My main job on these pages is to distil the market Narrative™ for my readers, and recent events have made this week’s missive a layup. The debate on whether to fire, and how to arm, the fiscal bazooka has continued, and now monetary policymakers have joined the party. For a while, it seemed as if the world’s biggest central banks were sleepwalking into coordinated tightening, or in the case of the PBoC, failing altogether in the attempt to counter a sustained cyclical slowdown. To the extent that the Q4 chaos in equities was investors’ vote on this strategy, they should consider their message received. In Japan, signs of wage growth briefly alerted markets to the prospect that the JGB market would be un-frozen by further loosening of the yield-curve-control. But the truth is that Kuroda-san is stuck. With global headline inflation pressures now easing, manufacturing and exports struggling, and the looming consumption tax, the BOJ isn’t going anywhere fast; zero rates and (modest) balance sheet expansion will continue as far as the eye can see. In Frankfurt, the ECB recently downgraded its assessment of the economy—the convoluted shift from “broadly balanced” to “downside” risks—and expectations are building that the TLTROs will be extended, or even renewed and expanded.
Read MoreFor all the talk about a flattening U.S. yield curve, it is ironic that it steepened last week, albeit slightly. The trend, though, is clear enough. The 2s5 and 2s10s have flattened 27 and 32 basis points in the past year, respectively. Another 12 months at this rate and the curve would invert by the middle of next year. This wouldn’t be odd. It’s normal for the curve to flatten as monetary policy is tightened, and it is also normal for the Fed to keep going until the curve inverts. If you believe that an inverted curve is a good recession indicator—which is debatable—this is tantamount to saying that the Fed will keep going until something breaks, consistent with what almost always happens at the tail-end of policy tightening cycles. This probably won’t prevent investors and analysts from continuing to pay close attention to the yield curve. I have sympathy for that, for two reasons. Firstly, it is not clear to markets whether the Fed cares about a flattening curve or not. Some members of the FOMC do, some don’t. Secondly, if the shape of the curve is important to the Fed, the recent pace of curve flattening challenges the prediction by economists and markets that the Fed funds rate will be hiked by 25 basis points three-to-four times in 2018 and 2019.
Read MoreA few weeks ago I provided a bird’s eye view of most of the major asset classes, what they did in Q1, and what they’re likely to do for the rest of the year. I neglected the most important one though; the dollar. I am convinced that other markets eventually will take their cue from what happens to the greenback. The bull case is simple. The U.S. economy is about to get a jolt of fiscal stimulus, propelling growth to above 3%. The labour market has plenty of hidden slack, and productivity is rising, which mean that the Fed won’t have to hike the economy into the stone age to quell inflation and wage growth. Trade wars aren’t a problem, and in the case of U.S. tariffs on imports, the dollar will appreciate offsetting a boost to competitiveness. If the shit hits the fan, the dollar will be the safe haven of choice as capital flees the more open and exposed economies in Europe and China. Mr. Trump might not get a lower trade deficit but he can “win” a trade war with the rest of the world. The contrasting bear case is equally straightforward. The U.S. twin deficit is about to widen significantly, and foreign investors need compensation to finance the party. Higher bond yields and a weaker dollar are a necessary adjustment to reach a new equilibrium.
Read MoreI promise that I will not do an explainer of the VIX this week. Instead, I will lead with some observations on markets and finish with a war-story from the world of retail investing. The return of equity volatility has engendered two responses. Firstly, it seemed as if investors breathed a sigh of relief on Monday when it became clear that we could peg the swoon to the blow-up of short-vol ETFs and related strategies. It is always scary when markest fall out of bed, and even more if so if we can’t explain why. Blaming excessive risk-taking in short-vol strategies assured that the sell-off, while painful, would be short. Secondly, every strategist note that I have subsequently read—and comments from policymakers—have echoed this sentiment. A sell-off was long overdue and is perfectly normal. There is nothing to worry about, and underlying economic fundamentals for risk assets remain robust. Many have even welcomed the volatility as a sign of healthy markets. I have no particular reason to disagree, but my spider sense tingles when investors and strategists welcome a 10% puke in equities. I understand that macro traders are excited but real money and long-only? The logical response from markets would seem to be: “Oh, so you think you’re tough?”
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