Market Analysis – Monday, February 13, 2017


This market analysis examines the recent performance of global financial markets, the role of liquidity in supporting financial markets, and the prospect of currency wars from the viewpoint of an analyst-trader that utilizes fundamental, technical, quantitative, and big data analyses.

It’s All About Liquidity

20170213-chart1As discussed ad nauseam, governments relied on loose monetary policies in the aftermath of the 2007-2008 Financial Crises to prop up financial markets as exorbitant debt levels curtailed fiscal remedies and fear of political blame prevented necessary structural changes. Like passing the baton in a relay race (or a game of hot potato), monetary bodies took turns implementing different brands of QE. In approximate order: Fed (QE1, QE2, Op Twist, ZIRP, QE3), BoE (asset purchases), BOJ (asset purchases, ZIRP, NIRP), SNB (asset purchases), ECB (asset purchases, ZIRP, NIRP). But, despite the influx of paper money, developed and many developing economies failed to rise from the mat leading to the next phase of the Financial Crises: currency wars.

Currency Wars

Fear of a repeat of the 1989 Tiananmen Square protests, China unilaterally devalued the yuan twice in August (~2.9%) and December (~4.4%) 2015 in an effort to boost exports and jobs, resulting in a significant global sell-off each time (light blue boxes in Charts 1 and 2). Leaders from Washington to Brussels to Tokyo gasped and an undisclosed agreement was made at the Feb 2016 G20 finance ministers and central bankers meeting in Shanghai between the US, China, EU, and Japan (G4) to prevent a future financial market panic. As described by Jim Rickards, China would peg the renminbi to the USD (e.g. CNY6.50-6.30, Nov 2015 to Feb 2016 range) which would weaken, while the yen and euro would strengthen (Charts 2 and 3). But, a funny thing happened on the way to the pagoda. With the US presidential elections approaching and Donald Trump unseemingly holding steady, DXY drifted upwards starting in May 2016 as the markets factored in the remote possibility of a Trump win and a pro-growth platform. Not part of the agreement, China devalued in May-Jul (~3.4%) and again in Oct-Dec (~4.9%), contributing to a minor sell-off in stocks (green boxes in Charts 1 and 2). Now, with Trump in the White House, all bets are off as the greenback reached a 15-year high in Jan (black circle in Chart 2; DXY intraday high 103.82 on Jan 3).

Pushing an “America first agenda,” Pres Trump has threatened to institute import tariffs, declared China a currency manipulator, counteract China’s aggressive posture in the South China Sea, and has pivoted the US away from China and towards Russia. Many of his cabinet appointees support this view. Nevertheless, the Communist Party’s cling to power resides in its ability to provide jobs for the masses and keep the economy growing – no amount of antagonizing is going to change its stance. With problems of its own making, China must battle internal political unrest stemming from Pres Xi’s centralization of power, a massive credit bubble, and capital flight, to name a few. If push comes to shove, China may forego mini-devaluations and opt for a 20-30% maxi-devaluation, which some neocons would surely label as an act of war. The situation could go pear shape in the short future.

Coming Soon

My next post will examine the current state of financial markets in detail, discuss the role of complexity theory in analyzing the global financial markets, drawing reference to the Thai butterfly that caused the 1997 Asian Crisis (see Case Study: 1997 Asian Financial Crises, Parts I and II), and apply complexity theory and Bayesian statistics to today’s markets to determine the key drivers that could trigger a global market sell-off. My subsequent post will discuss the role of gold, SDRs, or eDollars in the event of a financial market meltdown that surpasses those of 1987, 1998, 2000, and 2007-2008 and the importance of China having a seat at the table of the next global financial system reset. Ultimately, I shall post on my results of using big data analysis, predictive analytics, and ensembles modeling techniques to produce leading drivers and their assigned probabilities of inducing a major market correction using the conclusions from my next post. Stay tuned!


Emerging Markets Analysis – Thursday, April 28, 2016

Country-Sector Focus: Philippines – Mining


This emerging markets analysis examines the primary external factors affecting commodities, Philippine mining sector with a closer look at Nickel Asia, and the outlook for Philippine equities and mining stocks from the perspective of an analyst/trader that utilizes fundamental, technical, quantitative, and intermarket analyses. Lastly, a Philippine Mining Sector Dashboard is provided.

