Thought Bubbles from the Deep

Bank of Japan Yield Curve Target Strategy and revised inflation ambitions:

The BoJ decides that they will target yields at the long end explicitly rather than rely only on quantitative measures. Ultimately, they actually want the yield, so this sort of makes sense. Interesting that the money base is now >80% of nominal GDP, vs Europe and US of around 20%. That's an indiction of how much monetary stimulus has gone on in Japan. It is enormous.

...and yet they still can't generate (sufficient) inflation, nor the expectation for generating inflation - which is the key thing they look for. In some move that I don't quite comprehend, when the public doesn't believe a commitment that they will return inflation to 2% pa over some magic timeframe that keeps extending, they decide to respond with a firmer commitment not just to meet this target they have not been able to meet, but to deliberately overshoot it and keep it that way.

The rough equivalent might be something like:

Whilst gradually losing the title fight, having declared at the end of each round that he will knock Mayweather out within the coming two rounds, Pacquaio goes on to declare... "I'm not just going to knock out Mayweather in two rounds, but going to knock him clean out of the ring!" as if that's going to scare Mayweather into submission.

One for the WTF file.


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US Dollar Funding

The BoJ, RBA and BIS have recently made mention of tightening offshore US dollar funding conditions. Interestingly to me, at least, was that this is the result of plans anounced last year, due for implementation shortly, that US money market funds can freeze redemptions. It is causing a flight of capital away from these funds into government bond funds. As a result, financing of US corporate debt is becomming more difficult to secure.

The prospect of justice for this travesty brings happiness today:



Scumbag. That's a fact, not an opinion.

Hey Deepstate,

Like to know your thoughts behind the big rally in the FTSE at the moment, while the DOW and ASX seems to be quite stagnant as of late.

Is it directly related to the pound devaluation due to the brexit?


Thanks,
Mike

mcgrath111 said:

Hey Deepstate,

Like to know your thoughts behind the big rally in the FTSE at the moment, while the DOW and ASX seems to be quite stagnant as of late.

Is it directly related to the pound devaluation due to the brexit?


Thanks,
Mike

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Hi Mike, it's mostly the result of currency translation. The attached may be more illuminating. FTSE is compared to Euro Stoxx, both denominated in Euro. Pound devaluation more genrally since Brexit relates to economic uncertainty and also reduced economic growth outlook. In the last day or two, it looks like fat finger or flash crash was the cause of the spike. Hollande's words were no more informative than a whole lot of eminent and important people's before that.

Best

DS

The movement in the GBP and Gilt interest rates have been significant lately. They are reminiscent of a deterioration in credit quality. The markets (at least the bond and FX markets) are moving in a way which is consistent with an increasing concern for solvency.

See the divergence in yields and currency exchange rate in recent periods:



Carney was recently quoted as saying that the BoE is happy to see higher than target inflation to see the impending rise of unemployment through. Apparently this was not well received?? The policy statement is pretty much in line with those of the US Fed and BoJ. The banks are out of policy room with inflation so low and credit to huge. They need to generate inflation to handle this threat. If they could, central banks would probably be happy with inflation back at around 3-4% per annum with a stable outlook.

Perhaps the moves are best seen in the light of a market reaction to a very credible central bank policy adjustment. Long bonds would move higher as future rates would need to be higher to contain a surge in inflation. The currency would decline on the basis of PPP (inflation parity) arguments. This move is in contrast to the weak reactions to many other banks recently. Whatever it takes...

Hi DS,

Appreciate the previous reply.

On the note of GBP and on one end being seen as 'cheap' / given there is higher risk associated at the moment. However should one's investment portfolio have exposure to various currencies? such as GBP

If yes to the above: For the ordinary investor would exposure come through the likes of 'Betafunds GBP ETF' or through 'Physical' purchase of the currency in the likes of a broker torfx type?


Thanks,
Mike

mcgrath111 said:

Hi DS,

Appreciate the previous reply.

On the note of GBP and on one end being seen as 'cheap' / given there is higher risk associated at the moment. However should one's investment portfolio have exposure to various currencies? such as GBP

If yes to the above: For the ordinary investor would exposure come through the likes of 'Betafunds GBP ETF' or through 'Physical' purchase of the currency in the likes of a broker torfx type?


