Hive Intelligence Report: The Dollar And Yields Slide To Become A Smile?

There’s a big debate across our network on the dollar – many seem to be turning more bullish on the dollar on the back of its liquidity. Some are also worried about a volatile August. Then there are strong views on US rates, digital currencies and EM. Take a read and remember these are the view of our network, rather than the Macro Hive research team!

USD: Smile or Grin?

Do we see the dollar bid as the only liquid game in town?

• One investor is starting to like the dollar, but seasonals still suggest one last bull move in PMs and US rates and then a big turn that forces the Fed’s hand in September to cap rates.
• He thinks there is a tacit understanding that crisis alpha effects markets very differently – as such distributions in regular vs crisis times are so distinct that liquidity emerges as the only asset to chase… Hence, he can see a resurgent dollar not on its fundamentals but because it’s simply more liquid than the rest of the reserves basket.
• Stephen Jen on the dollar smile: capital flows have a greater bias on the dollar’s value than the US economic predicament.
• He knows this relationship is somewhat frowned upon, but it ties in very closely with my own view of the bipolar nature of crisis alpha.
• He thinks further pain to the global economy sees liquidity flood back to the dollar.

Source: expertinvestoreurope.com

But has the smile become a grin (i.e. a flatter smile)?

• Citibank’s Calvin Tse: ‘We believe that the USD Smile has turned into a USD “Grin” – where the magnitude of USD gains on either side of the Smile are now smaller than over recent years. Thus, with USD gains now likely to be muted on either side of the Smile, but losses still very large in the middle, the “expected value” of being long the dollar is no longer attractive. We advocate selling USD on rallies.’
• The US system is under attack from many sides where rules are rewritten in a matter of weeks. To me, the unknowable risks are greater in the USA than Europe.
• Also, the USD has much more exposure to any hiccup to asset prices; most of Europe is not driven by asset price inflation yet. Don’t get me wrong, though, I think the euro is totally flawed.
• I think I’d take that bet; the US is a colossal mess, but it’s essentially run for the benefit of a handful of corporations… while Europe is deficient in structure, policy, resources and liabilities.

Tactical USD outlook

• US real rates erosion has removed the benefit of being long USDs; but I don’t see a massive short USD position build up yet, so I think we have further to go.
• It’s a good opportunity to add to short USD. What’s happening seems, to me, to be a combination of position squaring, end of month dynamics, and some small misses in econ. data (Germany, etc.). But in the big picture, I still like selling USD/EMFX.
• Risk markets: don’t let your guard down in August. It can be a crazy month, and it’s been a crazy year; so, expect the unexpected is my approach ahead.
• This August might not only see assets redeemed but also ‘go poof’ as gravity pulls on valuations.
• I appreciate the warning about August being a difficult month for risk usually, but I’m expecting the vaccine story to keep driving markets.
• Ironically, Russia or China will be first with a vaccine, which should make EM look good versus G7.
• What impressed me is that what is clearly a second wave has not led to risk off.
• But isn’t this the new normal we should be expecting? Spikes flare up and action is taken to squash it, until there is a vaccine – which isn’t far away?

Source: Goldman Sachs

US Elections: Is Trump Laying the Groundwork for a Contested Election?

Trump floats idea of delaying the presidential elections

• Sub-100 days and the headline risks are gathering momentum. Investors have to react to polls even if they may have a differing personal view. Expect vol. to creep up again post summer holidays.
• Under the constitution, if the election isn’t held then Trump’s and Pence’s terms end in Jan. – and House Speaker Pelosi becomes president. Be careful what you wish for.
• I think it is a smart move from Trump to open the door for claiming fraud at the elections, which he knows he would lose, and which will be held as planned.
• The House speaker would be in line. But with no election, there would be no speaker… it gets weird, but a default majority Dem. Senate would (in theory) get to pick who they want.
• Small point, but you could still have confessional elections even if the presidential election were postponed. Lots of variables!
• There will be no legally valid decision to postpone this November’s election. So why is Trump calling for a postponement?

USTs: 10YR Sliding Towards the Big Trigger

We’re going to break 50 bps in the not too distant future

• US rates are sliding lower towards the Big Trigger.
• July’s target was 0.6%, and August’s is 0.48%. That means September is the bottom.
• Trend of US real yields in next few months [thread].

