A bullard in a China shop

Dollar higher, equities fall rate hike talk

Federal Reserve official James Bullard became the proverbial bull in a China shop on Friday when he said that the Fed might need to raise rates in late 2022 instead of 2023. That sparked a run for the exit door for equity markets and commodities while the US dollar powered higher. The US yield curve continued to flatten as long-dated bond yields slumped, notably in the 20-year tenor.

The major casualty has been the global reflation/cyclical recovery trade. The reaction of markets since the FOMC dot-plotted everybody last week indicates how much cash was in that trade. Equity markets in Asia are following Wall Street South in Asia today, notably, Japan, which is down nearly 4.0%. I can’t see any particular reason for Japan taking the bearish gold medal today, other than it has a very high retail FOMO level of participation. Tokyo markets are probably hanging out for the Bank of Japan to reappear and buy stock ETF’s aka China’s “national team.” They have been disappointed so far.

The US dollar has been the big winner post-FOMC as those reflation trades were unwound, and firmer short-term rates will likely continue to support the greenback. The Fed itself slipped a couple of liquidity measures into the latest FOMC, which I suspect may also be exacerbating the great reflation unwinding.

The Fed lifted the rate it pays on bank reserves (IOER) to 0.15% and raised the rate it pays on overnight reverse repurchase agreements from 0.00% to 0.05%. That was because the effective fed funds rate banks lend to each other out was in danger of turning negative thanks to the sheer amount of capital sloshing around in the system. One thing I like about the Fed is they hate negative interest rates, one of the most counterproductive and moronic tools deployed by central banks who have run out of ideas elsewhere.

Since Wednesday, reserves held at the Fed have rocketed by USD235 billion to around USD755.0 billion. Yes, you read that right. In a zero per cent world, five basis points of risk-free money is an irresistible lure. The net effect is that the Fed is draining some cash from the system at the short end, even as it quantitatively eases further out the curve. That might explain some of the US dollar strength and the run for the exit door everywhere else.

The unwinding of the global reflation trade still has some way to go in the sessions ahead, I believe. It’s a volume thing, and a lot of water needs to drain through the spillways yet. It is too soon to say whether this is a painful correction or a structural turn in the buy everything trade. Data prints of late globally suggest the recovery is on track, but expectations have been running ahead of reality for a while.

However, if it continues, we may see an overdue reckoning for some of the dumber investment decisions being made by investors searching for yield in a zero per cent world—high yield credit and SPACs for a start. The recent rush of Asia tech companies to announce SPAC floats in the US at ridiculously pimped-up valuations could come to a grinding halt. Virtual currencies may feel the heat and meme-stocks, although I wouldn’t bet against the outlaws of Sherwood Forrest continuing to take from the rich and giving to the rich on the other side of the trade while possibly remaining poor themselves. If investors starting asking aspiring IPO/SPAC companies, are you profitable? Do you have a path to profitability in my lifetime? Or is this just a way for early investors to cash out? The world will be a better place.

The data calendar this week is relatively quiet. China has left its one and five-year Loan Prime Rates unchanged already this morning, which was one of the week’s highlights. The US releases Personal Income and Durable Goods at the end of the week, and if they are soft, that reflation unwind may get a second wind. The Bank of England has a policy decision on Thursday, but with one eye on the delta variant cases in the UK, they will hold fast with an outside chance to start talking about starting to talk.

With no data to distract markets, they will move on positioning and sentiment, which is decidedly negative as the week begins. Another reason to believe the great unwind will continue at pace. The usual plethora of Fed speakers will be closely watched and generate more volatility than usual in the information vacuum after Mr Bullard’s efforts on Friday. He is speaking again tonight as well. Expect the word “whipsaw” to appear in the literature this week.

Finally, being Monday, and because so many readers ask me about it, it is the weekly paragraph on bitcoin time. Having invalidated the bearish symmetrical triangle earlier last week, Bitcoin faded ahead of USD42,000.00 of taxpayer revenue-baked US fiat currency dollars last week. The charts are not very clear this week, but this week’s support levels are USD31,500.00 and USD30,000.00. If, as I expect, the global buy-everything unwind continues this week, bitcoin will feel those chill winds as well. I am, of course, a perpetual mega bear anyway, but someone must balance out those experts appearing on tv in tee-shirts, surrounded by pizza boxes and computer monitors shouting, “you don’t understand.”

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Jeffrey Halley

Jeffrey Halley

Senior Market Analyst, Asia Pacific, from 2016 to August 2022
With more than 30 years of FX experience – from spot/margin trading and NDFs through to currency options and futures – Jeffrey Halley was OANDA’s Senior Market Analyst for Asia Pacific, responsible for providing timely and relevant macro analysis covering a wide range of asset classes. He has previously worked with leading institutions such as Saxo Capital Markets, DynexCorp Currency Portfolio Management, IG, IFX, Fimat Internationale Banque, HSBC and Barclays. A highly sought-after analyst, Jeffrey has appeared on a wide range of global news channels including Bloomberg, BBC, Reuters, CNBC, MSN, Sky TV and Channel News Asia as well as in leading print publications such as The New York Times and The Wall Street Journal, among others. He was born in New Zealand and holds an MBA from the Cass Business School.
Jeffrey Halley
Jeffrey Halley

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