Thanks,
Mike

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Welcome Mike. Appreciate the interest.

For an Australian investor, there is likely to be some benefit from holding offshore currency exposures. This is especially so right now when bond yields are so low and can offer only limited protection in the event of a weak economic scenario.

In the event of a global slowdown, in general, commodity demand tends to go down. It is usually the result of a slump in demand from elsewhere. The terms of trade decline...and the AUD tends to fall. Hence foreign currency tends to offer a form of loose insurance against weak equity markets.

In terms of the foreign currency basket composition, you could have developed market only or include EM as well:
- Developed markets tend not to be commodity oriented outside of Canada. Hence, commodity weakness arising from weak global demand has a good chance of leading to some buffering from AUD depreciation.
- EM currency exposure can provide help despite their generally similar exposure to commodities. The AUD actually performs like an EM currency at crucial times. The EM currency basket is useful when you are trying to hedge against a localised weak economy for reasons that do not affect commodity prices.

The mix of EM and DM is pretty much tweaking. In general, most insto investors would have around 85% of their foreign currency exposure in some mix of DM and the balance in EM. In general, these arise from natural holdings in offshore equities and they have some semblance of a cap weighted index for the most part.

As you have outlined, there are many ways to obtain foreign currency exposure. ALl of the ones you have outlined are possible. What you select is specific to your situation. In general, for simple investment arrangements where global equity exposures are no greater than 25% of total, it would suffice to buy some ETF that invests wither in global bonds on an unhedged basis or global equities on an unhedged basis. That's the simplest method.

As to buying a specific GBP currency investment becuase of a belief that there will be an appreciation of that currency against AUD, the most direct way would be you use a CFD provider or via a series of futures contracts (or crosses). It would be very inefficient to convert AUD Cash to GBP Cash for a retail investor...excuse me if you are a whale.

Hope that helps, Mike.

Always nice to hear from you.

DS

DeepState said:

As to buying a specific GBP currency investment becuase of a belief that there will be an appreciation of that currency against AUD, the most direct way would be you use a CFD provider or via a series of futures contracts (or crosses). It would be very inefficient to convert AUD Cash to GBP Cash for a retail investor...excuse me if you are a whale.

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Unless you are seeking leverage, long GBPAUD is suboptimal as you'd be paying carry, whereas if you buy the GBP ETF listed on the ASX, you pay no carry and while it costs to hold because the interest (0.15% trailing) is lower than the management fee (0.45%), it still costs less than carry.

InsvestoBoy said:

Unless you are seeking leverage, long GBPAUD is suboptimal as you'd be paying carry, whereas if you buy the GBP ETF listed on the ASX, you pay no carry and while it costs to hold because the interest (0.15% trailing) is lower than the management fee (0.45%), it still costs less than carry.

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Hi InsvestoBoy. Thanks for your observations.

Payment or receipt of carry depends on the relative interest rates between the two currencies involved in an exchange pair. At present, the interest rates in the Australian inter-bank market exceed those available on the GBP inter-bank market. As such, a long position in AUDGBP via CFD will result in negative swap points....payments even if the actual exchange rate does not move. If you are able to do this via futures, there is virtually no other cost to think about. If via CFD, then there are administrative charges build in to the tom-next spreads used to determine the payments/receipts for interest rate differences.

The GBP ETF is, for all intents, a bank account in AUD and a forward contract from AUD to GBP over the whole notional. AUD cash plus an AUDGBP forward is the same as GBP cash holdings in the absence of credit risk. Carry is still being paid, but just not reported in the same way...and then there is the 0.45% management fee...on top of brokerage and spread to transact in the ETF, which is larger than the spreads generally available on the derivatives markets.

If you do not require leverage, and have a chunk of AUD in the bank that you may want to swtich to GBP exposure, your choices become:

1. Sell AUD and buy GBP, then place that into a GBP interest bearing account
2. Sell AUD and buy GBP ETF
3. Hold AUD and buy AUDGBP overlay derivative

If operating in the size that enables the use of futures or, even, OTC, then option 1 or 3 will be the most efficient implementation. If very small, then option 2 is the only choice. Each option is essentially identical with variations only for admin fees and trading expenses.

In each case, carry will be paid, in effect. It's just a question of accounting as to how it is reported.

