting slammed… Worst 2 days for 30Y in a year – few things to consider – major issuance demands rate-locks, Japanese reverse twist chatter contagion, ECB losing faith at long-end, and finally Congress signed the 9/11 bill today allowing families to sue Saudi Arabia who have threatened to sell their Treasuries…

The entire curve is back to Brexit level highs in yields.

2s30s jumped around 12bps on the week (with a bear steepening) – the biggest weekly steepening since Jan 2013

Notably USTreasuries and Bunds tracked each other almost perfectly this week (as JGBs and Bunds managed to get back to 0% yield)…

The Dollar Index ended the week lower, despite a notable rise in the last two days (led by Cable and commodity currency weakness)… Yen strengthened on the week.

Dollar strength slammed into commodities with crude giving back yesterday’s inventory gains and silver rolling over notably… (gold and silver closed below their 50DMAs)

Today’s crude retracement of yesterday’s inventory drawdown…

Charts: Bloomberg

Bonus Chart: A gentle reminder of how well things are going in the ‘economy’

Bonus Bonus Chart: Stocks year-to-date…

(courtesy zero hedge)

Gundlach states that Yellen may surprise markets and raise interest rates even though the Fed may blow itself up.

“This Is A Big, Big Moment” – Gundlach Warns Yellen May Surprise Markets

Wholesale Sales Tumble Most Since January, Inventories Ratio Deep In Recessionary Territory

(courtesy zero hedge)

Labor Department Revises Away 150,000 Jobs