Justifying Lower for Longer

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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

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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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Target $TGT Retail Indicator, Gloomy CEO Today

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

 

Pick up our latest Bear Traps Report here.

 

Today’s 52-week lows are ALL retail:
 
* Foot Locker
* Nordstrom
* L Brands
* Gap
* Macy’s
* Target
 
 
Shift to Online Sales Impact:
At least some of the pressure on retailers’ corporate earnings has come from the Shift!
 
Online sales as a % of yoy Growth for Sector
 
2015-16: 9-11%
2012-13: 4-6%
 
Bear Traps Report Data
 
 
Target TGT CEO in earnings call sounds gloomy target:
“after Easter sales and traffic trends softened noticeably”
Retail vs S&P

 

Target CEO
“competitors have excess inventory which will extend promotional environment into months ahead”
TGT
TGT -10% here today
 
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Classic Q2 Seasonal Bounce in the U.S. Economy, Inflation. The Fed now has some ammo for a Hike

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

We’re seeing a hint of inflation coupled with Fed governors on the speaking tour keeping a summer rate hike in play.  In just eight trading days, the U.S. 2 Year Treasury bond yield has surged 15bps to +0.83%, a substantial move for a short term government bond.  The German 2 year yield is all the way down to -0.51% (see below).

As we stressed to subscribers in our May 2nd Bear Traps report, we don’t think they will hike in June, July or September, but they will give it a try.  Once again, the beast inside the market will stop them, as it did in September of 2015 and March 2016.

US 2s

As oil has nearly doubled since February, gas prices just came in with largest surge since August 2012.  The yield spread between U.S. 2 year Treasuries and German 2 year bunds is near record levels (see below).  You get 1.35% more for lending to Uncle Sam, this is putting a bid into the US Dollar.

2s

Pick up our latest Bear Traps Report here.

Headline industrial production advanced 0.7% in April, exceeding the consensus forecast of a 0.3% gain.

IP

After the Fed shot the March rate hike right between the eyes, the U.S. dollar plunged during the 60 day period between early March and May.

The Winner?

In April, U.S. overall industrial output surged (see above), there was  greater output of consumer goods, particularly motor vehicles and parts.

 

CPI Pop

Stripping out fuel and food, the gain in so-called core consumer prices was propelled by services, with costs for rents, medical care, auto insurance and airline fares all increasing. Prices for goods — such as household furnishings, which fell the most since in six years — acted as a check on the CPI’s advance. Federal Reserve policy makers will likely want to see whether the higher prices stick as they consider the appropriate time to raise interest rates again. – Bloomberg noted.

  • Rose 0.4 percent (forecast was 0.3 percent), most since February 2013

CPI Surge

CPI

  • Increase driven by higher prices for gasoline, rents and medical care
  • Core CPI, which excludes food and fuel, advanced 0.2 percent after 0.1 percent gain
  • CPI increased 1.1 percent year over year; core CPI up 2.1 percent

Bloomberg data

Bottom Line

Remember, the Fed doesn’t have to hike rates.  Last summer, they signaled for a September rate hike, the U.S. Dollar surged and global credit risk took the steering wheel out of Janet Yellen’s hands.

On August 22, 2015 We Tweeted @convertbond:

1. Fed hints at #ZIRP Exit
2. US $ Surge
3. Commodity Plunge
4. Global Economic Risk
5. Corp Default Risk
6. EM Currency Risk
7. Fed on Hold

There are three key trades around this latest dollar surge….

Pick up our latest Bear Traps Report here.

 

 

 

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Futures: Chances of a June / July Rate Hike Surge Most in 3 Months

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

 

As you can see in the quote above, earlier this month we emphasized that long dollar position trades should benefit from a hawkish shift from the Fed.

We’re happy that the Fed Funds Futures for July have moved from 14 to 24% over the last week.

The U.S. Treasury curve is the flattest since 2007. The 2-year has gone from 68 to 80 bps over the last few weeks. The market is starting to price in July Fed action.

Pick up our latest Bear Traps Report here.

WIRP June 2
US Dollar Ripping

DXY hit $94.70 today up from below $92 earlier this month.

The next President of the United States is going to have an enormous impact on the Federal Reserve as Fed Chair Yellen’s term ends in 2018.

Pick up our latest Bear Traps Report here.

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Defense Stocks Love The Donald

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

Find value in our menu here.

 

In late March, as the GOP nomination was in doubt, the ITA defense sector ETF was up 12.3% from the February lows, while the S&P 500 SPY was 15.5% higher.  That’s 320bps (3.2%) of underperformance for the defense sector.

Today, the S&P is 17.8% above the lows, while defense stocks have surged 20.3%.  Bottom line, defense related equities have substantially outperformed the S&P 500 over the last 45 days.

ITA

Find value in our menu here.

From the moment Ted Cruz and John Kasich dropped out of the race, defense stocks have outperformed the broad stock market.  Someone is pricing in a Trump Presidency.

Even more telling, volume found in the ITA ETF above:

Pre-Trump Nomination Secured: 26k shares a day

Post Trump Nomination Secured: 103k shares a day

“I’m gonna build a military that’s gonna be much stronger than it is right now, It’s gonna be so strong, nobody’s gonna mess with us. “

Donald Trump, said on Meet the Press, in March

The Defense Department budget for 2016 is $575 billion. President Barack Obama’s 2017 proposal increased it to $583 billion. By comparison, China spent around $145 billion and Russia around $40 billion in 2015…..

For the rest of our report and 2016 election trade ideas,, find value in our menu here.

 

 

 

 

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Great Rotation

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

Find value in our menu here.

Two years ago Wall St. started lecturing us on the “great rotation.”

They confidently said the Federal Reserve would hike rates seven times in 2015 and 16.  Their target of the US 10 year yield by the end of 2016 was 3.50% vs 1.70% today.

“It’s time to get ready for life after liftoff.”

The argument went, you must take down your exposure to bonds and add to stock holding as this historic rotation takes place, two year later we’re still waiting:

2016 Inflows vs Outflows (ETFs and Mutual Funds)

Bonds: +$53B

Stocks: -$85B

Bloomberg, IIF data

Last year, we told them they were wrong here.

When you see and hear this kind of “group think” from sell side analysts, run don’t walk the other way.

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