The Party Ends When The Punch Bowl Is Removed

As the 2013 Taper Tantrum foretold, anticipation and the eventual ending of QE3 in Oct 2014 led to massive unwinding of leverage trades and re-assessment of yield-searching investments. As capital returned to the US, the greenback strengthened, boosting the USD Index from around 80 to over 100, or 25%, within eight months (Chart 1). Simultaneously, huge capital outflows from China resulted in the weakening of the renminbi as the PBOC side-stepped the dollar freight train (Chart 2). The Fed givenths and takeths away.

For the Middle Kingdom, its credit-fueled investment boom ground to a halt that, along with the appreciating USD, increased volatility, withdrawal of liquidity, excess capacity, and global slowdown in business investment, contributed to the bludgeoning of commodities. In the aftermath, China’s banking and financial system remains a major risk as rising NPLs and special mention loans (loans very likely to become non-performing) on normal on-balance sheet loans at commercial banks and imploding off-balance sheet/SIV high-interest paying wealth-management products  continue to be a prime drag on the economy as loan officers, rightly so, are hesitant to lend. China’s regulators seem to be buying time by forcing banks and financial institutions to equitize certain NPLs (swap NPLs for common stock). Should the underlying companies turn insolvent, the central government would most probably provide capital infusions to needy financial institutions and the more viable, troubled private companies become nationalized.

As discussed in previous reports, the Fed’s dovish shift in mid-Jan leads this author to believe that no interest rate hike is forthcoming in 2016 and that the next major move shall be a rate cut, ZIRP, NIRP, or QE4 (even, possibly, “helicopter money”), most likely occurring after the 2016 US presidential elections (Emerging Market Analysis for Apr 4 2016 and Market Analysis for Mar 29).

Philippine Mining Sector

Over the last 24 months Philippine miners get caught in the maelstrom, under-performing the blue chip PSEi by 30% through the recent Jan lows (black arrow, Chart 3). Those miners recognizing the global macroeconomic and monetary policy implications would have started serious hedging in Sep 2014, if not earlier, as the GreenMango PSE Mining Index penetrated below a previous swing-high in early-Sep and swing-low in late-Sep (horizontal green dashed lines, Chart 3).

Nevertheless, miners’ fortunes took a turn for the best when the Fed, after a widely anticipated rate hike in Dec, suddenly reversed stance just weeks later. The PSEi and mining stocks, after falling for eight months and upwards of twelve months, respectively, immediately bottomed-and-reversed in a “V”-shaped fashion (green dashed “V”, Chart 3). In the last 13 weeks Philippine mining stocks are up 21.8% vs PSEi 13.8% and in early Mar was outperforming blue chips by nearly 20% (Chart 4). A closer look shows that a handful of miners really attracted the eyes of investors: Global Ferronickel +78%, Nickel Asia +52%, Philex Mining +47%, Lepanto Consolidated Mining +46%, Century Peak Metals 45%, and Marcventures +45% (Chart 5, Chart 6, Chart 7).  The constituents and weightings of the GreenMango PSE Mining Index are provided at the end in DB Table 1 and DB Chart 1. Next, a glance at leading Philippine lateritic ore nickel producer Nickel Asia.

Nickel Asia

After a brisk run-up, Nickel Asia’s twin mountain top price formation in late-2014 / early 2015 gave way in the wake of the termination of QE3 (left side, Chart 8). Like all miners, Nickel Asia’s share price was hammered, falling from an intraday high of P16.11 in late-Dec 2014 to intraday low P3.30 in late-Jan 2016. For the last two months, NIKL has been range-bound between P5.85 and P5.10-P4.74 (Chart 9).

The bottoming formation currently taking place in Nickel Asia’s share price (green ellipse, Chart 8) could acquire legs as global investors once again hunt for yield and OFW remittances pick up steam following Feb’s 9% YoY rise (Emerging Market Analysis for Apr 4 2016). Furthermore, as China may likely re-peg the renminbi to the depreciating greenback to reinvigorate its exports, economy, and create inflation to give relief to its growing debt problem, commodities would get another boost.

