Nikkei retraces 50% of 5 year high/low


Tracking risk appetite across bipolar asset markets


SATURDAY MARCH 23, 2013       16:16:00 GMT


During last week's trading the Nikkei 225 achieved almost exactly the target discussed here more than a month ago. The adjacent chart shows how the top of the cloud coincides exactly with the 50% retracement of the distance covered between the five year high and low for Japanese equities. The reason for this exact coincidence results from the method of calculating the key Ichimoku levels rendered on the chart. Senkou Span B - which is one of the two metrics from which the cloud is plotted - is derived from the highest high plus the lowest low over the preceding 52 periods. This calculation - given the 52 month period that has elapsed since the 2007 peak - will exactly coincide with the 50% fibonacci retracement.

Last Thursday (March 21st) the intraday peak level reached was at 12650 just 15 points beyond the level of coincidence seen on the chart.

The extraordinarily high inverse correlation between the yen and the Nikkei is very well documented and has been discussed in my commentaries frequently. From reviewing the weekly chart on USD/JPY the two most recent weekly candlestick formations give a strong hint that there could be some respite from a continually weakening yen in coming sessions.

Given the almost parabolic rise in USD/JPY since last November it is not easy to discern where to target a bout of yen strengthening might go, but a re-test of 90.86 level seen in late February is quite conceivable. In harmony with this move in the Japanese currency it would also be feasible to see the Nikkei retreat - possibly as far as the 38% retracement level around 11,300.

Macro risk aversion might well be a contributory driver to both a stronger yen and weaker Nikkei in the intermediate term, and in addition there could well be a challenge to the resolve of many large hedge funds that have become too complacent with large bearish yen bets.

Systemically significant banks cannot be a little bit insolvent


Tracking risk appetite across bipolar asset markets


WEDNESDAY MARCH 20, 2013       11:16:00 GMT


In the unfolding Cyprus on the brink saga a comment yesterday (March 19th) by the governor of the country's central bank struck a discordant note. He claimed that when the island's banks re-open (when that might be still remains unclear at the time of writing this) there was a suggestion that distressed deposit holders might withdraw 10% of their deposits. It is unclear where that percentage estimate came from but the suspicion is that the number was just plucked out of thin air. The reliability of such an estimate raises an issue that can be summarized as follows:

When circumstances become critical there is no longer a continuum for trust -> distrust or solvency -> insolvency. After a certain tipping point there is a dramatic discontinuity in the willingness to consider mitigating factors or compromises in the judgments we make. We may start out, if transactions are small and inconsequential, in overriding any discomfort that we may be experiencing about having to make a critical decision as to whether to trust the solvency or ability of counter-parties to honour their obligations. However once we move beyond a certain threshold and when more critical circumstances (the risk that one's life savings might be lost) present themselves to us there is absolutely no propensity to tolerate doubts or mistrust. The discontinuity a jump from a linear to a non-linear method of weighing up the risks/benefits of having trust in a counter-party (or bank).

As an example, in September 2008 counter-parties that were dealing with Lehman Brothers completely lost trust in the company, refused to fund it in the money markets, and quite rapidly the overall market realized that the company was insolvent. Traders and investors were no longer prepared to tolerate self-serving statements from the company’s CEO and its management team that its balance sheet was sound and that it could fund itself. There was a total breakdown in trust of the company’s declarations regarding its financial position. In such circumstances, there are no degrees of solvency – a company, especially a bank, either is solvent or it is not – there is no halfway house. It is this unwillingness to tolerate any ambiguity regarding solvency that explains why companies can be full of employees in opulent offices one day and then bankrupt the next with the employees walking out of those same opulent offices with cardboard boxes with their hastily packed personal possessions.

The real catch 22 for the Cypriot central bank and the chances that a white knight (ECB, Russia) might ride to the rescue was neatly summed up in this remark which came from FT Alphaville's insightful commentary this morning. Alluding to the iconically absurd Monty Python sketch about a deceased parrot the article raises the real question mark about the survivability of Cyprus as on offshore financial haven.

Already risk managers in London are sending internal mails quietly removing Cypriot counter-parties from acceptable trading lists. As go the deposits, and the trading entities so go the jobs in law and accountancy. Even if the system survives, the sector looks very vulnerable. No, Cyprus The Financial Centre is not resting, it’s shuffled off this mortal coil, run down the curtain and joined the bleeding choir invisible.

The article's conclusion has a question which should resonate through Berlin Brussels and Moscow

Why bother to protect foreign deposits if they’re on their way out already?

