So many headless chickens

To say the overnight moves in financial markets were chaotic would be an understatement. This week, and last night, in particular, has seen enough headless chickens running around to send even Colonel Sanders into a cold sweat. I’ve been plant-based for two weeks now, so I am thinking about chickens a lot. Asset markets sold off everywhere, led by a dramatic rise in US 5 and 10-year bond yields. That sparked a rout in equities, commodities and gold, which is staring at the abyss once again today.

It is ironic that, amongst the bonfire on Wall Street, GameStop finished 19% higher, having traded in a lazy 100% range intraday. If last night’s price action was a self-perpetuating negative feedback loop of the buy-everything trade, GameStop’s price action tells us there is still plenty of dumb money out there, waiting for a strong dose of efficient capital allocation reality.

Looking back on the week, financial markets have been chasing their tails. Jerome Powell’s soothing comments, in hindsight, have had a half-life of fewer than 24 hours. Markets have become myopically fixated on inflation. The expectations being that we will see an explosion in demand as vaccines reopen developed market economies. The fact is, data has shown we have seen an increase in demand anyway up till now, despite the pandemic walls erected globally.

The US 10-year yield finished the day 17 points higher at 1.53% overnight, a mighty move in anybody’s book. But the rise in yields has seen around the world. Germany (-0.23%, we’re doomed!), Japan (yes, Japan), Australia, New Zealand and Canada have all suffered selloffs in their benchmark bond yields. Markets now seem intent on calling the central bank bluffs across the world, or so it seems.

The inflation the world is seeing is a cost/push inflation, which isn’t the economy destroying “sticky” inflation. Price rises on this side of the economic vortex drop out of the CPI measures after one year and reflect economic activity expansion. Absent is the more dire wage/price spiral inflation. Given that more than 10 million Americans less are employed than pre-pandemic. Fiscal job support globally has kept millions in work; we are unlikely to see the latter anytime soon.

Markets are never one to let reality get in the way of a good story, though, and that story is inflation regardless of the type. I would argue that the carnage seen in the equity and bond markets overnight is due to the extended long positioning of the 10-month buy-everything trade (except the dollar). The reintroduction of the concept of two-way price action is a welcome one. Everyone looks like a genius in a rampant bull market, even “institutional” crypto analysts who say a 20% fall is a healthy market correction, with a straight face.

If Jerome Powell couldn’t calm markets this week, perhaps Warren Buffet can when his annual message is released on Sunday. But if Wazza can’t, then I fear the Bonfire of the FOMO’s will continue. With the Biden USD1.9 trillion stimulus looking increasingly likely to pass mostly unscathed, Mr Powell may look at the bond market this week and have a few cold sweats as well because that’s a lot of US government debt that’s going to hit the market. If the Fed does blink, it will likely be in the shape of a “twist and shout” move to redirect Fed intervention to the bond curve’s outer reaches. But don’t call it debt monetisation; this is America, not the Philippines or Indonesia…

The travails sweeping the US and developed market bonds could cause Asia a few headaches, though. Just about all of the region runs some sort of dirty peg to the US dollar, comfortably snuggled up in China’s PBOC fixing orbit. With US bonds in a coma for most of the past year, with the ensuing weak US dollar, most of Asia has been able to cut interest rates with the US as their currencies appreciate. When you fix your currency to another country’s currency, you import their monetary policy directly or indirectly, depending on whether the peg is clean or dirty.

A sustained rise in US yields and/or a subsequent surge by the US dollar because of that will muddy the playbook. Regional markets will either have to tighten monetary policy to reflect moves in the US and elsewhere or accept a much weaker currency. That will be problematic with the data showing that despite the export sector firing on all cylinders, domestic consumption in Asia remains fragile, to say the least. If you have lots of offshore denominated debt or are running a current account deficit, the picture gets muddier still. Now might be the time to step to the side-lines in Asia and to wait and see how the picture unfolds.

Overnight, US Durable Goods data blew expectations out of the water. The headline number rose by 3.40% MoM, well ahead of 1.10% expectations. Even the ex-transport number (read aeroplanes), rose by 1.40% versus a 0.70% rise expected. US Initial Jobless Claims also fell to 730,000, much better than expected. Combined with recent data, it all points to a US economy shrugging off pandemic restrictions and recovering impressively.

Against that background, fragile financial markets face a substantial risk point tonight in the shape of US Personal Income and Spending data. It is one of the Fed’s favourite inflation measures. With inflationistas standing by with swords drawn, higher than forecast numbers could see them banzai charge en masse for the exit door. I fear for equities, bonds and precious metals in this scenario, but I won’t be sorry if cryptos and GameStop are stretchered off. Tesla, a crypto ETF that used to make money selling electric car carbon credits to other carmakers, may also burst a tire.

On a final note, the fun will continue over the weekend, and I don’t mean trading cryptos on Saturday and Sunday. Sunday sees China release its official Manufacturing and Non-Manufacturing PMIs, followed by pan-Asia PMIs on Monday. It goes without saying that if the buy-everything unwind has continued into the New York close, weak PMIs from China and Asia could make Monday emotional.

My first chief dealer over 30 years ago, (goodness me), told me to always buy US dollars in an emergency or a war. Waldo’s advice was sagely then as a wide-eyed youthful currency trader, in an age of green screens and something that was called a telephone. It is sagely advice 30 years later as we head into the end of the week.

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