Do not worry; I will not make this a habit. And I certainly will not talk about “head and shoulders patterns” or “Elliott waves” or any such bollocks.

If the only market indicator you watch is the Dow, you might not think very much is happening… But some strange things seem to be afoot.

First, the dollar had a rough week, with the yen reaching heights not seen since the start of the year:


Last winter, USD/JPY breaching 90 was one sign of the Apocalypse, since it indicated massive unwinds in carry trades. (Or as I liked to put it, “Sayonara!”).

Over at Across the Curve, Jansen has re-posted somebody’s analysis:

In the last three weeks, Usd/Jpy and risk correlation has broken down. Usd/Jpy typically trades w/a 60/70% correlation w/equities, but in the last three weeks the correlation has broken down, now only 30% correlated.

That is, the Yen has gained big but the stock market has not tanked like you might expect.

One explanation for the correlation breakdown is that 3mth USD LIBOR is now LOWER 3mth JPY LIBOR. This spread turned negative about three weeks ago, and in the same timeframe, Usd/Jpy has also fallen 2.9% (see chart attached). Bottom line, the USD is soon becoming the new global funding currency, taking over JPY’s role.

In other words, it is now cheaper to borrow in dollars than in Yen, so the dollar is becoming the new currency of choice for the carry trade. Isn’t that grand?

The Japanese have maintained a weak currency and low interest rates since 1990 or so. I wonder what happens, exactly, if we attempt a re-run of 1990s Japan using the world’s reserve currency? (As an aside, Japanese equities have not exactly been a good investment during this period.)

It is hard not to notice gold closing the week above $1000:


So is this an inflation trade? 2-year swaps suggest not; they have barely budged:

2-year inflation swap rate

And the 10-year Treasury yield is only 3.34% despite the flood of supply, including $20 billion in issuance this week. In fact, that auction went very well. Somebody out there really likes Treasuries.

Finally, my favorite chart of the week, natural gas:


That’s right, natural gas prices spiked 20% in a few hours on Thursday, then fell 10% in a few hours on Friday. Clearly a highly efficient market at work.

So there you have it. As near as I can tell, the market is now pricing in a re-run of 1990s Japan for the United States. (This week, anyway.) Wouldn’t that be fun?

5 comments to Charts

  • OregonGuy

    What are cash reserve accounts doing? Velocity of money? We won’t know the answer for a while.

    Cash is seeking yield. GS, JP Morgan, Treasury, the Fed, and the Obama Admin are loudly sounding the “all clear” signal on the economy and the assumption of risk. The Fed has succeeded, for now, in making cash trash and is letting the world know that borrowing rates will remain at ZIRP for an extended period of time. Asset prices are getting bid up; holding cash is a loser (for now).

    The Fed/Treasury/TBTF nexus is winning the reflation battle. Whether they win the war remains to be seen – it is not possible without job creation, rising middle-class wages, and FIRE economy reform. Wall Mart greeter and fast-food jobs won’t do it and the political will to strengthen the middle class does not exist in this country. Real financial reform looks dead. There are enough Tea Baggers that can be persuaded to act against their own interests in the name of religion, country, and free markets to block any effort at real reform. Politicians of both parties are captured by corporate interests.

    I’ll wager we see an even larger Minsky Moment in the next 3-10 years than the one we just lived through. For now though, the real economy is improving. My company’s customer base is reporting greatly improved activity and the improvement is started to trickle though. Our business is capital-intensive equipment – first into recession, last out – and we do see real signs of improvement. I’m going to enjoy it while it lasts.

  • Arkansas

    heh ! Me made lotsa dinero shorting USDJPY this week. I’m glad someone finally noticed !
    That being said, I wasn’t on the natural gas and it bothers me… Is there really someone out there who can move markets farther than me ?!?

