Tectonic shift threatening the global reserve currency system
As Mark Carney observed at Jackson Hole: the global reserve currency system is broken — it has been since Nixon defaulted on gold backing for the Dollar in 1973 — and there is no fix. We have to find a replacement along the lines of Carney’s suggestion. On Macrovoices, two experts on the EuroDollar system, Jeffrey Snider and Luke Gromen discuss the massive tectonic shift facing the global financial system.
https://www.macrovoices.com/683-macrovoices-184-luke-gromen-jeff-snider
This is a complex topic but it is important that we grasp the implications before a tsunami appears on the horizon.
Silver leads Gold lower but safe haven demand rising
Silver has broken support at $15/ounce, warning of a test of primary support at $14. Declining Trend Index peaks indicate selling pressure.
Gold continues to test medium-term support at $1280/ounce. Precious metals tend to move together and Gold is expected to follow Silver in a test of primary support ($1180 for Gold).
The Dollar index, however, retreated below its new support level at 97.50. Penetration of the rising trendline would warn of a correction.
China’s Yuan fell sharply against the Dollar as trade talks encountered major turbulence. The outlook for a trade deal now looks poor.
10-Year Treasury yields are also falling as the prospect of further Fed rate hikes dims. Trend Index peaks below zero warn of strong demand for Treasuries (downward pressure on yields).
Failure to ink a trade deal is likely to boost demand for safe haven assets like the Dollar, Yen, Gold and US Treasuries. Capital flight from China may accelerate.
The Fed and Alice in Wonderland
In Lewis Carroll’s Alice in Wonderland a young Alice experiences a series of bizarre adventures after falling down a rabbit hole. The new Fed Chairman Jerome Powell will similarly have to lead global financial markets through a series of bizarre, unprecedented experiences.
Down the Rabbit Hole
In 2008, after the collapse of Lehman Bros, financial markets were in complete disarray and in danger of imploding. The Fed, under chairman Ben Bernanke, embarked on an unprecedented (and unproven) rescue attempt — now known as quantitative easing or QE for short — injecting more than $3.5 trillion into the financial system through purchase of long-term Treasuries and mortgage-backed securities (MBS).
The Fed aimed to drive long-term interest rates down in the belief that this would encourage private sector borrowing and investment and revive the economy. Their efforts failed. Private sector borrowing did not revive. Most of the money injected ended up, unused by the private sector, as $2.5 trillion of excess commercial bank reserves on deposit at the Fed.
Richard Koo pointed out that the private sector will under normal cirumstances respond to lower interest rates with increased borrowing but during a financial crisis, when their balance sheets have been destroyed and their liabilities exceed their assets, their sole focus is to restore their balance sheet, using surplus cash flow to pay down debt. The only way to prevent a collapse is for the government to step in and plug the gap, borrowing surplus capital and investing this in infrastructure.
One Pill Makes you Larger
Fortunately Bernanke got the message.
… and spread the word.
And One Pill Makes you Small
Unfortunately, other central banks also followed the Fed’s earlier lead, injecting vast sums into the financial system through quantitative easing (QE).
Driving long-term yields to levels even Lewis Carroll would have struggled to imagine.
The Pool of Tears
Then in 2014, another twist in the tale. Long-term yields continued to fall in Europe and Japan, while US rates stabilised as Fed eased off on QE. A large differential appeared between US and European/Japanese rates (observable since 2014 on the above chart), causing a flood of money into the US, in pursuit of higher yields.
….. with an unwanted side-effect. The Dollar strengthened. Capital inflows caused the trade-weighted value of the US Dollar to spike upwards beween 2014 and 2016, damaging US export industries and local manufacturers facing competition from foreign imports.
The Mad Hatter’s Tea Party
A jobless recovery in manufacturing and low wage growth in turn led to the election of Donald Trump in 2016 promising increased protectionism against global competition.
Then in 2017, to the consternation of many, despite rising interest rates the US Dollar began to fall.
Learned analysis followed, ascribing the weakening Dollar to rising commodity prices and a recovery in emerging markets. But something doesn’t quite add up.
International bond investors are a pretty smart bunch. When they look at US bond markets, what do they see? The new Fed Chairman has inherited a massive headache.