Will US dollar and S&P 500 remain inversely correlated?


Tracking risk appetite across bipolar asset markets


FRIDAY MARCH 8, 2013       14:52:00 GMT


The chart below showing correlation between the US dollar index and the S&P 500 is cited as confirming evidence by Joe Wiesenthal to substantiate his claim in the modestly titled article "The Most Important Dollar Chart In The World Is Saying That The Economic Crisis Is Finally Over" (capital letter emphasis is in the original)

Here's the reasoning for Wiesenthal's view that everything is now fixed:

That's because during the crisis years, when people were in panic mode, they would rush to hold safe-haven dollars, dumping everything else. And then when they were panicking less, they would step out of dollars, and buy other stuff. But the chart above means the crisis is coming to an end, or has come to an end. There's no longer this phenomenon where the dollar represents something you hold when you're panicking about everything else. You can buy stocks, and also feel eager to hold dollars.
Not wishing to be a party pooper for its own sake, but let's try out another scenario where the US dollar continues to strengthen and it is entirely in accordance with the inverse correlation between US equities (and other risk on assets) and the USDX. Since 2008 central bankers have added more than $10 trillion to their balance sheets and have been virtually giving money away. The largest single systemic threat ahead of us (not in the rear view mirror) is the cessation of such a super generous monetary policy - the so called exit strategy problem.

The trigger for a new financial crisis might not even require an announcement by the Fed that they plan to begin a selling program of UST's - as suggested here but simply a recognition by the markets that the Fed will no longer be topping up the punchbowl. In the Alice Through the Looking Glass world where bad news has been good news for markets for so long, a strengthening US economy and a stronger US dollar could well lead to a sell off in risk assets as the Fed will be hard pressed to find new measures to prevent chaos in the Treasury market, even if that does require higher interest rates.

It's even conceivable that the Fed could continue to buy UST's and ratchet up short term rates at the same time...not something that may have been already "discounted".

$UUP: Reasons to be bullish about the US Dollar


Back on February 8th I suggested here that there was convincing technical evidence that the US dollar was emerging from a basing pattern and that I would expect a steady increase in the value of the US currency against a basket of currencies over coming months. The technical picture is improving although the dollar (and DX futures contract) may be temporarily over bought. The weekly chart for the futures contract shows that there is a clear triangular pattern from which an upside breakout would confirm that the basing pattern has been completed and again from which there could be an enduring (lasting perhaps years) and perhaps vigorous dollar rally.

Several other factors would lend support to the technical pattern and point to a key turning point for the US currency and I shall list them with only minor comments

  • The US was the first in to QE in an aggressive fashion and the underlying economy in the US may be the least ugly sister of the major economies in the world. This would suggest that while the Fed will almost certainly maintain its very accomodative monetary policy the tide may be turning towards a more "normal" policy within the next 24 months.
  • The Europeans have not undertaken any meaningful structural changes to the Eurosystem's architecture despite the relatively calmer conditions for the single currency since Signor Draghi's "we'll do whatever it takes speech" of last July. Macro economic conditions within the EZ continue to weaken and there has been no real progress on the required structural and political changes which would ensure that a currency union has the necessary fiscal architecture to become irreversible as Draghi has claimed.
  • Japan seems committed to a policy of debasing its currency to protect its trade competitiveness - a program at which it may or may not be successful and where the yen will most likely drift downwards unless there is a new systemic crisis at which point its risk off status may re-asset itself.
  • The conditions under which the Federal Reserve will exit its QE policy are looking murkier and, along with others I am beginning to doubt whether there really is a properly conceived exit strategy to unwind the Fed's multi-trillion dollar balance sheet.

    The Fed is now the largest single holder of US Treasuries, the duration of its portfolio is being extended and the hit to its balance sheet from even a one percent rise in long term rates would be considerable - let alone the havoc that could be created as the Fed tries to find buyers of all the bonds that it would need to sell. The likelihood is that at some point the Fed may taper its purchases of new UST's but refrain from trying to unload its existing holdings and allow these to slowly mature.

    While this vital part of the capital markets would therefore continue to be "manipulated" by the US central bank (creating further distortions in price discovery in other asset markets) it would still be US dollar supportive as there would be a reduced risk of having to sell off legacy debt at distressed prices. For these reasons, and for the simple reason that in a more challenging financial environment for other developed markets which seems to be the most likely scenario in the medium term, the US dollar could be embarking on a sustained rally which might stretch out for some considerable period.