    Thanks Nemo :-)

  • Arkansas

    OregonGuy said “I’ll wager we see an even larger Minsky Moment in the next 3-10 years than the one we just lived through. For now though, the real economy is improving. My company’s customer base is reporting greatly improved activity and the improvement is started to trickle though. Our business is capital-intensive equipment – first into recession, last out – and we do see real signs of improvement. I’m going to enjoy it while it lasts.”

    Do you really think we’ll have 3 calm years ? And here I thought that we were all going to die :( I shouldn’t have listened so much to Roubini.

  • OregonGuy —

    The picture you describe makes sense… Except it is hard to imagine much “reflation”, much less a vibrant economy, with 10-year and 30-year Treasury yields at such historically low levels.

    Then there are all the wild cards in the mix. The trillion-dollar question might be where this chart goes next.

    Incidentally, it sounds like you and I work in similar industries. Possibly the same industry. Heck, possibly the same company :-). For now, my own employer is seeing the same as yours; equipment orders are way up. Whether end-user demand actually stabilizes and/or recovers remains to be seen…

  • OregonGuy

    Nemo –

    Our machine orders aren’t way up yet, but interest in new projects and the sales prospects are returning to normal after months of near zero activity. We reduced labor hours dramatically to preserve cash and wait out the storm. I’m forecasting a return to full hours in October for a workforce that has been reduced by 30% in headcount since Oct 2008. The “great recession” was much, much worse than the 2001-2002 downturn. Is it over? I’m not 100% convinced yet, but the alternative is so bleak I’m going to act on the idea that the improvement is real.

    Interesting conversation with the bank (large regional) last week on investments and a LOC renewal. The investment desk expects short-term rates on instruments with no loss of principal risk to stay low and said clients are starting to chase yield in longer-term and overseas debt instruments. Our account rep says Q3 bank numbers won’t be as good as Q2 because much of the gain in Q2 was one-off (duh!) and the risk managers have been too slow to approve new loans and customers to replace lost loan base. My boss and I were told that since we still have a LOC the bank wants to see us using it – too many of their customers, including us, are paying down debt and staying off the LOC. Having several million on deposit and no debt makes us a bad customer in the upside-down world of banking.

    The PRC is watching your chart too and per Michael Pettis they don’t want to give up the mercantilist model. I think it is highly unlikely the PRC will stop purchasing US bonds. Demand for bond auctions has been strong despite enormous issuance and rising equity markets because there is a lot of cash that the Fed has made trash. The equity markets aren’t big enough to soak up all of the liquidity, so I think debt prices are going to keep rising (yields fall) for a while. What I heard at that bank reinforces this theory and it also backs your point – the economy won’t be vibrant in the near-term. Credit contraction means there are deflationary headwinds fighting the Fed and Treasury’s tsunami of liquidity, but credit growth is a lagging indicator, so I don’t think this rules out recovery (

    I think inflation is the wild-card. The Fed doesn’t care about asset price inflation (hell, worse than that, the Fed encourages it), so I mean CPI-measured inflation. Current policies, speculation, and economic recovery will run-up commodity prices, but there is not going to be any wage inflation pressure for quite some time. Will commodity price inflation feedback into CPI sufficiently to force the Fed to raise interest rates? If so, the recovery would be short-lived. So here’s a tin-foil hat idea for you. Notice how Larry Summers is saying the unemployment is too high and will remain that way for a long-time. In other words, regrettable, but there is nothing that can be done. A full-employment policy would require more deficit spending and entail a huge battle in Congress. It would also create upward pressure on wages. Methinks the Obama Admin is willing to accept high unemployment so it can win the mid-terms in 2010 on the basis of recovery. Not a vibrant recovery mind you, but good enough for placate the masses. So I’ll predict a second stimulus is definitely not in the cards, for stated fiscal and hidden political reasons.

    If the recovery does go on for a while, those low yields on 10 and 30 year Treasuries will start to chafe the debt holders. Yields will rise; speculation will increase. Then we’ll be off to the races to meet our next “Minsky moment”. But risk appetite is just now starting to increase from a very low point. I think the low long-term yields reflect this and are a lagging indicator of the late crisis.

    Best regards.

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