20160428 Chart 11
Chart 10. Source: InfoMine.

For Nickel Asia, the global economic slowdown led to a glut of stainless steel (SS) product world-wide of which China has been trying to sell-off over the last 18 months, or so (upsetting local SS producers in some countries). Until the SS inventory overhang alleviates and/or SS production capacity reduces, sustainable increased demand for raw nickel will be slow to realize. Hence, LME warehouses remain flush with nickel at 415,075 MT (Chart 10), while spot nickel price sits at around $4.26 per pound (as of Apr 29), having traded above $9/lb in early 2014 and $13/lb in early 2011 (Chart 11). But, the tide seems to be turning as spot nickel is up 23% from its nearly 13-year low in early April.

Looking ahead, the LME 3-month nickel future price stands at $9180/MT, up +10% from early Apr (Chart 12), signifying increasing future demand. For China, rising demand may stem from abroad, from domestic consumption, or both. According to Stainless Steel World, China’s growing domestic consumption of SS shall outpace the country’s GDP rate of growth for years to come.

With Indonesia’s mineral export ban still in place (since Jan 2014, although some concession on nickel concentrates may be forthcoming in 2017), the Philippines and Nickel Asia, specifically, is well-positioned to pick-up any increased demand for nickel from China. Major potential competitors in New Caledonia have long-term supply contracts with South Korean and Japanese firms and South American and North American nickel miners would have additional logistics and transportation costs to contend with.

Outlook for Philippine Equities and Mining Sector Stocks

As discussed last week, since mid-Mar, a flag pattern has emerged in the PSEi signifying a rolling-stop as early-profit takers depart and new equity investors clamber aboard – note confirming volume slow down.  As a continuing indicator, the flag suggests the PSEi would likely run to about 8600-8700 before the first significant correction. Looking ahead, forceful penetration of the upper resistance zone of the flag at around 7370-7380 denotes resumption of the bullish trend. The trigger could emanate from any direction: poor Q1 US earnings announcements, more dovish Fed talk (next FOMC Meeting, Jun 14-15), major FDI announcement, strong OFW remittance inflows, relatively smooth Philippine presidential election (May 9). Two major risks facing Philippine equities and mining stocks are the perceived outcome of May’s elections and yet another flip-flop by the Fed. A down-break below 7180 on heavy volume nullifies the bullish trend set-up, requiring reassessment of the (then) current situation.

Mining companies face other factors, such as shifting USD, USDPHP exchange rate, demand for metal and mineral commodities, energy and transportation costs, and regulatory environment, to name a few. All told, should the Fed push through with an easing monetary policy, causing USD Index to break below its lower support level at 93-94 (lower green dashed line, Chart 1), that would set the stage for further greenback weakening, bringing respite to the mining sector.

So, what is the likelihood of a pick-up in natural resource commodity demand, specifically from China? According to Reuters, Chinese off-balance sheet local government financing vehicles (LGFVs) issued over 538 billion yuan ($83 billion) in bonds in Q1, including a record 287 billion yuan ($44.3 billion) in March. Much of this capital shall likely go to funding infrastructure projects as last year the government raised the debt-to-equity ratio for project financing. This can only help Philippine miners.

Nevertheless, sustainable demand for final products, consolidation or capacity reduction, and further cost reduction and inventory draw-down may still be needed to ensure that metal and mineral prices continue its recovery. Of course, should central banks lose control of the money printing apparatus to create not just moderate inflation, but high inflation, gold, silver, and other metals and minerals would truly show what a price recovery looks like. Presently, spot gold trades at around USD1250/oz  (as of Apr 27), up from USD1050/oz in Dec, or +19%, while silver has risen 25% over the same time frame to roughly USD17.25/oz.