There’s a much bigger problem with bond markets in general

• They’re ‘supposed’ to be a risk ballast; yet for decades they’ve been a solid return generator, which isn’t likely to continue to any meaningful extent.
• On top of that is the impact of duration when rates fluctuate at low levels vs at high levels. Rising rates are palatable with a coupon offset and painful without one.
• At the end of the day, the total returns from here of both major asset classes got to be somewhat more limited than at any time I’ve been in the markets.
• I mean, perhaps I’m wrong, and equities roof – if we are bound by zero band why have money in fixed income which has no coupon (as discussed above) and really downside to upside risks of 10 to 1? At least with equities you have a chance of upside. And in many cases a better coupon.

I disagree – not if you hold bonds to maturity

• I don’t agree that USTs are worse risk return than equities. Even with no coupons, you get no downside at all if you hold to maturity.
• I don’t think most investors hold Treasuries to maturity. In fact, I don’t think most investors hold Treasuries to begin with – unless maybe Robinhood offers individual bonds… and investors actually hold them for more than 5 minutes.
• Bond maturity is kind of like ‘stocks go up over the long run’ → well yes, but investors still sell when the mark to markets are negative.
• I am not talking about long duration. Just buy T-Bills and roll or anything short. You can’t lose money; you might even be protected from inflation. I am not sure about the USD, but if that’s your base, it does not matter.

Brent: Fundamental Realities Still the Driver

Brent breaking out of $38-43 range stuck in past six weeks

• The driver seems to be macro factors such as a weaker dollar.
• But Brent is still lagging the broader commodity breakout, in particular for metals.
• For Brent, fundamental realities are still the driver; we have built up 900mb of stock over 1H20.
• That will need to be worked through over the coming 18 months, and the reality is that the recovery is going to be in fits and starts.
• This is most visible in China, which, after embarking on a buying spree post the oil price crash (and as its economy recovered), has been hit by heavy rains in central and southern China. Physical markets have weakened rapidly, and the prompt Brent spread has moved towards a 50 cent contango, having flirted with backwardation not long ago.

Where next?

• Would expect Brent flat price to consolidate or take a tactical pause around these levels for now.
• For the contango to ease: Chinese buying will need to return, and key demand centres such as India will need to demonstrate that the virus has been brought under control so that partial lockdowns can be lifted.

Source: Bloomberg

Does there come a point when falling rig counts have an impact on production?

• I just find it remarkable that we’re at 2018 production levels with 20% of the rigs.
• The correlation between rigs and production is not as strong anymore; you need rigs initially for drilling, but then the well doesn’t need to be completed (fracked with proppant etc…).
• That can be done at a later stage. Hence, a better indicator is the drawdown/build-up of drilled but uncompleted wells (EIA) and the number of frac crews/spreads.

EU Banks: Business Model Is Defeated

On average, banks are trading at less than 40% of book value of net assets

• The problem isn’t their assets or ‘net’ assets… It’s the unknowability of their liabilities.
• Exactly. Derivatives, swapbook maybe off b/s liabilities…
• Capital destruction takes many forms. Bank balance sheets are opaque, but I’d surmise that’s where most of it happens these days.
• The second biggest source is probably excessively long tech depreciation and amortisation schedules. They should be 3-5 years, not 7-10 or longer.
• All good points but primarily their business model is defeated; there’s no margin in core lending/deposit. And that’s before we think about demand for debt.
• Investment banking in Europe: a destroyed model, no yield curve no point.
• Not even a change in regulations and balance sheet encumbrance can save them.
• Inflation would save them, but that’s a bigger wish list…
• All you need to know about overbanking in Euroland is the G-SIB list.

Source: FT

Central Bank Digital Currency: Only a Matter of Time

An inevitability delayed only by the strength of the existing lobbying efforts

• The day is surely coming when CBs (including the Fed) move to digital currency and everyone has an account at CBs.
• Covid-19 could well accelerate the coming of that day.
• With the Fed buying corporate bonds and positioning itself to move into direct corporate lending, helicopter money becoming ever closer to reality, various private payment networks springing up and gaining market share, and nonbank banks filling niches that banks can’t fill due to various regulatory restrictions, who needs banks anymore?
• It makes perfect sense. What value add is there in the intermediation of a bank and the end market or individual?
• The financial services industry is ripe for major disruption.
• For central banks to control the entire mechanism of monetary transfer would eradicate most crime, tax avoidance and clearly provide real time economic and consumption insights.
• CBDC is an inevitability delayed only by the strength of the existing lobbying of the industry and clearly the Covid chaos.
• The fundamental nature of fiat money would be revolutionised, access to capital would be instantaneous, risk and measurement would be real time. So again, what value add does intermediation provide?
• Banks just have to evolve. FinTechs are doing stuff banks could do. They are just stuck with legacy problems and an old mindset. Banks need to remember they are in the service industry. But they can still be of value, as service providers as much as liquidity creators.

