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Tuesday, April 11, 2017

Risk Aversion Bumped Up- MARKET INSIGHTS APRIL 012, 2017



Market Review:

The dollar index slipped downward Monday, with reporters saying during that day it was in anticipation of Yellen’s speech at 4 pm. We didn’t buy it then and we don’t buy it now. Yellen's remarks contained nothing surprising or new and nobody with any experience should have expected anything else. She did suggest the Fed’s posture has shifted from just getting the economy back on a recovery track (healing) to keeping the recovery going (sustaining)--hardly news.



A more plausible explanation for the dollar’s loss of upward momentum is a renewed case of the jitters over geopolitical concerns—still no coherent policy stance on Syria from the White House and too many unknowns, including N. Korea, Iran and Russia. North Korea said it is prepared for “any mode of war desired by the US” after the US increased the Navy presence in the region. Analysts expect another nuclear weapons test on Saturday, the last leader’s birthday. Secy State Tillerson goes to Russia today and may get snubbed by Putin.

No wonder risk aversion bumped up, as seen by the drop in US yields and the rise in gold and VIX. VIX is not in screaming-fear territory, but at a 4-month high. It jumped 9.2% yesterday to 14.05. The longterm average is 20. See charts below.








Another issue is a rise in French 10-year yields by 4 basis point to 0.97% on concerns about the upcoming election. The 2-year premium over Bunds is high and rising. Fortune magazine reports Japanese investors dumped a record amount of French paper in Feb. The two elections are April 23 and May 7.

In the UK

March inflation was up 0.4% for the same 2.3% y/y as in Feb, with the core rate actually a bit lower at 1.8% from 2.0%--but just wait. Input prices are up 17.9% y/y while output prices are up 3.6% y/y, which has to damage margins. Also, retail sales fell 1.0% in March, with non-food down 0.8%. It’s the biggest quarterly drop in retail sales since 2011. Bloomberg notes “Staples such as milk are left untouched due to strong competition, but price tags on items purchased less frequently -- such as light bulbs -- had increased by 19 percent since October.”


In the Eurozone

Feb industrial output surprised on the downside at -0.3 % when a rise of 0.1% was expected. Jan was revised down from 0.9% to only 0.3%.

On the bright side, the ZEW index of current economic conditions in Germany rose to 80.1 in April from 77.3 in March when far less was forecast (77.5). “Future expectations” rose an impressive 6.7points to 19.5 for the best reading since Brexit.


In Canada

The CAD jumped on rising oil and a surprise gain in March housing starts, 253,720 units when a drop was forecast and the highest in nearly a decade (led by multifamily buildings). The BoC meets tomorrow but this one data set is not likely to change its mind (keeping rates at the same 0.50%). BoC Gov Poloz thinks low rates are not fueling housing speculation, according to Reuters.


Euro/USD Update:

The euro pulled the usual FX trick of two steps forward, one step back. After putting in a lower low four days in a row in Monday 1.0570, the euro us popping upward this yesterday. It could be due to a shift in sentiment on good German data or a reduction in dollar long positions on rising risk aversion after nearly a week without a policy statement from the US. Note the linear regression channel was not broken to the downside.



The Main Event The 10-year yield index closed at 2.361% from 2.373% the day before, with a higher high during the day but a lower close at the end. This morning it is quoted at 2.348% from 2.385% Monday morning.

Market News notes that on “Dec. 15, 2016, 10-year U.S. Treasury yields topped out at 2.639%, the highest since the Sept. 19, 2014, peak near 2.655%. A decisive break above 2.655% would set the stage for a larger move to 3.0%, a year-end yield target for several firms.”

But note that a big player (Gundlach) sees 2.25% instead and 3% not achievable this year. Market News reports that RBS Capital Markets still sees 2.60% over the next 1-3 months. The yield would have to break 2.29% to "nullify our core bearish view."




The Bund yield is 0.220% this yesterday from 0.228% on monday and 0.245% on Friday morning. Market News notes “On Jan. 26, German yields topped out at 0.499%, which was the highest since midJanuary 2016. Ten-year Bund yields last traded above 0.50% in January 2016. The 2016 10-year Bund yield high was 0.627%, seen Jan. 4 of last year.”

Market Outlook:

The yield differential is not the only FX determinant, but it’s a big factor. The US yield is dropping by more than the German yield, and we can suspect that the German yield is influenced by flows out of French paper—and can explode upwards once those elections are over.





Nobody knows if the dollar remains a safe haven currency when its country is the one raising the risk aversion level. The dollar has lost its short-lived upward momentum, in part on the usual pause but also probably renewed jitters over geopolitical concerns—still no coherent policy stance on Syria from the White House and too many unknowns, including N. Korea, Iran and Russia. North Korea said it is prepared for “any mode of war desired by the US” after the US increased the Navy presence in the region. Analysts expect another nuclear weapons test on Saturday, the last leader’s birthday. Secy State Tillerson goes to Russia today and may get snubbed by Putin. No wonder risk aversion bumped up, as seen by the drop in US yields and the rise in gold and VIX. 



It’s not hard to make a case for rising yields and the dollar tagging along, given somewhat higher inflation and a resolute Federal Reserve. See the chart—the yield struggles to reach and hold 2.60%, in part because tax reform and infrastructure spending keep getting pushed out into the future. As in foreign affairs, the absence of preparation and planning at the White House are damaging.



Politics:

Trump continues to disclose, every day, an unprepared and inept administration. Confusion reigns about the airstrikes against Syria, starting with constitutional authority. In general, Article 2 allows the president to use the military to defend national interests, but Trump has not even tried to name the national interest in this case. Syria was obviously not a threat to the US itself. In the absence of genuine national interest, the president needs to consult Congress, which is the only arm of government with the authority to declare war.

Congressmen screamed because Obama used military force against Libya and an equal number are screaming now about Trump. The key reasons the framers gave war authority to Congress was to ensure a fruitcake president doesn’t act on impulse and to get a full account of the policy intentions behind military action.



Congress has not always behaved well—it took Pearl Harbor to get Congress to allow Roosevelt to declare war—but that impulsive fruitcake/lack of a plan aspect is all too prescient. For all we know, Trump ordered the airstrike solely to impress Chinese Pres Xi and his N. Korean client state. We are certain there is no plan.


Ideally there is a plan and it’s made clear to Congress and the public before the first shot is fired. Here we are a week later and all we have are conflicting statements from the president, Secy of State Tillerson, ambassador to the UN Haley, and national security advisor McMaster, who is probably the only credible party present. But each is saying something different—focus on defeating ISIS only, regime change or regime change maybe later, one-time thing. The press secretary makes the ridiculous claim that these ideas are not mutually exclusive. Well, yes, they are. And all of this blather is 180 degrees from the Trump campaign promise of America First, which the voters fully understood to mean no more military engagements, especially in the Middle East.

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