Donald Trump is determined to stimulate job growth through tax cuts and infrastructure spending. This will certainly create jobs. But when you stimulate an economy that is already at full employment you get inflation.
Who Stole the Tarts?
Jerome Powell is sitting on a powder keg. More than $2 trillion of excess reserves that commercial banks can withdraw without notice. Demand for bank credit is expected to rise as result of the Trump stimulus. Commercial banks, not known for their restraint, can make like Donkey Kong with their excess reserves provided by the Bernanke Fed.
Under Janet Yellen the Fed mapped out a program to withdraw excess reserves from the market by selling down Treasuries and MBS at the rate of $100 billion in 2018 and $200 billion each year thereafter. But at that rate it will take 10 years to remove the excess.
Bond markets are worried about what will happen to inflation in the mean time.
Off With His Head
The new Fed Chair has made all the right noises about being hawkish on inflation. But can he walk the talk? Especially with his $2 trillion headache.
….and the Red Queen, easily recognizable from Lewis Carroll’s tale, tweeting “off with his head” if a hawkish Fed threatens to spoil the party.
One pill makes you larger
And one pill makes you small
And the ones that mother gives you
Don’t do anything at all
Go ask Alice
When she’s ten feet tall….When the men on the chessboard
Get up and tell you where to go
And you’ve just had some kind of mushroom
And your mind is moving low….When logic and proportion
Have fallen sloppy dead
And the White Knight is talking backwards
And the Red Queen’s off with her head
Remember what the dormouse said
Feed your head
Feed your head~ White Rabbit by Grace Slick from Jefferson Airplane (1967)
Footsie stalls as Pound strengthens
Pound Sterling is strengthening against the US Dollar as well as the Euro (mentioned last week). Recovery of the Pound above 1.27 (GBPUSD) completes a triple bottom, suggesting that a base is forming. Crossover of 13-week Momentum above zero indicates a primary up-trend.
Breakout above 1.20 against the Euro (GBPEUR) would strengthen the signal.
The FTSE 100 continues to test support at 7100. Declining Twiggs Money Flow indicates medium-term selling pressure. A rising Pound is likely to result in a Footsie test of primary support at 6700.
Why BREXIT matters
From The Guardian, June 14th:
Support for leaving the EU is strengthening, with phone and online surveys reporting a six-point lead, according to a pair of Guardian/ICM polls.
Leave now enjoys a 53%-47% advantage once “don’t knows” are excluded, according to research conducted over the weekend, compared with a 52%-48% split reported by ICM a fortnight ago.
….Prof John Curtice of Strathclyde University, who analyses available referendum polling data on his website whatukthinks.org, noted that after the ICM data, the running average “poll of polls” would stand at 52% for leave and 48% for remain, the first time leave has been in such a strong position.
If the UK votes to LEAVE, we can expect:
- A sell-off of UK equities. GDP is expected to contract between 1% and 2%. A Footsie breach of support at 6000 would signal a test of 5500, while breach of 5500 would offer a target of 5000 (5500 – [ 6000 – 5500 ]).
- UK housing prices fall.
- A sharp sell-off in UK banks in response to falling GDP, equities and housing — threatening contagion in financial markets.
- BOE rate cuts to support the UK economy.
- A sharp fall in the Pound due to uncertainty, lower interest rates and lower capital inflows.
- The Euro falls in sympathy, as confidence in the EU dwindles.
- The US Dollar strengthens, causing the Fed to back off on further interest rate rises.
- Volatility surges across all markets.
- Gold spikes upward.
Hat tip to The Coppo Report
Treasuries fall and Dollar strengthens on latest Fed minutes
Treasury yields rose and prices fell sharply after release of minutes from the Fed’s latest monetary policy meeting. The April minutes reveal that policy makers see a June interest-rate hike as appropriate if labor markets and economic growth continue to strengthen. The 10-year Treasury yield jumped 12 basis points, suggesting a rally to test resistance at 2.0 percent.
The Dollar strengthened against China’s Yuan, testing medium-term resistance at CNY 6.55. Breakout would force the PBOC to further deplete foreign reserves in support of the Yuan. The alternative of an uncontrolled descent would instill panic and encourage capital flight to gold and the USD.