I have an ‘out there’ thesis on all of this

• The fungibility of money is no longer feasible. One asset serving as a medium of exchange and store of value will disappear soon. This dichotomy is everywhere; savings vs consumption, CPI vs asset price inflation, reserve currency erosion, etc…
• Agreed. Store and value and medium of exchange are incompatible together in one.
• This has historically been resolved by inflation and individuals’ desire for private property.
• I don’t think this world of the gold bugs survives modern technology. A different paradigm is on the horizon.

TRY: A Long Leash?

Have financial markets given TRY a long leash?

• I don’t think EM FX market players underestimate the TRY risks.
• Probably until now domestic banks and CBRT plus controls managed to keep TRY from falling even more.
• You are right. There is no underestimating of the risks in my opinion as well. Foreign outflows from Turkish markets have been large lately.
• What I found really strange is that Turkey’s CA deficit didn’t get much help from lower oil prices. Partially, it was because there was no domestic demand contraction – the opposite, judging by the massive credit impulse.
• Turkey has managed to survive so far without a payment crisis thanks to its heavy dollarization. But with tourism slow, Turkey badly needs more dollars, or a massive demand contraction which has been the norm for how EMs avoid payment crises in the past.
• Biggest recent example is Lebanon – a blindingly obvious pyramid scheme run by the central bank, local banks and elites and some poor unaware folks.

Do you think CBRT gives up and TRY devalues?

• I think they will extend swap lines with Qatar again.
• Qatar seems to be the lender of last resort to Turkey.
• Yes. That is the only external lifeline left.
• Around 50% of domestic deposits are in dollars. Don’t quote me on percentage, but it is high.
• So, having such high deposits in dollars has allowed the country to avoid a payment crisis?
• Yes. CBRT is borrowing those dollars effectively to stem the payment crisis. CBRT now has negative foreign reserves as a result.

Federal Reserve: All Eyes on Jackson Hole

FOMC review

• Chair Powell done – same old dovishness, nothing major new, getting close to releasing the policy framework (but they are basically just going to codify what they are doing already). I guess no news is fine and keep bidding up risk and PMs, for now.
• I’m guessing they release any policy framework tweakage at this year’s public streaming of Jackson Hole.

Pensions: The $64 Trillion Question

What if the government pays off the pensions with newly created money?

• We will finally get to 2% inflation. I see it as a win-win situation.
• My suggestion is exactly that! Or change to a real rate CB mandate (tricky).
• Right. My view on the pension deficit has always been that it is an accounting issue. I.e., there isn’t a real temporal budget constraint; rather there is constraint on real resources.
• And it seems this is the ‘perfect’ time to test this as we’ve got ‘nothing’ to lose; i.e. we want to see higher inflation, and we have been unable to accomplish this so far.
• For what it’s worth: that is precisely the argument that the pensions industry makes.
• But those folks have never even heard of the concept of a Minsky Moment, where the risk of ruin is greater than the risk of recovery.
• My view is that we might be closer to that point than thought.

Source: Author, WEF

Interesting Links

• The biggest fraud: the hocus ‘science’ behind lockdown [a sceptic’s take]
• Taiwan’s strategic importance re. silicon chips
• Absentee Ownership: How Amazon, Facebook, and Google Ruin Commerce Without Noticing
• ‘ECB is on the wrong track’, says former ECB Chief Economist

• Bundesbank President Weidmann criticises joint borrowing of EU countries

• Americans now say they need less money to feel rich
• How they’re really making money on your free Robinhood trades [podcast]
• US opinions on other countries

Source: The Economist/YouGov

• Revisiting the white swans of 2020, by Nouriel Roubini
• The cautionary tale of equity research
• Congress Proposes Taxpayer-Funded Bailout Of $550 Billion CMBS Industry
• China Has Squandered Its First Great Opportunity
• The Fed Needs to be Ready to Go to Negative Rates and the Bank of Japan Needs to be Ready to Go Deeper Negative
• Report: Amazon’s Monopoly Tollbooth
• Gold: A Six Thousand-Year-Old Bubble Revisited

Source: Citibank

• ‘Calm before the storm’: UK small businesses fear for their future
• Many retail investors worship at the temple of alpha when they really should be praying for beta.