Fed Moves, will they Go or Back Away?

Join our Larry McDonald on CNBC’s Trading Nation, Tuesday May 24, at 2pm.

Pick up our latest Bear Traps Report here.

“The risk-reward in betting on Fed action in the July – September time frame is the most attractive in three months. Global credit and economic risks shot the March and June rate hikes right between the eyes, took the steering wheel out of Janet’s hands. This will position the Fed to start signaling for a July hike, sometime in the next 45 days. That would be a dollar positive; gold / commodities / EM negative. She’ll likely try and get back in the driver’s seat. In recent years, the rebound in Q2 vs Q1 GDP has been meaningful, north of positive 1%.”

The Bear Traps Report; May 2, 2016

As we witnessed last July and again in November, Fed governors are starting to prepare the market for a rate hike.

Why Should You Care?

2008-15

Average stock market returns on days around when the Federal Reserve meets were over 20x the average trading day, per Bear Traps Report analysis.

The Road Ahead

As we trade and invest around the all important Federal Reserve policy moves, a key distinction must be made.  Will they prepare the market and then “back away” or will they prepare the market and then “go.”

In 2015

Last September: Prepared the Market, then Backed Away

Last December: Prepared the Market, then Hikes Rates

Beware of No Skin in the Game!

It blows my mind as to how many people focus on the latter, while ignore the former.  Too many economists espousing on Fed policy have NEVER taken professional risk.  Their dribble is couched in “no skin in the game.”  Thus, the crucial reality of the situation is often ignored.  There are colossal trades in both scenarios, see our latest Bear Traps report here.

In measuring the efficacy of Fedspeak, its far more important to watch for changes in a Fed Governor’s language, than Fed regional bank Presidents.  In order to trade stock, bond or currency  markets around central bank positioning, we must all be aware of who’s in Janet Yellen’s inner circle.

 

FOMC Governors (Voters) in 2016:

-Janet Yellen, Board of Governors, Chair
-William Dudley – New York
-Lael Brainard, Board of Governors
-Stanley Fischer, Board of Governors
-Jerome Powell, Board of Governors
-Daniel Tarullo, Board of Governors

 

Regional Bank President Voters in 2016

-Loretta Mester – Cleveland

 -Eric Rosengren – Boston

 -James Bullard – St. Louis

-Esther George – Kansas City

Futures Bets

In the futures market, something funny happened on the way to the June Federal Reserve rate hike.

In recent days, June’s chances have stalled at 31% since May 18th, while July’s chances have continued their surge onward to 45%, see below.

Catalysts

June 2: ECB Decision

June 15: Fed Decision

June 16: Bank of Japan Decision

June 23: Brexit Vote

Fed Fund Futures Probability

July

“If I’m convinced my own forecast is on track, then I think tightening in the June-July time frame is reasonable”
Fed Governor Dudley, May 21
“I think the incoming data have actually been quite good and reassuring in terms of policy decisions, so, in my view, June is a live meeting”
Fed Williams, May 17, 2016
“The most recent data are encouraging and consistent with the Fed policy committee’s view that inflation will gradually move back to target over time.”
Regional Bank President, Mester, May 12, 2016
“I wouldn’t take it off the table, markets are more pessimistic than I am.”
Regional Bank President, Lochhart, May 18, 2016
Voters Mester, Rosengren and George all spoke May 12, 2016.
All the recent Fedspeak is:

“telling us one thing, the market is still underestimating the expectation of a rate hike this summer.

Mohammed El-Erian

Bottom Line: Fortunes will be made or lost in getting this summer right, join us here.

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2016 Leadership

Back in December, we passionately made the point that “credit risk will veto the Fed policy path in 2016.”

Investments which benefit from a weaker dollar (emerging markets and commodities) will be standouts in the first half of 2016.”

It’s interesting to note below how well some emerging markets are doing relative to others.

