All the king’s horses and all the king’s men

The big institutions all warned about negative consequences from Brexit.  Obama’s “back of the bus” line was especially ill-advised in my opinion, but whether it was the US President, the IMF, or former prime ministers, the warnings were explicit.  I’ve seen many explanations that the people simply didn’t know what they were voting on, but the fact is that dire projections were shrill and constant.  And exit still won.  The majority decided that current institutions might be serving someone, but certainly not them.  Whatever else you might think of Trump, he has been on the correct side of that sentiment shift.

It was only 8 days ago that Bullard released the St Louis Fed’s new and improved characterization of the US economy, projecting regimes as stable and “persistent”.  I don’t know what the ramifications of Brexit will be over time, but conditions are likely to change.  An easy analogy is the subprime crisis, when many so-called experts calmly advised that such mortgages were but a small fraction of total debt markets, and that problems would surely be contained.  We know how that turned out.

The topic of contagion is demonstrated by research that I first saw in a John Mauldin letter, about a computer simulated program which dropped single grains of sand on a hill.  Which sand grain causes collapse?  The researchers couldn’t tell, but what they did note was that larger piles of sand hid “fingers of instability” and that the extent and proximity of these pockets were the key warning sign.

“To find out why [such unpredictability] should show up in their sandpile game, Bak and colleagues next played a trick with their computer. Imagine peering down on the pile from above, and coloring it in according to its steepness. Where it is relatively flat and stable, color it green; where steep and, in avalanche terms, ‘ready to go,’ color it red. What do you see? They found that at the outset the pile looked mostly green, but that, as the pile grew, the green became infiltrated with ever more red. With more grains, the scattering of red danger spots grew until a dense skeleton of instability ran through the pile. Here then was a clue to its peculiar behavior: a grain falling on a red spot can, by domino-like action, cause sliding at other nearby red spots. If the red network was sparse, and all trouble spots were well isolated one from the other, then a single grain could have only limited repercussions. But when the red spots come to riddle the pile, the consequences of the next grain become fiendishly unpredictable. It might trigger only a few tumblings, or it might instead set off a cataclysmic chain reaction involving millions. The sandpile seemed to have configured itself into a hypersensitive and peculiarly unstable condition in which the next falling grain could trigger a response of any size whatsoever.”

As noted many times, the grains of sand keep raining, and words of cautionary advice are repeated.  On Friday there were two specific instances that were compelling.  First, in monotone logic, was Greenspan, perhaps discredited in some ways but still extremely sharp at 90, who said he had thought the 1987 crash was a huge crisis, but then added , “This is the worst period I recall since I’ve been in public service… has a corrosive effect that will not go away.”  This description is somewhat reminiscent, though of course in completely different context, of Jim Cramer’s famous rant of August 3, 2007 when describing conditions related to Bear Stearns. “BERNANKE HAS NO IDEA HOW BAD IT IS OUT THERE. NO IDEA!”  Clip is well worth watching, even if only for Erin Burnett.

Yesterday’s other example was also on CNBC, but now it’s Melissa Lee, accusing Doubleline’s Gundlach of having a “bunker portfolio”, and him, with a frustrated quaver in his voice almost on the verge of a rant of his own, trying to explain that sometimes it’s the best course to sit on the sidelines, and take a paltry return while waiting for true opportunity.  “The markets take the stairs up and the elevator down.  Avoid being on the elevator.”  Melissa’s giving him the eye-roll as if he has no idea how to put money to work.

A couple of quick thoughts on markets.  Yes, it was an awful day for GBP, but taking a step back, the high in 2014 vs the USD was 170, and it was around 136.50 late Friday, for a total decline of about 20%.  In 2014 EUR was around 139 and was 111 late Friday, also a loss of about 20%.  Does the value of GBP represent catastrophe?  A more overt sign of damage is in shares of the financial sector, with many new lows on Friday.  DB and Barclays fell 17%, CS down 16%, UBS 13%.  As a comparison, MS fell 10%, GS and JPM down 7%.  (SPX  -3.6%).  The ECB is depending heavily on banks as the transmission mechanism for their sketchy policies.  Instead the banks are holding shards of glass and trying to reflect SOS signals.  The bund is trading at -5 bps.  What else do people need to perceive danger?  Thor’s hammer to crash down on their heads?  Oh yeah, Swedish short rates are also negative.

Besides the news on Brexit, it’s worth noting that US Core Capital Goods Orders, (released Friday) were -3.6%, another bad omen relating to productivity.  Also, the Chicago Fed National Activity Index came out weak at -0.51, with the three month moving average the lowest since late 2012, when Europe’s peripheral crisis was in full swing.  Finally from Reuters: “China said Saturday (Jun 25) that communications with Taiwan had been suspended after the island’s new government failed to acknowledge the concept that there is only ‘one China’.”  Just a reminder that issues can also easily flare up in Asia…



6/17/2016 6/24/2016 chg
UST 2Y 70.7 64.9 -5.8
UST 5Y 113.7 109.1 -4.6
UST 10Y 161.6 157.9 -3.7
UST 30Y 243.1 243.3 0.2
GERM 2Y -60.7 -64.3 -3.6
GERM 10Y 1.9 -4.7 -6.6
EURO$ U6/U7 21.0 19.0 -2.0
EURO$ U7/U8 19.0 23.0 4.0
chg to Sept
EUR 112.77 111.17 -1.60
CRUDE (1st cont) 48.56 47.64 -0.92
SPX 2071.22 2037.40 -33.82
VIX 19.41 25.76 6.35
Posted on June 27, 2016 at 5:16 am by alexmanzara · Permalink
In: Eurodollar Options

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