Philippine Mining Sector Dashboard20160428 DB Table 1

DB Table 1. Source: Philippine Stock Exchange

20160428 DB Chart 1

Emerging Markets Analysis – Monday, April 4, 2016


This emerging markets analysis examines the outlook for capital flows into emerging economies and its impact on emerging equities over the next twelve months and the outlook for the US dollar from the perspective of an analyst/trader that utilizes fundamental, technical, quantitative, and intermarket analyses.

A Lull in Fed Activity

20160404 Chart 1

After a false start in Dec (perhaps, planned), the Fed all but rescinds its hawkish interest-rate normalizing strategy as conveyed via recent dovish FOMC meeting decisions, released FOMC meeting minutes, and speeches. Not only would the Fed not be implementing its original three hikes this year (300 bps over the next several years was the original plan) but, perhaps, none at all, depending on the “data” (Chart 1). With the US economy teetering on recession, energy companies facing bankruptcy, at-risk banks and financial institutions confronting massive write-downs, and US presidential elections just seven months away, the Fed will likely hold-off until early 2017, after the energy sector completes its current round of capital raisings, lenders off-load much of their exposed risk, and the new president swears in before making any major decisions. As discussed in the Market Analysis Reports for March 11 and March 29, this author believes NIRP (plus, possibly, QE4) constitutes the next weighty move by the Fed. Thus, this lull in Fed activity presents opportunities for emerging market equity investors.

Emerging Countries’ Capital Flows

20160404 Table 1

As noted by many analysts, in the wake of the 2007-2008 Global Financial Crisis, capital flow between advanced and emerging economies has become sensitive to monetary policies and its effect on interest rates and central bank balance sheets of developed economies. When considering heightened geopolitical and terrorist tension, lackluster economies, and the uncertainty of monetary policies, capital flows, understandably, have grown volatile. The current abatement in Fed action entices global investors to venture abroad in search of yield.

Some emerging economies will attract a relatively larger share of short-term (and even long-term) capital flows over the next twelve months. Countries with a high dependence on foreign capital that experienced large foreign capital withdrawals over the last eighteen to twenty-four months could expect an influx. During the 2013 Taper Tantrum, the so-called “Fragile Five” (Brazil, India, Indonesia, South Africa, and Turkey) experienced heavy portfolio outflows only to see much return in months. Some countries to watch include Turkey, South Africa, Colombia, Brazil, Peru, and Indonesia – all with high current account deficits that rely copiously on external debt and portfolio equity flow (positive net debt and portfolio equity flows) for financing. To a lesser extent, Poland and Chile could also see strong capital inflows. Interestingly, Argentina, under new President Mauricio Macri, recently settled its dispute with hold-out foreign bond investors and has taken aggressive steps to tackle the country’s problems and seeks to raise up to $15bn in international debt markets in April to settle the bill with holdouts – upon success, more capital raisings would follow to fund government expenditures and to boost depleted foreign currency reserves (Table 1). Also, India could see healthy capital inflows as it weathers the global economic storm better than most, expecting its economy to grow by 7.5% this year– a tad optimistic, perhaps, but significantly better than other economies. And, of course, Mexico, with its close proximity and integrated economy (to the US) could expect a rush of incoming capital. Furthermore, smaller developing economies sporting higher current account surpluses could see a bump up in allocation that would launch local equities: Vietnam, Philippines, and Thailand. Malaysia could be included in this last group, however some money managers still hold concerns over the 1MDB scandal. Another faction that could benefit are emerging commodity-producing countries.

Relief for Commodity-Producers

Since the start of the 2007-2008 Global Financial Crisis, commodities get hammered. But, the widely-broadcasted ending of QE3 creates a massive “risk-off” environment, commencing the summer of 2014, that sends USD parabolic and commodities on its next downleg (Chart 2). The recent dovish stance of the Fed enables commodities to finally form a bottom (Chart 3). Will it stick? Commodity fundamentals remain horrid, but as the adage goes: “Don’t fight the Fed.” And, the corollary: “Especially during a presidential election year.”

