April 10. Carry trade…carry what?
Last week I started with a sentence noting that the Nikkei was down over 15% on the year. It was slightly lower again this week. But the real action this week was in the currency, with $/yen having broken 108 before ending just above that level. Last Friday it closed just under 112. A concurrent market theme is weakness in global banking stocks. I recreated the chart below from BofA research. I’m not even sure of the context – correlation isn’t necessarily causation, even with carry trades- but these two were moving along on the same track this year, until the last two months. Red line is the Japanese yen and white line is XLF, the financial sector SPDR.
I suppose the idea is that the financial stocks will ‘catch up’. These guys at BofA have some pretty good research. On the other hand, this is the same place that instructed staff not to use the word Brexit. As if the problem is going to go away if we don’t mention it. I’ve tried that. Doesn’t work. Anyway, the larger point in my opinion is that unlike the broad SPX, financials haven’t come anywhere close to retracing the drop from December to mid-Feb. I would make the argument that the broader market is likely to ‘catch down’ to financial stocks.
Here’s how I would frame that notion. QE had the effect of spurring corporate borrowing, but it mostly went towards stock buybacks. That dog will no longer hunt. Corporate debt has become bloated, at a record nominal level $8.097T. The growth rate of corp borrowing has decelerated in the last three quarters of 2015, from 8.6 in Q2, to 4.6 in Q3 to 2.7 in Q4 (from FRB Z.1). Obviously the well-advertised junk bond scare served notice that credit markets aren’t quite as welcoming as before; the propensity to borrow has declined. And while commercial and industrial loans from banks have grown smartly, capex remains weak. Low rates along with a flat curve aren’t doing the financial system any favors as can be surmised from those stocks. As I have mentioned previously, the red/gold Eurodollar pack spread (2nd to 5th year), is only 74bps and hit 71.5 during the week, the lowest since 2007. Recall that the last hiking cycle was from 2004 to 2006 and culminated with a FF rate of 6.25%. In August of 2007 the Fed began to ease. My contention is that a curve this flat near zero rates is a much worse signal for the economy than it is with high rates. Previously I have used the tube of toothpaste analogy with the curve, noting that when a series of hikes were expected in the near term, the front part of the curve would steepen but the back end would flatten. Conversely, if no hikes were expected in the near term, then the front spreads would be flat but the back end would steepen. Now it just seems like the toothpaste is gone, and the tube is flat no matter where you press.
In any case, the Atlanta Fed GDP Now estimate for Q1 was revised to a barely positive +0.1 at the end of the week, having been as high as 2.75% two months ago. Earnings for financial stocks are expected down 9.2% according to Reuters. In terms of the broad market, this is what FactSet says: ‘For Q1 2016, the estimated earnings decline is -9.1%. If the index reports a decline in earnings for Q1, it will mark the first time the index has seen four consecutive quarters of yoy declines in earnings since Q4 2008 through Q3 2009.’
A friend (thanks CL) sent me a note that the word “global” was cited 22 times in the FOMC minutes that came out last week. Dudley said Friday that rate hikes would be cautious and gradual, inflation remains a concern, and there’s uncertainty abroad. Circling back to financial stocks, this global uncertainty is glaringly obvious in non-US financials. Deutsche Bank, HSBC, Credit Suisse, Nomura, etc, are all probing new lows and have been halved from last year’s highs.
In terms of the Fed’s impact on various markets, tens bottomed on FOMC day, 16 March, and got another boost from Yellen’s speech on the 29th of March. SPU’s were already on the upswing and were jolted higher both times as well, but this week closed below the March 29 close. While crude oil had a solid bounce last week, copper plunged and is now around the 61.8% retracement of the year’s rally. Most markets are signaling a risk off posture. EEM, the emerging markets etf, had been supported by the weaker dollar, improvement in commodities, and more lenient Fed. However, this week it traded soft, and also closed below the March 29 settle.
This week includes inflation data, with PPI and CPI on Wednesday and Thursday, expected +0.3 with +0.2 Core and +0.2 both headline and core on CPI. Retail Sales Wed expected +0.1. Earnings season kicks off Monday with Alcoa.