Observations on Global Trade

The volume of trade has been associated with the health of the world economy. Since late 2014, the volume of global trade has declined and this has caused concern about the outlook for the world’s economy and financial stability.

The following chart compares the real World GDP with the index on the volume of global trade. A link is certainly evident.



In the decade leading in to the GFC, world trade grew faster than GDP. Since the GFC, trade volume has not grown as fast as the world economy. Since late 2014 it has declined.

Over the long term, trade has generally grown 1.5 times faster than world GDP, but in recent years has slipped towards equivalent growth. If the recent WTO forecast for 2016 trade growth of only 1.7% holds, it will be the first time in 15 years that trade growth has fallen below that of world GDP.

The rapid expansion of trade volumes in the 2000-2008 era was partly caused by more benign economic conditions which led to increased investment. This led to much plant and machinery being built, whose parts are drawn from many parts of the world. Value chains became more disintermediated with a specialization in production increasingly evident in Asia. Less sophisticated product which used to be built largely in China became more sophisticated product whose value chain was increasingly dispersed across Asia.

Merchandise exports from China grew very significantly and helped develop their large foreign reserves. US imports from China ballooned and US domestic manufacturing was hampered, causing much distress amongst manufacturing employees.

So world trade has been growing at a slower rate since the GFC and has been outright declining since 2014. Should we be concerned?

Well…slightly.

Part of the reason why trade has declined certainly is related to low demand. One of the features of the economy since the GFC has been the difficulty of stimulating the private sector to invest again. As a result, materials required to facilitate this are not flowing around. Hence low trade is a symptom of weak demand (relative to capacity) and business confidence.

Prior excess investment into production capacity is one reason why lowlation remains such a broad feature. Trade helps to spread this around between countries to some extent. It also means that, whilst many seem to feel safe that China’s authorities are currently keeping the economy floating via stimulus into areas of excess production, that very same stimulus is pushing deflation across its borders to the rest of the world. Watch this flashpoint. It is a form of competitive devaluation.

A value chain being divided further into smaller, more specialized, chunks adds value progressively, but the incremental return for increasing division. Hence the extent to which GDP might grow from increased trade will progressively decline. As a result, the impetus to increase the length of supply chains, which increases trade volumes, would also naturally decline.

World economic growth is increasingly sourced from services. Growth in these areas does not require much growth in trade. The delivery of nursing care in a country, for example, does not lead to world trade volumes increasing much. Growth in the digital economy and e-commerce may also have a role. Hence, the link between trade and GDP may be decreasing in relevance over time.

Trade volumes can largely be seen as an outcome of aggregate economic activity and the changing composition of it. Trade is weak because the economy is weak and changing in its composition towards services. Weak trade does not lead to a weak economy beyond the embedded beliefs that it creates – we fear trade will be weak and this makes it so. Just because.

What is most concerning for world trade is the rise in nationalism and populism which is clearly evident on the political landscape, particularly in Europe and the US. The US Presidential election has highlighted that there is hostility to major trade deals which are coming closer to fruition. This is on both sides of politics. Reduction in trade frictions has helped release value from specialization over time and contributed to trade volume growth. If this is halted or reversed, world trade becomes a driver of GDP as barriers to trade make production less efficient. Historically, the US was very strident in seeking to break open markets and force open trade on others. How times do change.

Only days ago, the leaders of the International Monetary Fund, World Trade Organisation and World Bank Group expressed concern about the anti-global trade sentiment, and the potential for a downward spiral of low growth and protectionism. More recently, the Wallonia region of Belgium has managed to thwart the finalization of the EU-Canada free trade agreement, citing concerns about the impact on European farmers and the excessive power being granted to global corporate interests. Momentum appears to be building.

Populism may harm trade which then harms the broader economy. Looking further behind that, we find that populism is arising because – in significant part – the rise of world trade helped create economic gains which were concentrated into the hands of a very small proportion of the populace. Many who did not participate in these gains endured hardship as the economies underwent significant transformation. Whilst trade may have helped with equality between nations, the day to day lives of people are more driven by what happens within nations.

Once again, we find inequality as a source of material risk hidden beneath concerning, yet sterile, economic aggregates. When talking about trade as a means to discern an outlook for GDP, we really should be talking about populism instead.

Though I won’t expand here, the date that trade volumes started to peak out seems to correlate well with a distinct change to the behavior of the currency markets.