Emerging commodity-producing country equities bottom and track commodity prices upward in near lockstep, from mid-Jan 2016 (immediately after NY Fed Pres Dudley speech). As expected, high net commodity-to-GDP economies lead the way. The steep rise in UAE equities suggest the market expects bullish oil prices to continue, which Russia and Indonesia certainly cheer. Even problem-riddled Nigeria is forming a trough (Chart 4). For moderately high net commodity-to-GDP economies, Brazil and Colombia stage a remarkable turnaround zooming from group laggards to top of the class in several months (Chart 5). The prospect of Macri winning the presidency helps push the Merval to an all-time high. And, the long-awaited settlement with foreign bold holdouts and a state visit by Pres Obama solidifies Argentina’s planned return to the international debt markets (Chart 6). Argentina’s return is timely as the USD Index nears completion of a one-year topping formation (green circle in Chart 2 and Chart 7) that would lead to USD weakening for the indefinite future (USD Index next probable target: 85, a 10% depreciation), thereby making future repayments in relatively stronger pesos more attractive.

The Weakening US Dollar20160404 Chart 7

Emerging economies benefit from a softer dollar in several ways. China gains as pressure lessens on the PBOC, which removed its peg to the dollar and allowed the renminbi to weaken against the strengthening greenback (Chart 7).  Thus, watch for the PBOC to “re-peg” to the weakening USD, thereby helping exports. But, pressure increases on other emerging exporters, who may further loosen monetary policies and lower interest rates to defend its exports – the currency wars continue.

As already mentioned, commodity-producers enjoy a fillip and capital inflows into emerging economies could pick-up significantly that would boost local equities and bump up local and international bond prices, jump-start FDI and M&A activity, replenish depleted foreign exchange reserves and help finance current account deficits, and should local currencies strengthen vis-a-vis the dollar, imports of raw materials, natural resources, and machinery and equipment become attractive. Also, a weaker dollar brings relief to US dollar international bond holders as underlying names get a credit rating pop due to improving emerging economies and repayment spur, as mentioned for Argentina.

As business activity springs to life, local consumption rallies, particularly for discretionary spending; the lending cycle swings upwards to reinvigorate whole swaths of industries: banking, brokering, insurance, residential and commercial construction, existing  home selling, appliances, home furnishing and fixtures, houseware and accessories, office supplies, packaging and containers, paper and paper products, textiles, auto and trucks, construction equipment, business equipment, electronic equipment, computer equipment and software, communication systems, foods, cement, farm and construction machinery, building materials, industrial electrical equipment, industrial equipment, lumber and wood, machine tools and accessories, tools and accessories, waste management, and all types of consumer and business services. For emerging market investors, all this adds up to finance, cyclical, and technology stocks advancing first, closely followed by industrials.

Nevertheless, emerging exporters require a destination for their goods and services. Is China’s economy large enough and ready to sufficiently supply demand for final goods? What about India? Surely, rich or large commodity economies, like a rejuvenated Canada, Australia, Russia, Indonesia, Brazil, Nigeria, and Mexico would draw-in products. Little help from Continental Europe, which remains weighed down by a horrendous banking situation, a swarm of refugees, terrorist attacks, and a populace that grows more scared by the day. Also, the UK is not in the buying mood as it contemplates Brexit and economic life thereafter (what happens to existing EU trade, banking, and financial agreements), while staring at a current account deficit-to-GDP of 5.2% (2015), total official national debt-to-GDP of 81% (2015), and total external debt-to-GDP of 569% (2014). So, who does that leave?

Final Thoughts

How long this downleg in the USD lasts is anybodies guess. But, as previously examined, a US move to NIRP could cause economic and financial market linkages to eventually unhinge as the dreaded “Doom Loop” (see Market Analysis for Mar 11 2016) becomes reality to create a self-inflicted implosion and strong inflation (and, even possibly, hyperinflation). In the most extreme case, USD Index approaches the zero limit and some form of SDRs takes over (most likely backed by some portion of gold), but not before global economies and financial markets are thrown into disarray. No wonder China tried so hard to get the renminbi added (effective Oct 1 2016) to the IMF SDR basket (and a seat at the next global financial system re-set). That would also help explain China, Russia, and other nations’ obsession with gathering gold.