South Africa’s 1% performance relative to Brazil, Russia and Chile speaks volumes to the political crisis in Johannesburg.  In the second half of 2016 we see a …  Pick up our latest Bear Traps Report here

Some 2016 Global Markets in U.S. Dollars, through May 20

Brazil +28%
Russia +18%
Canada +13%%
Chile +10%
Thailand +9%
New Zealand +8%
Norway +7%
Philippines +6%
Indonesia +5%
Greece +5%
Turkey +4%
Malaysia +2%
Netherlands +1%
Portugal +1%
South Africa +1%
S&P 500 +0.4%
Australia 0%
Argentina -0.2%
Korea -1.4%
Mexico -1.5%
Taiwan -1.8%
Russell -2.1%
UK -2.8%
Saudi Arabia -3%
France -3%
Japan -4%
India -4%
NASDAQ -5%
Germany -5%
Spain -5%
Ireland -5%
Euro Stoxx 50 -7%
HK -10%
Italy -15%
China -21%
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Our 21 Lehman Systemic Risk Indicators are on the Rise

Over the last year, the U.S. Dollar has been a global wrecking ball.  Since 2007, there’s over $10T of new dollar denominated debt on earth.  As the Federal Reserve has kept interest rates near zero for nearly eight years, global debt excesses have piled up, especially in emerging markets and commodities (oil) leverage.

Surges in the U.S. dollar now come with more global systemic risk than ever before.

If you’re trading stocks and not keeping a sharp eye on the dollar as well as policy hints coming out of the Federal Reserve, you’re sitting at the table at a disadvantage.

Pick up our latest Bear Traps Report here.

This week, U.S. Treasuries forged their biggest weekly decline since November.

Fedspeak (FOMC governors on the speaking tour) and minutes from the April meeting, brought back bets that policy makers will raise rates as soon as next month. The dollar soared and brought systemic risk back on the front page.

Bloomberg Dollar Index

  U.S. Trading Partner Total Trade 
China $626B
Canada $540B
Mexico $500B
Japan $199B
Germany $173B
South Korea $116B
United Kingdom $115B
France $79B
India $65B
Italy $59B
Netherlands $57B
Brazil $56B
Belgium $52B
Switzerland $51B
Singapore $51B

One of our key 21 Lehman systemic risk indicators has been focused on China’s currency.

At the Bear Traps Report, our passion is focused on helping our subscribers understand leading risk indictors.  There are always warning signs which take place just BEFORE large, elevator shaft like drops in the stock market.  As you can see below, China’s “currency devaluation moves” have occurred just before the last two 13-16% drops in the S&P 500.

CNY

In recent days, the Chinese yuan is on the dangerous devaluation train yet again (see above), be warned.

There are several reasons for this leading risk indicator’s effectiveness, join us here to learn more.

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Catalyst Dates, 10 Things You Need to Know