Comments/questions welcome.

DS

DeepState said:

The GBP ETF is, for all intents, a bank account in AUD and a forward contract from AUD to GBP over the whole notional. AUD cash plus an AUDGBP forward is the same as GBP cash holdings in the absence of credit risk. Carry is still being paid, but just not reported in the same way...and then there is the 0.45% management fee...on top of brokerage and spread to transact in the ETF, which is larger than the spreads generally available on the derivatives markets.

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Well, looks like the BetaShares GBP ETF no longer exists, but in any case this is not factual, the ETF was against an account that held GBP in a GBP denominated bank account and paid out distributions from interest on that account accordingly.

InsvestoBoy said:

Well, looks like the BetaShares GBP ETF no longer exists, but in any case this is not factual, the ETF was against an account that held GBP in a GBP denominated bank account and paid out distributions from interest on that account accordingly.

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I think you might find that it does exist right now.

Also, please check whether AUD held in deposit at BBSW rates plus AUDGBP forward is an arbitrage relationship to GBP held at LIBOR priced in AUD. I think you'll find that they are. The form of POU-ASX is, as you allude, a GBP deposit. The movement in its vaue to an Australian based investor would be matched by an equivalent AUD deposit with AUDGBP forwards rolling at the same deposit maturities. These forwards, if effectively overnight CFD style contracts, comewith swap points explicitly listed due to carry. Hence, carry is being paid in whatever form you choose to obtain the GBP exposure. It's just an accounting format. Sorry if this was not clear previously.

InsvestoBoy said:

Well, looks like the BetaShares GBP ETF no longer exists, but in any case this is not factual, the ETF was against an account that held GBP in a GBP denominated bank account and paid out distributions from interest on that account accordingly.

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indeed POU as asx code, have been using it for a while, relatively narrow buy/sell gap, happy so far with the tool, good eofy tax report for us in Oz.

Observations on the Australian Labour Force


One of the things I have observed over recent times is the increasing number of people I know who have left traditional full-time employment in favour of part-time employment. For some it was by choice, for others it was by circumstance.

The RBA recent looked in to this issue for Australia. It turns out that almost all the job creation since the mining boom ended and significant stimulus kicked in has been via part-time jobs. There has been virtually no full-time job creation in the last four years:



This increase in the proportion of workers who are part time has occured across goods, business services and household services. The overall increase in part-time labour is exacerbated by things like there being less jobs for male workers who used to work in full time factory or mining jobs and more jobs created in “household services”. These are industries like health, recreation, arts and hospitality. These fields where women traditionally dominate in employment terms.

The sisters are doing it for themselves. But increasingly on a part-time basis.

Part time female employment has grown rapidly whilst full time male employment has stagnated. The casualisation of the workforce has impacted workers of either gender.

Whilst unemployment has declined, the proportion of underemployed has moved up. Many who have found jobs are not working as much as they would like. Employers are deliberately using part-time labour to add flexibility to the workforce.

It appears that wage pressure remains lower than might be thought from an observation of the unemployment rate declining from the post mining-boom peaks. Weak wage growth is probably the key reason the RBA would seek to cut rates further now. Their projections suggest that CPI will be at the low end of their target in two years. I can understand that the market has a bias to another cut.

With unfair dismissal laws
Paid parental leave
Redundancy pay
Over time rates
Stacks of public holidays
4 and 5 weeks leave with loading


Casual/Part time staff make sense.

What I find unusual is casual staff want their jobs
And work harder to keep them than the full time workers.
My experience shows complacency is rife .

Another democracy moves towards autocracy. Politics by strongman is returning.

DeepState said:

Another democracy moves towards autocracy. Politics by strongman is returning.

View attachment 68739

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Just phase II of his master plan... AQG has a goldmine in turkey if anyone wants to take a punt on whether its going to get nationalized

Hey DS,

What are your financial thoughts on the outcome on the U.S election. Have the result has significantly changed your economic forecasts and the way your portfolio is structured? - particularly in regards to Australian and US equities.

From what I can see at the moment, whether it be a Brexit or an unlikely leader in Trump; initially the markets fall significantly, however few things can stop an almost instantaneous 'relief rally'; yet using the schiller PE model as a rough gauge, equities appear expensive and increasingly risky. (Not fear mongering just yet)

Your insight is always appreciated.