Until that event occurs (Japan remains upright after two and half decades of deflation), however, America awash in liquidity, albeit tied up in the financial markets, could overturn its pessimistic posture with a new president at the helm to get businesses to invest, expand, and hire again (fast-food and temporary teaching jobs don’t count) so that consumers feel stable enough to start spending once more to keep the global economic ball rolling. Combine that thought with the prospect of the strengthening (after three years of free-fall) of the world’s third largest economic currency (which, of course, helps its consumers and boost imports; Chart 8) and the posed paradox is solved: US and Japan to the rescue with back-up support from the OECD (many of whose currencies shall appreciate vis-à-vis USD by default, with the Brexit exception of the UK and GBP; Chart 9). Thus, watch for emerging market stocks (and emerging domestic and international bonds) to put in a relatively decent performance over the next twelve months, or so. And, should the Fed decide to buttress its dovish talk with action (ZIRP, NIRP, QE4) before then, back-up the truck.  Or, at least, that seems to be Plan A. Of course, Plan B could always be dusted-off and enacted: War.

Market Analysis – Tuesday, March 29, 2016


This market analysis examines recent actions by the Federal Reserve and its impact on financial markets, with a focus on emerging equity markets, and the outlook for Fed activity from the perspective of an analyst/trader that utilizes fundamental, technical, quantitative, and intermarket analyses.

All Eyes On The Fed

Fed actions continue to act as the primary driver of developing economies and financial markets. The mere suggestion of liquidity tightening by Fed Chair Bernanke in May 2013 sets off the Taper Tantrum that sucks capital out of risky assets, propelling emerging equity and debt markets downward in weeks (far left, Chart 1). This leads directly to QE3 and a resurgence in risky assets, including emerging equities, which reaches a 3-year high to form the peak in a HS pattern (center, Chart 1). But, stoppage of US liquidity injections (end of QE3), results in emerging markets exit, despite liquidity infusions from BOJ, ECB, BOE, Riksbank, SNB, and DNB (right, Chart 1).

China’s credit-fueled investment expansion grinds to a halt that, combined with a strengthening USD, sends commodity prices plummeting (Chart 2).

In Dec 2015, the Fed finally raises the target Fed funds rate (and indicates a total increase of 300 bps over the next several years), after threatening to do so for two and half years, despite signs of a slowing US economy, shattering US energy companies, lackluster Europe, and imploding China, shoving emerging equity (and debt) markets into freefall (first green down leg, Chart 3). By mid-Feb 2016, the Fed, once again, reverses course to deliver a dovish spin, halting the equity correction in a near perfect “W” bottom reversal. At the widely anticipated Mar 15-16 FOMC meeting, the Fed confirms no raise and then Chair Yellen, at a speech at the Economic Club of New York on Mar 29, implies that not only would the Fed not be implementing its original three hikes this year but, perhaps, none at all, depending on the “data” (Chart 3).  What the heck is happening?

Set-Up for NIRP

The BIS and major CBs coordinate monetary actions since the 2007-2008 Financial Crisis to prevent a meltdown in global financial markets. Eight years later, and after rounds of traditional monetary policy, quantitative easing, qualitative easing, and ZIRP, global financial systems remain on life support. Now, European CBs and BOJ are employing NIRP to support the Fed’s effort to strengthen the greenback and normalize interest rates as official US national debt soars over $19.2 trn, or 102% of GDP. But, with the US economy teetering on recession, energy companies facing bankruptcy, at-risk banks and financial institutions confronting massive write-downs, and US presidential elections just seven months away, the likelihood of a rate hike diminishes by the day. The pretend wealth effect must continue for a little while longer.

By early 2017, once the energy sector has completed its current round of capital raisings, lenders off-loaded much of their exposed risk, and the new president sworn in, the Fed and banks may likely stand aside and let markets re-price. Would this be the ultimate cleansing discussed in earlier reports? Unlikely. More probably, similar to the 2008-2009 equity sell-off, after a 50%, or so, drop, the Fed would enact NIRP and, even, QE4, in a final (hopefully) effort to let the new administration and Congress find a solution to the financial morass.

