Ok, it’s time for “narrative” check – as it were.
The market is demonstrating a propensity to generally ignore the Brexit boondoggle. I mean, sure, there are some folks trading it and if you’re an FX strategist, you can’t very well just sit on your hands and not churn out some largely useless decision tree that purportedly shows where sterling “should” trade based on the dizzying array of possible outcomes which at this juncture seem to range from “hostile coup” on one end to “call the whole thing off and stay in the EU” on the other. Clearly, trying to trade that is an exercise in abject futility – even tactically, given that the sheer number of embedded contingencies is almost impossible to fathom let alone make sense of.
Stateside, Trump is a mess. I haven’t even checked his Twitter feed as of 11:15 AM ET because what’s the point? Everyday it’s just him ranting about star-crossed FBI “lovers” conspiring with “leak monsters” and “lyin’ sleazes” to undermine his regime and/or him insisting that gangs of violent immigrants are plotting to “dismember” white school children. And when it’s not that, he’s tweeting about the “1,000 hamberders” he served to the Clemson Tigers. How anyone expects the government shutdown to be resolved amicably given his mind state is beyond me.
So, when it comes to Brexit and the US shutdown, just forget it. Things will pan out however they pan out.
Meanwhile, we’re all forced to turn to the Politburo as a model of sane governance. The key question for markets and for the macro narrative (and those are the same thing these days) is whether China’s ongoing efforts to tip/hint at/float/implement additional easing, both monetary and fiscal, will be successful at slamming the brakes on the economic deceleration evidenced by data point after excruciating data point.
On Tuesday, it was more tax cuts and, crucially, there were signs in the December credit data that the monetary stimulus is starting to “work”, which is key considering the two-step RRR cut announced earlier this month is now set to be implemented, leading some to postulate that the data could start to turn around by the time the next PMI numbers are due.
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On Wednesday, there were more headlines and while we could go through these with a fine-tooth comb, we’ll just leave it to Nomura’s Charlie McElligott to summarize via the following handy bullet point list which he notes is evidence to support the contention that things “had to get worse before they got better” (i.e., things had to really deteriorate to push Beijing in the direction of a panic effort to stimulate and otherwise “reflate”):
- Overnight Chinese Premier Li called for more investments in infrastructure and services, while also voicing support for a “stepping-up” of targeted economic controls from authorities
- The annual PBoC liquidity injection to offset the pre-Lunar New Year holiday- / pre-tax payment peak- / maturation of MLF funds- cash drain goes “full mental” last night, with the Chinese central bank injecting a record 560B Yuan ($84B USD) into the system using 7d reverse repo operations–the largest 1d cash injection in their history
- This comes after the “unified front” two days ago in a press conference between the PBoC, the MoF and the NDRC where new tax cuts, fresh measures to stabilize auto consumption and an announcement that authorities are supportive of increasing issuance of local government “special bonds” to stimulate infrastructure spending were all made in a “stimulus” spasm
- Finally and also highlighted yesterday, this short-term liquidity injection adds to the larger “credit impulse” being re-engineered by Chinese authorities, which on the headline level came in as “better than consensus” estimates across new aggregate social financing & new loans
The last bullet point is a reiteration of the points made above about the December credit data and that second bullet looks like this on a chart:
(Bloomberg)
Obviously, that’s designed to do more than just meet “seasonal demand” for tax payments and holidays.
We seem to be approaching some kind of tipping point beyond which Beijing will have to “kitchen sink it” if things don’t turn around. That goes double (and triple) if President “Best Brain” decides to upset markets by refusing to strike a comprehensive trade deal ahead of the March deadline after which the tariff rate on $200 billion in Chinese goods will more than double. For reference, here’s a snapshot of how various Asian benchmarks have performed in the new year:
(Bloomberg)
For equities and risk assets in general, the story remains the same. Everyone is “torn”. Here’s how we described it on Tuesday:
… investors [are] pulled in one direction by an express desire to extend the YTD risk surge catalyzed by the dovish Fed pivot and yanked in the other by ongoing signs of economic malaise (China’s December trade data), the US government shutdown and the ever present threat that someone, somewhere is going to step on a geopolitical landmine (e.g., Brexit, China vs. Canada, Turkey vs. Kurds).
That linked post cited Nomura’s Masanari Takada who fretted about the inherent fragility of a rally predicated on squeezed shorts (i.e., forced buy-ins), most notably in the CTA “community” (assuming it makes sense to use the term “community” to talk about programmatic investors/robots).
On Wednesday, the bank’s Charlie McElligott was out updating his own pseudo-famous (if controversial) CTA model and today he includes a set of visuals that I (for one) haven’t seen before.
“[We saw] a bit of consolidation overnight for risky-assets after the Equities ‘force-in’ commenced yesterday, as systematic trend funds reduced their prior ‘Max Short’ positions in SPX, NDX and SX5E through meaningful notional buying (and following the prior day’s covering in ‘Max Shorts’ in Russell 2k, DAX, FTSE, Hang Seng, ASX and KOSPI as well), with CTA Equities trades now sized-down to a smaller ‘-82% Short’ position”, he writes, describing how the move higher is leading to forced covering.
He adds the following additional color on the fundamental/discretionary crowd and also re: macro investors:
As the performance of Equities is dictating the terms of overall cross-asset sentiment, the “macro calm” provided by EPS season is critical in maintaining this rally and further perpetuating this “chase” back into adding exposure (nets- and grosses-) from the fundamental / discretionary side of the universe–and thus far, investors are increasingly comfortable “buying the lowered bar” following the powerful negative earnings revision impulse…although macro traders continue voicing a desire to “short the rally,” currently identifying ~2630-35 area (50% retrace of SPX 1Y move and 50DMA).
As far as the charts mentioned above are concerned, the following visuals shed a little more light on McElligott’s CTA model. The blue dots are current positioning, while the red shaded areas are his “estimate of tomorrow’s positions for various levels of market close today”. We’ll present these without further editorializing.
(Nomura)
On a situation-by-situation/country-by-country basis, it sure looks like we’re racing to the edge of the canyon, ‘Thelma and Louise” style. But deep in my (shrinking) liberal-can’t-we-all-be-friends gut, I think the powers that be will figure out a way to kick the can down the road and keep the pretense of “liberal democracy” alive for a while longer. Call it muddling through, but that’s what they make the big bucks and why I think it’s the most likely outcome. I hope I’m right.