July 30. Weaker USD as Inflation Spark?

There’s a lot going on these days, Trump shake-ups, N Korea missile threats, Russian sanctions.  But I write mostly about the markets.  And, on that particular topic, there’s not a heck of a lot of interesting things to comment about.  Sure, stocks continue to press record highs; the dollar closed at the low of the week; crude oil had a strong resurgence and copper is breaking out to the upside.  But overall, SPX was nearly unch’d on the week, and the ten year note yield rose less than 6 bps.  Volatility, as everyone knows, is in the dirt.

I also read other market summaries.  A lot of them have useful information, but can be numbingly boring.  Especially when there’s not a lot to say, people tend to fall back on the old industry standards of ‘mean-reversion’ and ‘relative value trades’.  Now it’s all about passive vs active.  Time for a nap.

I was once invited to an insurance company presentation, an asset-gathering hunt, where the enthusiastic ‘wealth management’ presenter was going through the magical mechanics of compounding.  As I said, I was invited by a friend, but I still was tempted to get up and say, “How does all of that work out in a sub-2% ten year note environment?  Maybe you should be running the Chicago Teachers Pension if you can consistently compound at 7-8%.”


Above is what we might loosely call a relative value idea that clearly shows stocks in a wicked bear market.  Huh?   Oh, it’s SPX priced in bitcoin.  Perhaps it’s more appropriate to show Nasdaq in terms of bitcoin, since the crypto-currencies rely on cutting edge technology.  Looks the same.

Reversion to the mean?  I guess that means we keep buying volatility because we’re way below the long term average.  I guess it means we keep selling Eurodollars because over the long term the FF target is more like 3%.  As we know, it’s all a matter of timing and time frames.  We may be seeing some clues of change currently.

Where we did see a breakout of sorts this week is in copper, which closed at the highest level in two years.  Post-election, copper broke through a long term downward sloping trendline.  It made new highs in Feb, only to sputter back lower.  However, it is now above highs from the early part of the year and poised to test the high of 2015.  This move corresponds with the weaker dollar and perhaps a relaxation of China’s shadow banking clampdown into the National Congress.

In many ways, the broad strokes of exchange rates are likely a key determinant of markets now.  In late 2012-2013, Japan embarked on its yen devaluation.  By 2014, it was europe’s turn, with EUR falling from 140 to 105 in a year.  Finally, two years ago, in August of 2015, China devalued and has allowed the yuan to trade lower ever since.  That is, until Q2 2017.  As the yuan weakened, China could be thought of as ‘exporting deflation’.   This year, it has been the dollar’s turn to weaken.  The yuan has firmed, and is through long term moving averages (CNY hadn’t been below the 200 day since late 2014, but broke below in June of this year.  Chart below).  As mentioned earlier, DXY is at the low of the year.

From RTRS:  “The euro has risen nearly 3 percent against the dollar so far this month and more than 11.5 percent this year. It is on track for its third straight weekly gain and the fourth in five weeks.”  And on Saturday:  “The European Central Bank should start thinking about how it wants to return to normal monetary policy and when it wants to wind down it bond purchases, governing council member Sabine Lautenschlaeger said…”  Does USD weakness continue?  For now, the lower trend is in place.

The dovish interpretation of this week’s FOMC actually sparked steepening in the US curve, with 5/30 closing at 106.4, near the week’s high of 108.4, and well off the low of 93 made after the June hike.  The red/gold pack spread closed 62.375, up 5 on the week.  If the dollar continues to weaken and yuan strengthen, the implications are a steeper US curve, a slowing or reversal of flows into US equities, and perhaps, a catalyst in the Fed’s elusive search for inflation.


This week’s main event is the employment report on Friday.  NFP expected 180k with avg hourly earnings +0.3.  ISM and Personal Income / Spending Tuesday.  Core yoy change in PCE price index expected +1.4.

The FCA announced the phasing out of LIBOR as a benchmark by 2021.  A market maker informed me that their group would no longer be making markets in Gold Midcurves after the September expiration.  There are nearly 700k open positions on the dollar strip from EDH21 on back.  Perhaps we can expect a bit more looseness along the entire back end of the curve.

Posted on July 30, 2017 at 5:13 pm by alexmanzara · Permalink
In: Eurodollar Options

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