Obviously, monetary actions have proven ineffective, so political leadership and regulatory, legislative, and structural changes are required to normalize the banking and financial systems and labor markets so that the real economy can grow, once again. If the actual problem of excess debt is not directly addressed, the US faces lost decades of fudged numbers and economic decline, just like Japan. But, under NIRP (see Market Analysis for Mar 11 2016), the unraveling may come much sooner. Throughout, of course, savers suffer and receive the blame for the ineptitude of borrowers.

Market Analysis – Friday, March 11, 2016


This market analysis examines the current economic environment, global monetary policy, and the outlook for global financial markets from the perspective of an analyst/trader that utilizes fundamental, technical, quantitative, and intermarket analyses.

Aftermath of QE3

Anticipation of the “official” ending of QE3 in Oct 2014, monetary easing at the BOJ, and easing rumors at ECB and Riksbank propels USD higher, starting in July 2014 (circle in Chart 1). Correspondingly, commodities plunge, dragging emerging markets along two months later (dashed vertical line in Chart1 and circle in Chart 2). Meanwhile, US equities, partially thanks to brethren central bank liquidity injections (see Market Analysis for July 27 2015), remain resilient, albeit volatile (first half of Chart 3). But, by mid-2015, Fed Chair Yellen’s talk about a rate hike finally takes hold as US equities breakdown through uptrend support (circle in Chart 3). Chair Yellen promises three rate hikes in 2016 and to raise Fed funds rate 300 bps by 2017. Despite intermittent rallies, equities face a decidedly downward journey…or, do they?

Energy Sector Gets Decimated

If a stronger dollar wasn’t bad enough, a slowing Chinese economy, prospect of new energy supplies from Iran, and highly-levered shale oil companies makes shorting energy a trade of a lifetime as crude oil trades below $30/bbl. With bank loans in dire straits (Citigroup $58bn, BoA $43bn, JPMorgan Chase $42bn, Wells Fargo $42bn exposures), energy companies manage to unload new equity offerings despite collapsing oil and share prices. According to Bloomberg, another $9.2bn share offerings have been announced YTD (as of Mar 1). With this as background, beware of bear market rallies…that knife is still falling! But…

The Fed to the Rescue

Despite the rhetoric out of the Eccles Building and deeply-massaged and contorted official unemployment figures, the facts are that oil prices are under $40/bbl. (not good for Russia nor US banks), US equities are trending down and volatile, and a lot of angry American voters are attending Trump rallies. At a 0.25%-0.50% target rate, the Fed is out of traditional ammunition to fight the next economic downturn, which is imminent. Any delay in a rate rise now means that the eventual hike arrives during a weaker economy, thereby triggering recession. With remaining FOMC meetings slated for Apr, Jun, Jul, Sep, and Nov 1 prior to the Nov 8 elections, perhaps, as NY Fed Pres Dudley’s speech on Jan 15 suggests, it’s too late to raise them at all. Like Pavlov’s dog sensing a free meal, financial markets make a swing-low in early Feb as the S&P 500 bounces from 1864 and WTI Futures Apr 16 from around 29.00. So, what next?

Alice in Wonderland Time

Picking up the QE mantle from the Fed, the BOJ (see Market Analysis for Jan 12 and Jul 27 2015), following the election of Prime Minister Shinzo Abe in 2012, unleases its own version of liquidity infusion, triggering the Yen Carry Trade. ..and, just to be sure, officially enacts NIRP on excess bank reserves last month. The ECB, for its part, announces in early 2015 an “expanded asset purchase program” of Euro 60 bn per month, expected to total at least Euro 1.1 trn. On Mar 10, the ECB increases monthly purchases to Euro 80bn, cuts interest rates (including the deposit rate to -0.40%), re-declares inflation target of 2% (despite ECB projections showing sub-2% inflation for next 5 years), and announces a scheme to pay banks to lend. On the latter, don’t be surprised if European banks use this opportunity (gift seems more like it) to generate some lending and broking fees to help eurozone corporates engage in some good ol’ American-style share buybacks to give European equities a boost. Remarkably, in his speech, Pres Draghi all but rules out further interest rate cuts…er, get it while it’s hot?  With traditional monetary policy, Quantitative Easing, Qualitative Easing, and ZIRP all failures, global CB focus now rests on NIRP to inflate government and bank debt away. And into the rabbit hole we go…

NIRP: What Could Possibly Go Wrong?