Thanks!

Thoughts on Trump Presidency


Boarded a plane last week as the results indictated a tighter race than anticipated. Got off the plane to find that Trump had won. The world was still spinning. As was my head. Wisdom of crowds? Could be.

The markets were falling sharply as the likelihood of a Trump win increased. When it became certain, they climbed sharply. Fear of capital flight from the US from a Trump Presidency turned into a draw of capital from emerging markets due to positive reassessment for the US economy and capital markets.

The wild swings may presage our immediate future. Conventional predispositions being turned on their heads in short order.

Trump is pro-isolationism, economic nationalist, fiscal expansionist, transactional deal maker. At least, that's what The Donald has said.

From a US perspective, reducing immigrant labour, raising barriers to trade, lifting infrastructure spending, reducing taxes...all point to higher inflation and EPS growth in the nearer term. This is why equity markets have climbed, yields have risen and inflation expectations have risen. Capital has flowed inwards, particularly from emerging markets. These factors have taken precedence over the increase in political risk and concerns that this would result in reduced confidence from corporates and households. Two sides of the same coin, pick your perspective. Either would be justifiable.

The US is actually in a reasonable position to undertake a fiscal expansion in the near term. If is invests the outcomes in high production assets, this would be a positive move. Reduced corporate tax rates may actually bring more capital back in to the US. Higher trade barriers may create demand for machinery and equipment. All of this is great for near term growth. If insufficient to improve the ability to pay for the debt incurred, that's not so flash.

It is arguable that the EU and Japan have been hitching a ride to the US economy in the last few years as they have continued on the QE route. China is accused of doing something similar via excessive capital investment and dumping. If this is regarded unfavourably, then Trump is doing what is a reasonable reaction to it. Given monetary policy accomodation is no longer desired, the thing to do is to hand it over to fiscal stimulus for the moment. In order to hang on to the benefits in the initial period, you raise the walls to stop capital from flowing out. It can work for a while, although the longer term outcomes are less sanguine...but that's up to a decade away.

Geopolitically, this is very concerning. A mandate to smash the system has been awarded to Trump. Add that with Xi's ascention to the level of Zhiang, Putin, Japan's increased militarism....you end up not wanting to live in the South China Sea and wondering if we have ordered enough submarines. Then we learn that Donald's advisers have told Turnbull that the Navy will be strengthened in the Pacific. Trump has suggested that Japan and Korea carry more of the weight for their own defence, even pointing to the possibility that they develop their own nuclear deterence. Madness.

Anyway, there will be a gap between the election rhetoric and outcomes. Obama's legacy will be unwound to some degree.

I am waiting to see who he appoints to his Executive. In here will be strong clues as to whether he is a total nutcase, or just acting like one. An election process is presumably less complicated than running the world's largest economy in a complex world. He had three campaign managers. He has had to fire his first choice for the Transition team. He has appointed his kids and son-in-law to key executive positions in this Team. I suppose JFK did appoint his brother to a key position...he learned from the Bay of Pigs.

The Pig has arrived in Washington. Let's see if it can fly.

DeepState said:

I am waiting to see who he appoints to his Executive. In here will be strong clues as to whether he is a total nutcase, or just acting like one. An election process is presumably less complicated than running the world's largest economy in a complex world. He had three campaign managers. He has had to fire his first choice for the Transition team. He has appointed his kids and son-in-law to key executive positions in this Team. I suppose JFK did appoint his brother to a key position...he learned from the Bay of Pigs.

The Pig has arrived in Washington. Let's see if it can fly.

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I think this article was quite interesting.

http://www.independent.co.uk/news/w...guage-president-president-elect-a7412186.html

My read is that he has learned something he didn't know before. It's a tentative hand position," Ms Wood said. “Trump holds his own hands as he begins speaking which is an indication he needs to comfort himself.”

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I can imagine Trump kind of regretting what he's got himself into. It's one thing to run a campaign, send a few crazy tweets and watch the reactions. It's also easy to insult certain groups of people without actually having to face them and bear the consequence. He could have been a happy-go-lucky idiot billionaire... but now he's definitely lost a lot of that carefree-ness.

Get ready for a period when a random tweet from Trump could put specific markets in a tailspin... yes all traders should follow Trump if they aren't already.