It’s Time To Drive Russia Bankrupt — Again
Interesting view from Louis Woodhill on Forbes:
Over the past 64 years, real gold prices have averaged $544.91/oz in 4Q2013 dollars, and real crude oil prices have averaged $38.85 bbl. This means that an ounce of gold will typically buy about 14 barrels of oil.
If we fully stabilized the dollar today, we could expect gold prices to fall toward $550/oz, and oil prices to fall toward $40.00/bbl. The huge dollar premiums that gold and oil currently command reflect the value that these easy-to-store commodities have as hedges against dollar instability. If we reformed our monetary control system to guarantee the real value of the dollar, we would eliminate this risk. The risk premiums currently enjoyed by oil and gold would then decline toward zero, as the new monetary system gained credibility.
Are the current gold and oil premiums simply a hedge against an unstable dollar?
Read more at It's Time To Drive Russia Bankrupt — Again.
Euro, Yen plunge against Dollar
The Euro broke support at $1.33, signaling a further decline against the Dollar with a target of $1.30*. Falling 13-week Twiggs Momentum, below zero, warns of a strong down-trend. Recovery above $1.35 is most unlikely, but would suggest that the down-trend is slowing.
* Target calculation: 1.35 – ( 1.40 – 1.35 ) = 1.30
The recent rally of the Euro against the Russian ruble has faltered. An economic contraction and rising tensions over Eastern Ukraine both contributed. The Euro remains in an up-trend and recovery above RUB 49 would suggest another attempt at the previous high of RUB 51. But failure of support at RUB 46 would signal a primary down-trend. 13-Week Twiggs Momentum oscillating close to zero reflects current uncertainty.
Vladimir Putin is attempting to exploit fault lines in the US/European alliance, targeting the powerful European farming and motor industry lobbies. Unauthorized incursions into Ukrainian territory by his white-painted “aid convoy” are another example, where the infringement is so apparently inoffensive that Angela Merkel will find it difficult to convince her European allies to escalate sanctions further. Failure to react will merely embolden Putin to conduct further minor infringements in defiance of the EU, confident in their response, until the Ukraine suffers “death by a thousand cuts”.
Only if the US/EU adopt an aggressive escalation, as suggested here on Defence & Freedom, are they likely to contain Russian aggression.
“…a defensive and reactionary game plan makes one predictable. The very existence of a crisis should be understood as a hint that someone used this predictability to predict the outcome of a produced crisis — and arrived at the conclusion that it’s a good idea. Aka failure of deterrence.”
Japan
As with the Euro, the Japanese Yen is also weakening against the Dollar. The Greenback broke resistance at ¥103.50, signaling a rally to test the 2013 high. Follow-through above ¥104 would confirm. Rising 13-week Twiggs Momentum above zero strengthens the signal. Reversal below ¥103 is unlikely, but would warn of another test of primary support at ¥101.
Australia
The Aussie Dollar, however, is holding its own — ranging between $0.92 and $0.95 against the US Dollar. The narrow band and 13-week Twiggs Momentum holding above zero both suggest continuation of the up-trend. Breakout above $0.95 would suggest a target of $0.97. Reversal below $0.92 is unlikely at present, but would warn of a decline to the band of support between $0.87 and $0.89.
The ASX 200, retracing slightly from resistance at 5650, is also influenced by strong foreign investment flows. Indications are predominantly bullish, including 21-day Twiggs Money Flow forming troughs above zero. Follow-through above 5660 would signal another advance, with a medium-term target of 5850. Reversal above 5550 is unlikely, but would warn of another test of primary support.
* Target calculation: 5650 + ( 5650 – 5450 ) = 5850
Weakening yen boosts Japanese stocks
The US Dollar retreated to test new support at ¥102 to ¥103. Respect is likely and would signal an advance to ¥110*. A rising Dollar/Yen exchange rate will assist Japanese stocks.
* Target calculation: 106 + ( 106 – 102 ) = 110
The Nikkei 225 retreated below its new support level at 16000, but respect of the rising trendline would confirm a healthy up-trend. 13-week Twiggs Money Flow holding above zero suggests healthy buying pressure. Reversal below 15000 is unlikely but would indicate a strong correction.
* Target calculation: 16000 + ( 16000 – 15000 ) = 17000