Pick up our latest Bear Traps Report here

Market Moving Catalyst Events, Next Few Weeks into the Fed Decision
Sunday, May 22
•Cyprus will hold its parliamentary elections
•Austria will hold the second round of its presidential elections
•The AKP Party of Turkey will hold a meeting to choose the successor to Ahmet Davutoglu as Prime Minister
•The Greek Parliament is expected to vote on additional indirect taxation measures worth approximately 1% of GDP and on a contingency mechanism regarding the country meeting its primary surplus targets
Monday, May 23
•@ 5:30 a.m.: Federal Open Market Committee (FOMC) Member James Bullard Speaks on Monetary Policy
•@ 8:00 a.m.: San Francisco Fed President John Williams Speaks on Monetary Policy
•Federal Reserve Releases Data on Foreign Exchange Rates
•@ 10:00: Eurostat Releases Monthly Survey of EU Consumer Confidence
•@ 6:30 p.m.: Philadelphia Fed President Patrick Harker Speaks
Tuesday, May 24
•The Eurogroup will meet to review the completion of the first Greek bailout review.
•@ 10:00 a.m.: Census Releases Annualized Number of New Single-Family Homes Sold   During the Previous Month
•@ 5:00 p.m.: The House Natural Resources Committee is scheduled to hear opening statements in a Markup of legislation designed to address Puerto Rico’s financial crisis
Wednesday, May 25
•@ 10:30 a.m.: Energy Information Administration (EIA) Releases Weekly Data on Crude Oil Inventories
•@ 1:00 p.m.: Dallas Fed President Robert Kaplan Speaks
Pick up our latest Bear Traps Report here
Thursday, May 26
•Federal Reserve Releases Data on the Aggregate Reserves of Depository Institutions & the Monetary Base
•G7 Leaders’ Summit begins in Tokyo
•@ 4:00 a.m: European Central Bank (ECB) Releases Financial Stability Review
•@ 5:15 a.m.: Federal Open Market Committee (FOMC) Member James Bullard Speaks
•@ 8:30 a.m.: Department of Labor (DOL) Releases Weekly Unemployment Claims
•@ 10:00 a.m.: National Association of Realtors Releases Monthly Pending Home Sales
•@ 12:00 p.m.: Rep. Mick Mulvaney (R-SC) and R Street will host a Capitol Hill Conference on the future of housing reform and Mulvaney’s legislation to recapitalize the GSEs
•@ 12:15 p.m.: Federal Reserve Governor Jerome Powell Speaks on Monetary Policy
•April durable goods orders. Sales of big-ticket, long-lasting items such as dishwashers show consumers’ confidence and willingness to shell out big bucks.
Pick up our latest Bear Traps Report here
Friday, May 27
•Federal Reserve Releases Data on the Assets & Liabilities of U.S. Commercial Banks
•@ 8:30 a.m.: Bureau of Economic Analysis Releases Annualized Quarter-on-Quarter GDP Numbers
•@ 10:00 a.m.: University of Michigan Releases Surveys of Consumer Sentiment and Inflation Expectations
•@ 10:30 a.m.: Fed Chair Janet Yellen will be honored at Radcliffe and questioned by Gregory Mankiw, a former Chairman of the President’s Council of Economic Advisors. The event will also feature reflections from former Fed Chair Ben Bernanke
Wednesday, June 1
•The ISM manufacturing report for May. Manufacturing has been in recession. In April, this key economic barometer surprised to the upside, reaching its highest level of the year.
Friday, June 3
•Jobs Friday: The government said only 160,000 jobs were created in April, 40,000 less than forecast. That makes the May jobs report critical, as the Fed will learn if the nation’s job-creation machine is slowing or revving back up. Investors will also get a look at how the sizable services sector of the economy fared in May.
Tuesday, June 14
•May retail sales. Many retailers reported weak first-quarter earnings, although Walmart bucked the trend early Thursday, posting better-than-expected earnings and boosting its second-quarter outlet. Retail sales overall, however, surprised to the upside in April, rising 1.3%. Will sales stay strong and relieve fears of consumers slamming their wallets shut?
Wednesday, June 15
•The Fed announces its decision on interest rates and Chair Janet Yellen explains why in a press conference following the release of the Fed’s policy statement.
Pick up our latest Bear Traps Report here
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Fedspeak Moving Markets

Fed’s Dudley: June is definitely a live meeting.
Today, he’s clearly making the point there’s a strong sense among the FOMC members that markets were underestimating tightening probability, echoing FOMC April minutes.

Fedspeak
*DUDLEY: WILL GET BACK TO 2% INFLATION WITH ABOVE-TREND GROWTH
*DUDLEY SAYS BIGGER UNCERTAINTY IS WHAT’S GROWTH GOING TO BE
*DUDLEY: I’M PRETTY CONFIDENT WE’LL GET BACK TO 2% INFLATION
*DUDLEY SAYS LABOR MARKET SHOWING SIGNS OF WAGE PRESSURES
*DUDLEY: CORE INFLATION PRETTY STABLE DESPITE ENERGY AND DOLLAR
*DUDLEY: BECOMING MORE CONFIDENT INFLATION WILL RISE BACK TO 2%

*DUDLEY SAYS INFLATION EXPECTATIONS SHOWN STABILITY RECENTLY
*DUDLEY: MUST ALWAYS ASK IF DOING ALL WE CAN ON PAYMENT SECURITY
*DUDLEY: FED SYSTEM WAS NOT PENETRATED IN BANGLADESH BANK CASE
*DUDLEY: MANY SIGNS IN ECONOMY POINT TO SATISFYING FED GOALS
*DUDLEY: MKT PRICING OF FED HIKE ODDS WAY TOO LOW PRIOR MINUTES
*DUDLEY SAYS IT’S ALL ABOUT IF DATA EVOLVES WITH EXPECTATIONS
*DUDLEY: FED WON’T LOSE CREDIBILITY IF DATA DON’T WARRANT HIKE
*DUDLEY: FINANCIAL CONDITIONS ABSOLUTELY DO MATTER
*DUDLEY: MONETARY POLICY WORKS THROUGH FINANCIAL CONDITIONS
*DUDLEY: HOW FINANCIAL CONDITIONS EVOLVE AFFECTS POLICY STANCE

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Justifying Lower for Longer

Pick up our latest Bear Traps Report here

The key to trading around Fed policy comes down to understanding credit risk.  The serpent inside the market will ultimately over power the Federal Reserve, take the steering wheel out of Janet Yellen’s hands once again.