By taking the NIRP route, CBs gamble that banks can withstand the hit on their income as lending rates move below deposit rates. For US banks, not as much a problem as not as relient on deposits for funding, but elsewhere it could cause major dislocations. Judging by collapsing European bank share prices, the gamble is not paying off (Chart 6). Making less money, weak banks cut-back on lending, weakening economies and driving CBs to take rates even lower, thereby inducing a self-inflicted death spiral. A WSJ diagram succinctly sums up the situation (Diagram 1).

Deflation-Led Implosion

As discussed in the previous report, economies currently running into strong deflationary headwinds. To be sure, these headwinds stem from underlying problems from the 2007-2008 Financial Crisis and before (see Case Study: US Bear Market of 2007-2009, Case Study: Dot-Com Bubble, and Case Studies: 1997 Asian Financial Crisis, Part I and Part II)*, which never went away: Too much sovereign, corporate, and mortgage-related/asset-backed debt. Keeping debt off-balance sheet, changing accounting rules, or re-classifying debt did not make the debt disappear. Unable to create gentle, steady inflation with the blunt tools at hand, CBs seem determined to pursue NIRP. But, as shown, secondary and tertiary effects can wreck havoc on NIRP.

20160311 Chart 7

Again, as discussed in an earlier report, the markets show early signs of deflation in Sep 2014 (Chart 7), while many pundits and economists focus on lagging indicators that suggest all-is-well. In Jul 2015, markets give another emphatic shout that deflation is now a significant problem. Further incongruous actions of monetary officials and politicians perpetuates extremely loose money policies that will likely push economies past the event horizon and into a deflationary-spiral with a nasty terminus: Hyperinflation. Thus, economies and financial markets find themselves today.

Probability of Hyperinflation?

So, assuming NIRP is enacted on a global scale (BOJ, ECB, Riksbank, DNB, SNB, and, possibly, Fed), the chance that monetary and political authorities can withdraw monies from the banking system before inflation takes-off is exactly nil. Hence, expect double-digit inflation as a result of NIRP. As for hyperinflation (+50% general rise in prices), those economies unable to remove liquidity in rapid order would be staring directly at a Zimbabwe or Weimar Republic hyperinflationary environment. How long do global economies have until the SHTF?


As suspected, this story does not have a happy ending. The CBs, led by the Fed, determine the duration and magnitude of the outcome. Out of traditional bullets, fanciful methods are tried to inject liquidity into economies that simply, like gigantic and tiny Alice, effectively inflate financial market prices temporarily before prices deflate once again, thereby inducing another round of the latest monetary potion – NIRP for now. So, how long does this go on for? Japan has managed to remain whole for two and half decades, while caught in its deflationary spiral. But, as explained, NIRP may change this.

If “The Doom Loop” proves to be moderately accurate, NIRP shall likely be the last kick-of-the-can and weak banks and financial institutions (e.g. insurers and pensions with 6-8% real long-term actuarial investment return assumptions are deluding themselves) will eventually be taken-over by relatively stronger ones, while the weakest, facing bankruptcy, split into “good” and “bad” entities, with “good” ones acquired by the strong and “bad” ones run-off. Of course, major unhinging in economies and financial markets occur, including forceful inflation and, possibly, hyperinflation. But, economists already know the solution: Stop printing money. Hopefully, politicians force the purging of putrid debt, letting several major financial institutions and corporates to go the way of the dodo bird, and, with any luck, setting an example for others, before declaring any moratorium on the painful cleansing.  Once again, that barbarous relic gold (silver as well) will prove its usefulness, as it has done, time after time throughout history, as the ultimate safe haven store of value.

*  Forthcoming Case Study: 1971-1973 End of Bretton Woods System examines, among others, the role that a reserve currency plays in abetting an economy and local borrowing and the massive build-up of debt (sovereign, corporate, mortgage-related/asset-backed, and personal debt) in the US after the US transitioned to a pure fiat monetary system.