Yesterday, the all important Fed minutes referenced the month of June,  7 times.  After spending much of February and March talking rate hike expectations far out into the future, in recent days they’re just starting to prepare the market for a summer rate hike.

Although, yesterday’s Fed minutes are from formerly private conversations between Fed governors during the April 27 FOMC meeting, more recent comments from Governors Williams and Lockhart are clearly talking up possible summer rate hike action.

Likewise, as we noted yesterday morning recent economic data has been more supportive.

File_000 (3)

Over the last two years, central bankers (in particular the Fed) have moved the student body all the way to the left, then all the way back to the right, over and over again.  Understanding this disingenuous game is the key to trading around the vicious market moves in equity, foreign exchange and credit markets.

Pick up our latest Bear Traps Report here

Justifying Lower for Longer

It’s interesting to note, if you examine the Fed minutes, over the years there have been some startling developments.  From 1995-2005, references to “economic growth” took up 45% to 51% of the conversations behind closed doors.  Today, focus on growth only makes up 23% to 28% of the minutes in recent years.

On the other hand, references to “inflation” have surged from 8% to 10% in the 1995-2005 period, to over 23% today.  As the Fed has had to justify their foolishly shallow policy path (not hiking interest rates 2008-15) in recent years, they’ve used low inflation as the excuse De jure.  This data is from LDA Analysis and ACG Analytics.

In the pre-QE ZIRP era, it took just $1.50 to generate $1.00 of GDP, today it takes $7.00.  This is the price of leverage / debt on a society.  “This is extremely rare and dangerous” says billionaire Stan Druckenmiller.

“Credit risk will veto the Fed’s desired policy path in 2016.”

Our Larry McDonald, on CNBC, December 2015

 

The chances of a July rate hike have surged from 14% to 40% in recent days (see below).

July

The yield on the U.S. 10 year Treasury popped 10bps higher yesterday.

One big problem? There is less and less liquidity in the global bond markets than ever before in modern times, U.S. Treasuries are no exception.

Pick up our latest Bear Traps Report here

Over the years, the “sell side” (global banks) had been the natural lubricant providing liquidity between “buy side” accounts (mutual funds, hedge funds, asset managers).  As Dodd Frank has morphed global banks into a fraction of their former selves, we’re seeing more and more violent swings in the global bond markets.

According to work compiled by the Bear Traps Report, from 2014-16 on both FOMC rate decision and Fed Minutes release days, the moves in the U.S. 10 year Treasury are 2 standard deviations greater than normal market periods.  Markets have become a meat grinder to asset managers, managing risk has become much more difficult.

Ten years ago, a typical Wall St trading desk had $2-3B of capital at their disposal, today that number is in the  $200-$400m neighborhood.

The unintended consequences of regulation have been found in disturbing market dislocations.  Get out the popcorn, we’re looking up at the stage, watching just the first act of this show.

US 10s Munutes

We have a report on trading ideas for illiquid markets, join us…

Pick up our latest Bear Traps Report here

 

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June

Join our Larry McDonald on CNBC’s Fast Money, Wednesday May 18, at 5pm.

Pick up our latest Bear Traps Report here.

“The risk-reward in betting on Fed action in the July – September time frame is the most attractive in three months. Global credit and economic risks shot the March and June rate hikes right between the eyes, took the steering wheel out of Janet’s hands. This will position the Fed to start signaling for a July hike, sometime in the next 45 days. That would be a dollar positive; gold / commodities / EM negative. She’ll likely try and get back in the driver’s seat. In recent years, the rebound in Q2 vs Q1 GDP has been meaningful, north of positive 1%.”

The Bear Traps Report; May 2, 2016

 

Fed fund futures exploded higher today as the market is starting to price in a June interest rate hike from the Federal Reserve.

Across the street, banks are revising their rate hike forecasts just weeks after pushing them out into the future.

Goldman, we’re told now has June as their “base case.”

 

FOMC

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